Financial Analysis, Planning and
Forecasting
Theory and Application
Chapter 18
Short-term Financial Analysis and Planning
By
Alice C. Lee
San Francisco State University
John C. Lee
J.P. Morgan Chase
Cheng F. Lee
Rutgers University
Outline


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18.1 Introduction
18.2 The components of working capital
18.3The concept of cash flow
18.4 Cash flow vs. funds flow
18.5 Organizing for short-term financial planning principles
18.6 The cash flow cycle and its calculation
18.7 Cash flow forecasting, budgeting, and planning
18.8 The cash budget
18.9 Demand-driven, capital-driven, and cost-driven cash budgets
18.10 Users of cash forecasts and business plans
18.11 Planning horizons and time intervals of cash budgets
18.12 From forecasting to budgeting to planning
18.13 Summary
Appendix 18A. Time-series components of sales
18.1 Introduction
18.2 The components of
working capital
18.3 The concept of cash flow
Exhibit 18-1 Flow of Funds
Investment
flow
Marketable
Securities
Uses (Outflows)
Excess cash
Financial
Flow
Sources (Inflows)
Productive Capital
Inventory
Building
Equipment
Labor
Raw material
Other
Sources (Inflows)
Accounts
receivable
Cash sales
Collection of A/ R
Cash
Bank loans
Trade credit
Term loans
Commercial paper
Bonds
Equity
Uses (Outflows)
Taxes
Interest
Dividends
Principal
payments
18.4Cash flow
vs.
funds flow
18.5 Organizing for short-term financial
planning principles
Exhibit 18-2 Cash Planning and Management Resources
Size of Organization
Officers in Charge
Staff Size
Small
President / Treasurer
Vice President / Controller
0-2
Medium
Treasurer
Assistant Treasurer
1-10
Large
Assistant Treasurer
Over 10
18.5 Organizing for short-term financial
planning principles
Figure 18-1
Matching Maturities of Financing Sources and Assets
$
Short-term Financing
Variable Short-term Assets
Long-term Financing
Permanent Long-term Assets
Time
18.5 Organizing for short-term financial
planning principles
Exhibit 18-3 Problems Associated with Balancing Liquidity and Profitability
Working Capital
Component
Forms
Cash
Dollars
Demand
Deposits
Risk of running
out of cash:
illiquidity, insolvency
Money market
Investments
(T-bills, CDs,
commercial
paper, etc.)
Insufficient
safety margin
to meet
excepted and
unexpected
cash
requirements
Marketable
Securities
Accounts
Receivable
Open-book
accounts of customers
Problem If Component
Is Too Small
Credit policy
may be too
strict and
noncompetitive
Demand for
product or services is
falling
Problem If Component
Is Too Large
Loss of return
from money
market
investments
Misuse of scarce
investor
capital needed
for real
investment
Credit policy
may be
over-generous
Collection problems
Costly use of resources
18.5 Organizing for short-term financial
planning principles
Exhibit 18-3 Problems Associated with Balancing Liquidity and Profitability
(Cont.)
Working Capital
Component
Inventory
Short-Term
Financing
Forms
Raw Materials
Work in process
Finished goods
Bank loans
Lines of credit
Commercial paper
Problem If Component
Is Too Small
Problem If Component
Is Too Large
Inability to
meet demand
Loss of sales
Production interruptions
Costs of carry:
storage
insurance and
handling will be higher
than necessary
Risk of
obsolescence
Not able to carry sufficient
short-term
assets to meet
demand or
operating requirements
Very costly;
may be
financing
many idle
assets that
may not be
productive
18.6 The cash flow cycle and its calculation
Cash flow cycle  average age of inventory  average age of accounts receivable
 average age of accounts payable
 number of days in the planning period 
average inventory
average accounts receivable
(

cash operating expenditures
sales
average accounts payable

)
cost of goods sold
(18-1)
where average inventory ＝ (beginning inventory＋
ending inventory)/ 2; average accounts receivable（AR）
＝（beginning AR＋ending AR）/2; and average
accounts payable（AP）＝（beginning AP＋ending AP）
/2.
18.6 The cash flow cycle and its calculation
managerial actions
＝ inventory financing, collateral for loans,
liquidation
＋ factoring, pledging, altering
credit terms, tightening collection, policies,
speeding up billing procedures
－ change payment frequency, stretch out
payables （forego discounts）
(18-2)
18.6 The cash flow cycle and its calculation
Exhibit 18-4 Speedy Maintenance, Inc., Financial Statement
Balance Sheet
31
December
19XX
31
December
19X1
31
December
19XX
31
December
19X1
Cash
Marketable securities
$10,000
5,000
$15,000
5,000
Wages payable
Accounts payable
$15,000
45,000
$15,000
55,000
Accounts receivable
Inventory
65,000
85,000
Mortgage payable
Bank note payable
25,000
130,000
25,000
130,000
Cleaning supplies
18,000
21,000
Common stock
50,000
50,000
Cleaning equipment
50,000
54,000
Retained earnings
8,000
25,000
Trucks(net)
80,000
75,000
Building ( office and
garage)
45,000
45,000
$273,000
$300,000
Total Liabilities
Total Assets
$273,000
$300,000
+ Equity
18.6 The cash flow cycle and its calculation
Exhibit 18-4 Speedy Maintenance, Inc., Financial Statement (Cont.)
Income Statement
(for year ending 31 December)
19XX
19X1
$379,000
$430,500
250,222
290,000
70,000
70,000
50,000
50,000
Taxable income
9,600
20,500
Income tax
1,600
3,500
Net income
$8,000
$17,000
Sales
Cost of services supplied
Labor
Supplies
Operating expenses
 18,000+21,000 
 65, 000  85, 000 
 45, 000  55, 000 






2
2
2
cash flow cycle = 365 

365

365





70,000
430,500
360,
000












= 102 days + 64 days  51 days
= 115 days
18.6 The cash flow cycle and its calculation
Exhibit 18-5 Financing Costs of Speedy’s Cash Flow Cycle
Assets
Average
Amount
Invested
[(being+end)/2]
Estimated Cost of Financing
(average investment × days ×
interest rate ÷ 365)
10﹪
15﹪ 20﹪
Average
Investment
period in
Days
Cleaning supplies
＄19,500
102
＄ 545
＄ 817
＄1,090
Accounts receivable
＄75,000
64
1,315
1,973
2,630
Accounts payable
＄50,000
51
(699)
(1,048)
(1,397)
115
＄1,161
＄1,742
＄2,323
Total cost to finance
18.6 The cash flow cycle and its calculation
Exhibit 18-6 speedy Maintenance Contract XYZ
Total contract ＝＄120,000 for one year
Payment terms ＝＄10,000 on the last day of each month
Cost of supplies per month ＝＄2,000
Cost of labor per month ＝＄7,500 (workers paid weekly)
Cash flow cycle= average age of inventory + average age of AR - average age
of AP
 2,000+0 
 0  10, 000 
 2, 000  7, 500 / 4 






2
2
2
= 30 

30

30





2,000
10,
000
9,500












= 15 days + 15 days - 6 days
= 24 days
18.6 The cash flow cycle and its calculation
Exhibit 18-6 speedy Maintenance Contract XYZ (Cont.)
Assets
Average
Amount
Invested
Average
Investment
period in
Days
Cleaning supplies
＄1,000
15
＄6.16
Accounts receivable
5,000
15
30.82
Accounts payable
1,938
6
(4.78)
Total cost to finance
Estimated Cost of
Financing at 15﹪
＄32.20
×12
Total cost per year
＄386.40
Yearly Cost －
Suggested Modifications
Effects
Make payments weekly
Reduce A/R
Make payments biomonthly
Increase A/R
Pay workers biomonthly
Increase A/P
Pay workers monthly
Increase A/P
18.7
Cash flow forecasting, budgeting,
and planning
18.8
The cash budget
18.9 Demand-driven, capital-driven,
and cost-driven cash budgets
Table 18-1
Sales and Cash Flow
Nov.
＄100,000
Dec.
＄100,000
Jan.
＄100,000
Feb.
＄50,000
Mar.
＄75,000
Apr.
＄100,000
May.
＄100,000
Cash sales( 20﹪of
current months
sales)
$20,000
$10,000
$15,000
$20,000
$20,000
Collection of A/R
(70﹪of previous
months)
70,000
70,000
35,000
52,500
70,000
10,000
10,000
10,000
5,000
7,500
$100,000
$90,000
$60,000
$77,500
$97,500
Sales
Collection of A/R
(10﹪of months
t-2)
Cash from
collection of Sales
and A/R
18.10
Users of cash forecasts and
business plans
18.11 Planning horizons and time intervals
of cash budgets
Exhibit 18-7 Cash Flow Budgets and Planning Intervals
A. Monthly Planning Interval
Beginning cash balance
＄30,000
Cash inflows
A/R collections
55,000
Licensing fee collections
25,000
Sale of surplus assets
15,000
Total cash inflow
＄95,000
＄125,000
Total cash available
Cash outflows
Salaries and wages
Raw material purchases
Supplies
＄24,000
19,500
5,000
Rent
14,000
Income tax payment
25,000
Payroll taxes
Total cash outflows
Cash at end of month
7,500
＄95,000
＄30,000
18.11 Planning horizons and time intervals
of cash budgets
Exhibit 18-7 Cash Flow Budgets and Planning Intervals (Cont.)
B. Weekly Planning Interval
Beginning cash balance
Week 1
Week 2
Week 3
Week 4
$30,000
(＄2,250)
(＄9,500)
(＄2,250)
$12,000
＄15,000
＄11,000
$17,000
Cash inflows
A/R collections
Licensing fee collections
25,000
Sale of surplus assets
10,000
5000
Total cash inflow
$12,000
＄15,000
＄21,000
$47,000
Total cash available
$42,000
＄12,750
＄11,500
$44,750
$6,000
$6,000
$6,000
$6,000
Raw material purchases
5,500
5,000
4,000
5,000
Supplies
1,250
1,250
1,250
1,250
Rent
6,500
2,500
2,500
2,500
Cash outflows
Salaries and wages
Income tax payment
25,000
Payroll taxes
Total cash outflows
Cash at end of month
7,500
$44,250
＄22,250
＄13,750
$14,750
(＄2,250)
(＄9,500)
(＄2,250)
$30,000
18.12 From forecasting to budgeting to planning
Exhibit 18-8 Assumptions for Cash Inflows and Outflows
Worst Case
Most Likely
Best Case
Revenues
5﹪ decline
Same as last year
10﹪increase
Credit sales
95﹪ of sales volume
90﹪ of sales volume
85﹪ of sales volume
Collection experience
80﹪ in 30 days
85﹪ in 30 days
100﹪ in 30 days
10﹪ in 60 days
10﹪ in 60 days
10﹪ in bad debts
5﹪in bad debts
Expenses
5﹪ increase
Same as last year
3﹪ decline
Capital expenditures
$0
＄100,000 in
February
＄150,000 in
February
18.12 From forecasting to budgeting to planning
Exhibit 18-9 Six-Month Cash Flow Forecast
January
Beginning cash balance
Cash sales
and collection
of A/R
Insurance claims
Dividends and interests
Most Likely Case
February
March
April
May
June
＄20,000
＄16,000
(＄63,000)
(＄3,000)
(＄5,000)
＄25,000
50,000
65,000
75,000
65,000
75,000
65,000
25,000
5,000
2,000
5,000
Total cash inflows
＄55,000
＄67,000
＄100,000
＄70,000
＄75,000
＄67,000
Total cash available
Cash Outflow
Labor wages
Salary
Raw material
payment
Dividends
Income taxes
New equipment
＄75,000
＄83,000
＄37,000
＄67,000
＄70,000
＄92,000
＄23,000
5,000
＄25,000
5,000
＄25,000
5,000
＄25,000
5,000
＄25,000
5,000
＄25,000
5,000
4,000
16,000
10,000
15,000
15,000
10,000
2,000
25,000
2,000
2,000
25,000
100,000
Total cash outflow
＄59,000
＄146,000
＄40,000
＄72,000
＄45,000
＄40,000
Cash at end of month
＄16,000
(＄63,000)
(＄3,000)
(＄5,000)
＄25,000
＄52,000
18.12 From forecasting to budgeting to planning
Exhibit 18-9 Six-Month Cash Flow Forecast (Cont.)
January
Beginning cash balance
Cash sales and collection
of A/R
February
Worst Case
March
May
June
＄15,000
＄12,500
＄26,500
＄82,500
＄83,500
＄109,500
47,500
62,000
70,000
62,000
70,000
62,000
Insurance claims
Dividends and interests
April
25,000
5,000
2,000
5,000
2,000
Total cash inflows
＄52,500
＄64,000
＄95,000
＄67,000
＄70,000
＄64,000
Total cash available
＄67,500
＄66,500
＄121,500
＄149,500
＄153,500
＄173,500
＄25,000
＄25,000
＄26,000
＄26,000
＄26,000
＄26,000
Salary
5,000
5,000
5,000
5,000
5,000
5,000
Raw material payment
3,000
10,000
8,000
13,000
13,000
10,000
Cash Outflow
Labor wages
Dividends
Income taxes
New equipment
2,000
20,000
2,000
20,000
－
Total cash outflow
＄55,000
＄40,000
＄39,000
＄66,000
＄44,000
＄41,000
Cash at end of month
＄12,500
＄26,500
＄82,500
＄83,500
＄109,500
＄132,500
18.12 From forecasting to budgeting to planning
Exhibit 18-9 Six-Month Cash Flow Forecast (Cont.)
Best Case
Beginning cash balance
Cash sales
and collection
of A/R
Insurance claims
Dividends and interests
January
February
March
April
May
June
＄25,000
＄17,000
(＄112,000)
(＄49,000)
(＄55,000)
＄29,000
55,000
70,000
85,000
73,000
78,000
73,000
25,000
6,000
3,000
6,000
3,000
Total cash inflows
＄61,000
＄73,000
＄110,000
＄79,000
＄78,000
＄76,000
Total cash available
＄86,000
＄90,000
(＄ 2,000)
＄30,000
＄23,000
＄47,000
＄25,000
＄27,000
＄27,000
＄27,000
＄27,000
＄27,000
Salary
5,000
5,000
5,000
5,000
5,000
5,000
Raw material payment
6,000
20,000
15,000
20,000
20,000
15,000
Cash Outflow
Labor wages
Dividends
Income taxes
3,000
30,000
New equipment
3,000
30,000
150,000
Total cash outflow
＄69,000
＄202,000
＄47,000
＄85,000
＄52,000
＄47,000
Cash at end of month
＄17,000
(＄112,000)
(＄49,000)
(＄55,000)
＄29,000
＄
0
18.12 From forecasting to budgeting to planning
Exhibit 18-10 Six-Month Most-Likely Cash Flow Plan*
Beginning cash balance
Cash inflows
Collection of A/R
Insurance claims
Dividends and interests
January
＄20,000
February
＄10,000
March
＄10,000
April
＄10,000
May
＄10,000
June
＄10,000
50,000
65,000
75,000
25,000
65,000
75,000
65,000
5,000
2,000
Maturing marketable securities*
5,000
10,100
43,531
2,000
498
30,803
Total cash inflows
＄55,000
＄77,000
＄143,531
＄70,000
＄75,498
＄97,803
Total cash available
＄75,000
＄87,100
＄153,531
＄80,000
＄85,498
＄107,803
＄23,000
5,000
＄25,000
5,000
4,000
＄25,000
5,000
16,000
＄25,000
5,000
10,000
2,000
25,000
2,506
＄25,000
5,000
15,000
＄25,000
5,000
15,000
Cash Outflow
Labor wages
Salary
Raw material payment
Dividends
Income tax
Payoff line of credit**
2,000
25,000
New equipment
Total cash outflow
Cash available
Minimum cash balance
Marketable securities at 12﹪/year
Short-term borrowing at 18﹪/year
100,000
＄55,000
＄34,000
＄146,000
＄69,506
＄45,000
＄45,000
20,000
10,000
$10,000
53,100
10,000
$43,100
7,531
10,000
10,494
10,000
$494
40,498
10,000
$30,498
62,803
10,000
$52,803
$2,469
* It is assumed that the marketable securities are invested for one month at one percent interest (12﹪/12 months = 1﹪/ month)
10,000 × 1.01 = ＄10,100 for February
** It is assumed that the borrowing is done for one month at 1.5 percent interest (18﹪/12 months = 1.5﹪/ month)
2,469 × 1.015 = ＄2,506 for April
18.13 Summary
In Chapter 18, we have identified and defined cash flow and
related it to the accounting-based concept of funds flow. The
short-term financial manager is much more concerned with the
actual cash flowing through the firm on a day-to-day basis than
the long-term funds flow perspective.
A three-scenario approach to short-term financial planning (using
worst, most-likely, and best-case scenarios) is recommended
because future events cannot always be forecasted with accuracy.
For this reason, the initial step of the planning process involves
making educated guesses about future cash flows that cover a
reasonable range of possible situations. In both budgeting and
planning, the cash flow manager should ask the following
questions: Dose this plan makes sense in light of my own
experience? Does it coincide with what I expect to happen during
the coming year?
18.13 Summary
Throughout the planning process, there should be a feedback mechanism
that enables the short-term financial planner to update the forecast in light of
new information and/or a new understanding of the situation that may come
about from actually preparing the budget and the plan. Cash flow managers
must understand that the process itself is the most important aspect of shortterm financial management. The final plan is not definitive. It serves only to
guide future courses of action and decisions and is subject to continual
revision.
The final part of the chapter demonstrated the interrelationship of forecasting,
budgeting, and planning. Once the problems have been defined, a financial
planner must generate alternatives that will lead to satisfactory solutions. The
material in the next two chapters expands on the possible alternatives
available to the financial planner. In most cases, there is more than one way
to solve a problem. Sometimes, it is worth the extra effort to look for the
optimal solution; sometimes it is not. With experience, the financial manager
learns when to use a satisfactory solution that may not be the best one
theoretically. It makes little sense to spend a lot of time and make many
improvements on a plan that will only marginally improve performance.
Appendix 18A. Time-series components of sales
Figure 18A-1
Sales ($)
Years
1
2
3
4
5
(A) Trend-Cycle (c)
6
Appendix 18A. Time-series components of sales
Figure 18A-1 (Cont.)
Sales ($)
Quarters
1
2
3
4
(B) Seasonal (s)
5
6
Appendix 18A. Time-series components of sales
Figure 18A-1 (Cont.)
Sales ($)
Years
1
2
3
4
(C) Irregular (I)
5
6
Appendix 18A. Time-series components of sales
2  2  2  2
O I C S
t
t
t
（18A-1）
t
Table 18A-1
Original Quarterly Sales Data for IBM, 1969 to 1982 (＄millions)
Original Series Year
1st quarter
2nd quarter
3rd quarter
4th quarter
Total
1969
1,685
1,832
1,778
1,903
7,198
1970
1,721
1,874
1,914
1,996
7,505
1971
1,870
1,942
2,082
2,380
8,274
1972
2,312
2,365
2,334
2,522
9,533
1973
2,451
2,547
2,756
3,240
10,994
1974
3,002
3,260
3,125
3,288
12,675
1975
3,272
3,496
3,600
4,068
14,436
1976
3,815
4,014
3,957
4,519
16,305
1977
4,090
4,419
4,586
5,038
18,133
1978
4,432
4,921
5,284
6,439
21,076
1979
5,295
5,355
5,384
6,829
22,863
1980
5,748
6,181
6,481
7,805
26,215
1981
6,461
6,895
6,721
8,993
29,070
1982
7,066
8,053
8,171
11,074
34,364
Appendix 18A. Time-series components of sales
Table 18A-2
Mean of the Absolute Average Percent Changes in Sales Related to Trend-Cycle, Seasonal, and
Irregular Components for One-, Two, Three, and Four-Quarter Time Span, 1969 to 1982 (in
percent)
Span in Quarters
Original
Trend Cycle
Seasonal
Irregular
1
9.25
3.19
7.29
1.9
2
9.54
6.31
6.26
1.44
3
12.73
9.47
7.59
1.57
4
12.89
12.78
0.44
1.45
Appendix 18A. Time-series components of sales
 
O
2
 .0190  .0319   .0729   .08076 
2
2
I component 
C component 
S component 
2
I2
 O '
2
C2
 O '
2
S2
 O '
2
2
.00035

 5.38%
.006523
.00068

 15.19%
.006523
.005180 79.42%


.006523 100.00%
Appendix 18A. Time-series components of sales
Table 18A-3
Relative Contributions of Components to Changes in IBM Sales for One-, Two-,
Three-, and Four-quarter Time Spans, 1969 to 1982 (in percent)
Span in Quarters
Trend-Cycle
Seasonal
Irregular
Total
1
15.13
80.82
4.03
100
2
45.51
51.73
2.76
100
3
58.46
40.35
1.19
100
4
98.40
.14
1.46
100