Wedescribe how financial managers trace changes in cash and working capital, and we look at how theyforecast month-by-month cash requirements or surpluses and develop short-term financin
Trang 1S H O R T - T E R M
F I N A N C I A L
P L A N N I N G
Trang 2MOST OF THISbook is devoted to long-term financial decisions such as capital budgeting and the
choice of capital structure Such decisions are called long-term for two reasons First, they usually
in-volve long-lived assets or liabilities Second, they are not easily reversed and therefore may committhe firm to a particular course of action for several years
Short-term financial decisions generally involve short-lived assets and liabilities, and usually theyare easily reversed Compare, for example, a 60-day bank loan for $50 million with a $50 million is-sue of 20-year bonds The bank loan is clearly a short-term decision The firm can repay it two monthslater and be right back where it started A firm might conceivably issue a 20-year bond in January andretire it in March, but it would be extremely inconvenient and expensive to do so In practice, such abond issue is a long-term decision, not only because of the bond’s 20-year maturity but also becausethe decision to issue it cannot be reversed on short notice
A financial manager responsible for short-term financial decisions does not have to look far intothe future The decision to take the 60-day bank loan could properly be based on cash-flow forecastsfor the next few months only The bond issue decision will normally reflect forecasted cash require-ments 5, 10, or more years into the future
Managers concerned with short-term financial decisions can avoid many of the difficult conceptualissues encountered elsewhere in this book In a sense, short-term decisions are easier than long-termdecisions, but they are not less important A firm can identify extremely valuable capital investment op-portunities, find the precise optimal debt ratio, follow the perfect dividend policy, and yet founder be-cause no one bothers to raise the cash to pay this year’s bills Hence the need for short-term planning
We start the chapter with an overview of the major classes of short-term assets and liabilities Weshow how long-term financing decisions affect the firm’s short-term financial planning problem Wedescribe how financial managers trace changes in cash and working capital, and we look at how theyforecast month-by-month cash requirements or surpluses and develop short-term financing strate-gies We conclude by examining more closely the principal sources of short-term finance
851
30.1 THE COMPONENTS OF WORKING CAPITAL
Short-term, or current, assets and liabilities are collectively known as working
cap-ital.Table 30.1 gives a breakdown of current assets and liabilities for all
manufac-turing corporations in the United States in 2000 Note that current assets are larger
than current liabilities Net working capital (current assets less current liabilities)
was positive
Current Assets
One important current asset is accounts receivable When one company sells goods
to another company or a government agency, it does not usually expect to be paid
immediately These unpaid bills, or trade credit, make up the bulk of accounts
re-ceivable Companies also sell goods on credit to the final consumer This consumer
credit makes up the remainder of accounts receivable We will discuss the
manage-ment of receivables in Chapter 32 You will learn how companies decide which
cus-tomers are good or bad credit risks and when it makes sense to offer credit
Another important current asset is inventory Inventories may consist of raw
materials, work in process, or finished goods awaiting sale and shipment Firms
Trang 3invest in inventory The cost of holding inventory includes not only storage cost
and the risk of spoilage or obsolescence but also the opportunity cost of capital,that is, the rate of return offered by other, equivalent-risk investment opportu-nities.1The benefits of holding inventory are often indirect For example, a largeinventory of finished goods (large relative to expected sales) reduces the chance
of a “stockout” if demand is unexpectedly high A producer holding a small finished-goods inventory is more likely to be caught short, unable to fill orderspromptly Similarly, large inventories of raw materials reduce the chance that anunexpected shortage would force the firm to shut down production or use amore costly substitute material
Bulk orders for raw materials lead to large average inventories but may beworthwhile if the firm can obtain lower prices from suppliers (That is, bulk ordersmay yield quantity discounts.) Firms are often willing to hold large inventories offinished goods for similar reasons A large inventory of finished goods allowslonger, more economical production runs In effect, the production manager givesthe firm a quantity discount
The task of inventory management is to assess these benefits and costs and tostrike a sensible balance In manufacturing companies the production manager isbest placed to make this judgment Since the financial manager is not usually di-rectly involved in inventory management, we will not discuss the inventory prob-lem in detail
The remaining current assets are cash and marketable securities The cash sists of currency, demand deposits (funds in checking accounts), and time deposits(funds in savings accounts) The principal marketable security is commercial pa-per (short-term, unsecured notes sold by other firms) Other securities include U.S.Treasury bills and state and local government securities
con-In choosing between cash and marketable securities, the financial manager faces
a task like that of the production manager There are always advantages to holdinglarge “inventories” of cash—they reduce the risk of running out of cash and hav-ing to raise more on short notice On the other hand, there is a cost to holding idle
on long-term debt Other current assets 248.9 Other current liabilities 507.4
Net working capital (current assets ⫺ current liabilities) ⫽ $1,547.5 ⫺ 1,233.9
⫽ $313.6 billion
T A B L E 3 0 1
Current assets and liabilities
for U.S manufacturing
corporations, first quarter,
2001 (figures in $ billions).
Source: U.S Census Bureau,
Quarterly Financial Report for
Manufacturing, Mining and
Trade Corporations, First
Trang 4cash balances rather than putting the money to work in marketable securities In
Chapter 31 we will tell you how the financial manager collects and pays out cash
and decides on an optimal cash balance
Current Liabilities
We have seen that a company’s principal current asset consists of unpaid bills from
other companies One firm’s credit must be another’s debit Therefore, it is not
sur-prising that a company’s principal current liability often consists of accounts
payable, that is, outstanding payments to other companies A firm that delays
pay-ing its bills is in effect borrowpay-ing money from its suppliers So companies that are
strapped for cash sometimes solve the problem by stretching payables.
To finance its investment in current assets, a company may rely on a variety of
short-term loans Banks and finance companies are the largest source of such loans,
but companies may also issue short-term debt, called commercial paper We will
de-scribe the different kinds of short-term debt toward the end of the chapter
CHAPTER 30 Short-Term Financial Planning 853
30.2 LINKS BETWEEN LONG-TERM AND SHORT-TERM
FINANCING DECISIONSAll businesses require capital, that is, money invested in plant, machinery, invento-
ries, accounts receivable, and all the other assets it takes to run a business efficiently
Typically, these assets are not purchased all at once but obtained gradually over time
Let us call the total cost of these assets the firm’s cumulative capital requirement.
Most firms’ cumulative capital requirement grows irregularly, like the wavy line
in Figure 30.1 This line shows a clear upward trend as the firm’s business grows
But there is also seasonal variation around the trend: In the figure the capital
re-quirements peak late in each year Finally, there would be unpredictable
week-to-week and month-to-month fluctuations, but we have not attempted to show these
in Figure 30.1
The cumulative capital requirement can be met from either long-term or
short-term financing When long-short-term financing does not cover the cumulative capital
requirement, the firm must raise short-term capital to make up the difference
When long-term financing more than covers the cumulative capital requirement,
the firm has surplus cash available for short-term investment Thus the amount of
long-term financing raised, given the cumulative capital requirement, determines
whether the firm is a short-term borrower or lender
Lines A, B, and C in Figure 30.1 illustrate this Each depicts a different long-term
financing strategy Strategy A always implies a short-term cash surplus Strategy C
implies a permanent need for short-term borrowing Under B, which is probably
the most common strategy, the firm is a short-term lender during part of the year
and a borrower during the rest
What is the best level of long-term financing relative to the cumulative capital
requirement? It is hard to say There is no convincing theoretical analysis of this
question We can make practical observations, however First, most financial
man-agers attempt to “match maturities” of assets and liabilities That is, they finance
long-lived assets like plant and machinery with long-term borrowing and equity
Second, most firms make a permanent investment in net working capital (current
assets less current liabilities) This investment is financed from long-term sources
Trang 5The Comforts of Surplus Cash
Many financial managers would feel more comfortable under strategy A than egy C Strategy A⫹(the highest line) would be still more relaxing A firm with a sur-plus of long-term financing never has to worry about borrowing to pay next month’sbills But is the financial manager paid to be comfortable? Firms usually put surpluscash to work in Treasury bills or other marketable securities This is at best a zero-NPV investment for a taxpaying firm.2Thus we think that firms with a permanent
strat-cash surplus ought to go on a diet, retiring long-term securities to reduce long-termfinancing to a level at or below the firm’s cumulative capital requirement That is, if
the firm is on line A⫹, it ought to move down to line A, or perhaps even lower.
Dollars
Cumulative capital requirement
Year 1 Year 2 Year 3 Time
A+
B C A
F I G U R E 3 0 1
The firm’s cumulative capital
require-ment (colored line) is the cumulative
investment in all the assets needed
for the business In this case the
requirement grows year by year, but
there is seasonal fluctuation within
each year The requirement for
short-term financing is the
differ-ence between long-term financing
(lines A⫹, A, B, and C) and the
cumu-lative capital requirement If
long-term financing follows line C, the
firm always needs short-term
financing At line B, the need is
seasonal At lines A and A⫹, the firm
never needs short-term financing.
There is always extra cash to invest.
2If there is a tax advantage to borrowing, as most people believe, there must be a corresponding tax
dis-advantage to lending, and investment in Treasury bills has a negative NPV See Section 18.1.
30.3 TRACING CHANGES IN CASH AND WORKING
CAPITALTable 30.2 compares 2000 and 2001 year-end balance sheets for Dynamic MattressCompany Table 30.3 shows the firm’s income statement for 2001 Note that Dynamic’scash balance increased by $1 million during 2001 What caused this increase? Did theextra cash come from Dynamic Mattress Company’s additional long-term borrowing,from reinvested earnings, from cash released by reducing inventory, or from extracredit extended by Dynamic’s suppliers? (Note the increase in accounts payable.)The correct answer is “all the above.” Financial analysts often summarizesources and uses of cash in a statement like the one shown in Table 30.4 The state-
ment shows that Dynamic generated cash from the following sources:
1 It issued $7 million of long-term debt
2 It reduced inventory, releasing $1 million
Trang 63 It increased its accounts payable, in effect borrowing an additional $7
million from its suppliers
4 By far the largest source of cash was Dynamic’s operations, which
generated $16 million See Table 30.3, and note: Income ($12 million)
understates cash flow because depreciation is deducted in calculating
income Depreciation is not a cash outlay Thus, it must be added back in
order to obtain operating cash flow
Dynamic used cash for the following purposes:
1 It paid a $1 million dividend (Note: The $11 million increase in Dynamic’s
equity is due to retained earnings: $12 million of equity income, less the
T A B L E 3 0 2
Year-end balance sheets for 2000 and
2001 for Dynamic Mattress Company (figures in $ millions).
Trang 72 It repaid a $5 million short-term bank loan.3
3 It invested $14 million This shows up as the increase in gross fixed assets inTable 30.2
4 It purchased $5 million of marketable securities
5 It allowed accounts receivable to expand by $5 million In effect, it lent thisadditional amount to its customers
Tracing Changes in Net Working Capital
Financial analysts often find it useful to collapse all current assets and liabilitiesinto a single figure for net working capital Dynamic’s net-working-capital bal-ances were (in millions):
Sources:
Cash from operations:
Uses:
T A B L E 3 0 4
Sources and uses of cash for Dynamic Mattress
Company, 2001 (figures in $ millions).
3 This is principal repayment, not interest Sometimes interest payments are explicitly recognized as a
use of funds If so, operating cash flow would be defined before interest, that is, as net income plus
in-terest plus depreciation.
4We drew up a sources and uses of funds statement for Executive Paper in Section 29.1.
Trang 8In 2000, Dynamic contributed to net working capital by
1 Issuing $7 million of long-term debt
2 Generating $16 million from operations
It used up net working capital by
1 Investing $14 million
2 Paying a $1 million dividend
The year’s changes in net working capital are thus summarized by Dynamic
Mat-tress Company’s sources and uses of funds statement, given in Table 30.6
Profits and Cash Flow
Now look back to Table 30.4, which shows sources and uses of cash We want to
reg-ister two warnings about the entry called cash from operations It may not actually
represent real dollars—dollars you can buy beer with
First, depreciation may not be the only noncash expense deducted in
calculat-ing income For example, most firms use different accountcalculat-ing procedures in their
tax books than in their reports to shareholders The point of special tax accounts
is to minimize current taxable income The effect is that the shareholder books
CHAPTER 30 Short-Term Financial Planning 857
Net worth (equity and retained earnings) 65 76
T A B L E 3 0 5
Condensed year-end balance sheets for 2000 and 2001 for Dynamic Mattress Company (figures in $ millions).
*When only net working capital appears on a firm’s
balance sheet, this figure (the sum of long-term
liabilities and net worth) is often referred to as total
capitalization.
Sources:
Cash from operations:
23 Uses:
Trang 9overstate the firm’s current cash tax liability,5and after-tax cash flow from ations is therefore understated.
oper-Second, income statements record sales when made, not when the customer’spayment is received Think of what happens when Dynamic sells goods on credit.The company records a profit at the time of sale, but there is no cash inflow untilthe bills are paid Since there is no cash inflow, there is no change in the company’scash balance, although there is an increase in working capital in the form of an in-crease in accounts receivable No net addition to cash would be shown in a sourcesand uses statement like Table 30.4 The increase in cash from operations would beoffset by an increase in accounts receivable
Later, when the bills are paid, there is an increase in the cash balance However,there is no further profit at this point and no increase in working capital The in-crease in the cash balance is exactly matched by a decrease in accounts receivable.That brings up an interesting characteristic of working capital Imagine a com-pany that conducts a very simple business It buys raw materials for cash,processes them into finished goods, and then sells these goods on credit The wholecycle of operations looks like this:
5 The difference between taxes reported and paid to the Internal Revenue Service shows up on the ance sheet as an increased deferred tax liability The reason that a liability is recognized is that acceler- ated depreciation and other devices used to reduce current taxable income do not eliminate taxes; they only delay them Of course, this reduces the present value of the firm’s tax liability, but still the ultimate liability has to be recognized In the sources and uses statements an increase in deferred taxes would be treated as a source of funds In the Dynamic Mattress example we ignore deferred taxes.
bal-Cash Receivables
Finished goods
Raw materials
If you draw up a balance sheet at the beginning of the process, you see cash If youdelay a little, you find the cash replaced by inventories of raw materials and, stilllater, by inventories of finished goods When the goods are sold, the inventoriesgive way to accounts receivable, and finally, when the customers pay their bills, thefirm draws out its profit and replenishes the cash balance
There is only one constant in this process, namely, working capital The nents of working capital are constantly changing That is one reason why (net)working capital is a useful summary measure of current assets and liabilities.The strength of the working-capital measure is that it is unaffected by seasonal
compo-or other tempcompo-orary movements between different current assets compo-or liabilities Butthe strength is also its weakness, for the working-capital figure hides a lot of inter-esting information In our example cash was transformed into inventory, then intoreceivables, and back into cash again But these assets have different degrees of riskand liquidity You can’t pay bills with inventory or with receivables, you must paywith cash
Trang 10The past is interesting only for what one can learn from it The financial manager’s
problem is to forecast future sources and uses of cash These forecasts serve two
purposes First, they provide a standard, or budget, against which subsequent
per-formance can be judged Second, they alert the manager to future cash-flow needs
Cash, as we all know, has a habit of disappearing fast Look, for example, at
Fi-nance in the News, which describes how Ford’s large cash surplus rapidly turned
into a shortage Ford’s financial manager needed to plan for this deficiency.
Preparing the Cash Budget: Inflow
There are at least as many ways to produce a quarterly cash budget as there are to
skin a cat Many large firms have developed elaborate corporate models; others use
a spreadsheet program to plan their cash needs The procedures of smaller firms may
be less formal But there are common issues that all firms must face when they
fore-cast We will illustrate these issues by continuing the example of Dynamic Mattress
Most of Dynamic’s cash inflow comes from the sale of mattresses We therefore
start with a sales forecast by quarter6for 2002:
859
F I N A N C E I N T H E N E W S
FORD’S DISAPPEARING CASH MOUNTAIN
At the end of 1998 Ford had $23.8 billion in cash
and marketable securities and only $9.8 billion in
debt But in the next three years Ford went on a
shopping spree that resulted in the expenditure of
more than $13 billion on acquisitions, such as Volvo
Cars and Land Rover In the same period Ford
spent a total of $20 billion on new products and
other capital projects Within three years Ford’s
huge cash mountain had halved
By most standards Ford remained relatively
con-servatively capitalized, but the outlook for the
au-tomobile industry was worsening rapidly In the
first nine months of 2001 Ford recorded a loss ofnearly $5 billion, so that its operations became acash drain rather than a source of cash At the sametime the company needed to set aside $3 billion tocover potential costs associated with alleged vehi-cle safety problems As Ford faced a potential cashshortage, the company sought to conserve cash byhalving its dividend payment and pruning its capi-tal expenditure program
Source: Ford Motor’s cash drain is described in “Ford Motor’s Cash
Goes Subcompact,” The Wall Street Journal, November 6, 2001.
30.4 CASH BUDGETING
6 Most firms would forecast by month instead of by quarter Sometimes weekly or even daily forecasts
are made But presenting a monthly forecast would triple the number of entries in Table 30.7 and
sub-sequent tables We wanted to keep the examples as simple as possible.
First Second Third Fourth
Trang 11But sales become accounts receivable before they become cash Cash flow comes
from collections on accounts receivable.
Most firms keep track of the average time it takes customers to pay their bills.From this they can forecast what proportion of a quarter’s sales is likely to be con-verted into cash in that quarter and what proportion is likely to be carried over to thenext quarter as accounts receivable Suppose that 80 percent of sales are “cashed in”
in the immediate quarter and 20 percent are cashed in in the next Table 30.7 showsforecasted collections under this assumption
In the first quarter, for example, collections from current sales are 80 percent of
$87.5, or $70 million But the firm also collects 20 percent of the previous quarter’ssales, or 2(75) ⫽ $15 million Therefore total collections are $70 ⫹ $15 ⫽ $85 million.Dynamic started the first quarter with $30 million of accounts receivable The
quarter’s sales of $87.5 million were added to accounts receivable, but collections of
$85 million were subtracted Therefore, as Table 30.7 shows, Dynamic ended the
quarter with accounts receivable of $30 ⫹ 87.5 ⫺ 85 ⫽ $32.5 million The generalformula is
Ending accounts receivable ⫽ beginning accounts receivable
⫹ sales ⫺ collectionsThe top section of Table 30.8 shows forecasted sources of cash for Dynamic Mat-tress Collection of receivables is the main source, but it is not the only one Perhapsthe firm plans to dispose of some land or expects a tax refund or payment of an in-surance claim All such items are included as “other” sources It is also possible thatyou may raise additional capital by borrowing or selling stock, but we don’t want
to prejudge that question Therefore, for the moment we just assume that Dynamicwill not raise further long-term finance
Preparing the Cash Budget: Outflow
So much for the incoming cash Now for the outgoing cash There always seem to
be many more uses for cash than there are sources For simplicity, we have densed the uses into four categories in Table 30.8
con-1 Payments on accounts payable You have to pay your bills for raw materials,
parts, electricity, etc The cash-flow forecast assumes all these bills are paid
on time, although Dynamic could probably delay payment to some extent
Delayed payment is sometimes called stretching your payables Stretching is
one source of short-term financing, but for most firms it is an expensive
First Second Third Fourth
3 Collections:
accounts receivable, you
have to forecast sales
and collection rates
(figures in $ millions).
*Sales in the fourth quarter
of the previous year were
$75 million.
Trang 12source, because by stretching they lose discounts given to firms that pay
promptly This is discussed in more detail in Section 32.1
2 Labor, administrative, and other expenses This category includes all other
regular business expenses
3 Capital expenditures Note that Dynamic Mattress plans a major capital
outlay in the first quarter
4 Taxes, interest, and dividend payments This includes interest on presently
outstanding long-term debt but does not include interest on any additional
borrowing to meet cash requirements in 2002 At this stage in the analysis,
Dynamic does not know how much it will have to borrow, or whether it
will have to borrow at all
The forecasted net inflow of cash (sources minus uses) is shown in the box in
Table 30.8 Note the large negative figure for the first quarter: a $46.5 million
fore-casted outflow There is a smaller forefore-casted outflow in the second quarter, and then
substantial cash inflows in the second half of the year
The bottom part of Table 30.8 (below the box) calculates how much financing
Dy-namic will have to raise if its cash-flow forecasts are right It starts the year with $5
million in cash There is a $46.5 million cash outflow in the first quarter, and so
Dy-namic will have to obtain at least $46.5 ⫺ 5 ⫽ $41.5 million of additional financing
CHAPTER 30 Short-Term Financial Planning 861
Calculation of short-term financing requirement:
3 Cash at end of period*
5 Cumulative short-term financing required †
T A B L E 3 0 8
Dynamic Mattress’s cash budget for 2002 (figures in $ millions).
*Of course, firms cannot literally hold a negative amount of cash This is the amount the firm will have to raise to pay its bills.
†A negative sign would indicate a cash surplus But in this example the firm must raise cash for all quarters.
Trang 13This would leave the firm with a forecasted cash balance of exactly zero at the start
of the second quarter
Most financial managers regard a planned cash balance of zero as driving too close
to the edge of the cliff They establish a minimum operating cash balance to absorb
un-expected cash inflows and outflows We will assume that Dynamic’s minimum ating cash balance is $5 million That means it will have to raise the full $46.5 millioncash outflow in the first quarter and $15 million more in the second quarter Thus itscumulative financing requirement is $61.5 million in the second quarter This is thepeak, fortunately: The cumulative requirement declines in the third quarter by $26million to $35.5 million In the final quarter Dynamic is almost out of the woods: Itscash balance is $4.5 million, just $.5 million shy of its minimum operating balance
oper-The next step is to develop a short-term financing plan that covers the forecasted
requirements in the most economical way possible We will move on to that topicafter two general observations:
1 The large cash outflows in the first two quarters do not necessarily spelltrouble for Dynamic Mattress In part, they reflect the capital investmentmade in the first quarter: Dynamic is spending $32.5 million, but it should
be acquiring an asset worth that much or more In part, the cash outflowsreflect low sales in the first half of the year; sales recover in the second half.7
If this is a predictable seasonal pattern, the firm should have no troubleborrowing to tide it over the slow months
2 Table 30.8 is only a best guess about future cash flows It is a good idea to
think about the uncertainty in your estimates For example, you could
undertake a sensitivity analysis, in which you inspect how Dynamic’s cashrequirements would be affected by a shortfall in sales or by a delay incollections The trouble with such sensitivity analyses is that you arechanging only one item at a time, whereas in practice a downturn in the
economy might affect, say, sales levels and collection rates An alternative
but more complicated solution is to build a model of the cash budget andthen to simulate to determine the probability of cash requirementssignificantly above or below the forecasts shown in Table 30.8.8If cashrequirements are difficult to predict, you may wish to hold additional cash
or marketable securities to cover a possible unexpected cash outflow
7 Maybe people buy more mattresses late in the year when the nights are longer.
8 In other words, you could use Monte Carlo simulation See Section 10.2.
30.5 THE SHORT-TERM FINANCING PLAN
Dynamic’s cash budget defines its problem: Its financial manager must find term financing to cover the firm’s forecasted cash requirements There are dozens
short-of sources short-of short-term financing, but for simplicity we assume that Dynamic hasjust two options
Options for Short-Term Financing
1 Bank loan: Dynamic has an existing arrangement with its bank allowing it to
borrow up to $38 million at an interest cost of 10 percent a year or 2.5
Trang 14percent per quarter The firm can borrow and repay whenever it wants to as
long as it does not exceed its credit limit
2 Stretching payables: Dynamic can also raise capital by putting off paying its
bills The financial manager believes that Dynamic can defer the following
amounts in each quarter:
CHAPTER 30 Short-Term Financial Planning 863
First Second Third Fourth
($ millions)
Thus, $52 million can be saved in the first quarter by not paying bills in that
quarter (Note that the cash-flow forecasts in Table 30.8 assumed that these
bills will be paid in the first quarter.) If deferred, these payments must be
made in the second quarter Similarly, up to $48 million of the second
quarter bills can be deferred to the third quarter, and so on
Stretching payables is often costly, even if no ill will is incurred The reason is
that suppliers may offer discounts for prompt payment Dynamic loses this
dis-count if it pays late In this example we assume the lost disdis-count is 5 percent of the
amount deferred In other words, if a $100 payment is delayed, the firm must pay
$105 in the next quarter
Dynamic’s Financing Plan
With these two options, the short-term financing strategy is obvious Use the bank
loan first, if necessary up to the $38 million limit If there is still a shortage of cash,
stretch payables
Table 30.9 shows the resulting plan In the first quarter the plan calls for
bor-rowing the full amount available from the bank ($38 million) and stretching $3.5
million of payables (see lines 1 and 2 in the table) In addition the company sells
the $5 million of marketable securities it held at the end of 1999 (line 8) Thus it
raises 38 ⫹ 3.5 ⫹ 5 ⫽ $46.5 million of cash in the first quarter (line 10)
In the second quarter, the plan calls for Dynamic to continue to borrow $38
mil-lion from the bank and to stretch $19.7 milmil-lion of payables This raises a further $16.2
million after paying off the $3.5 million of bills deferred from the first quarter
Why raise $16.2 million when Dynamic needs only an additional $15 million to
finance its operations? The answer is that the company must pay interest on the
borrowings that it undertook in the first quarter and it foregoes interest on the
mar-ketable securities that were sold.9
In the third and fourth quarters the plan calls for Dynamic to pay off its debt and
to make a small purchase of marketable securities
Evaluating the Plan
Does the plan shown in Table 30.9 solve Dynamic’s short-term financing problem?
No: The plan is feasible, but Dynamic can probably do better The most glaring
weakness is its reliance on stretching payables, an extremely expensive financing
9 The bank loan calls for quarterly interest of 025 ⫻ 38 ⫽ $.95 million; the lost discount on the stretched
payables amounts to 05 ⫻ 3.5 ⫽ $.175 million; and the interest lost on the marketable securities is
.02 ⫻ 5 ⫽ $.1 million.