Short-term financial planning is critical for the survival of a company. They must know what to do with excess money and how to deal with cash shortfalls. Handling either scenario correctly can fortify the business for years to come.

Forecasting Short-Term Financing Needs
The first step in short-term planning is to forecast the future cash flows (FCF) of the company. Doing so tells the company two things: 1. it determines whether it will have a surplus or deficit in cash for each period, and 2. They need to decide whether the surplus or deficit is temporary or permanent. A permanent surplus or deficit may affect the firm’s long-term financial decisions. Overall, short-term planning focuses on the cash surplus/deficits that are temporary. Short-term analysis is usually done on quarterly intervals.

Seasonality is when sales and revenues are concentrated during a few months. A firm with seasonality will usually experience cash surplus during the high sales volume months and cash deficits sometime after the volume falls. However, there are some businesses that generate so much cash in those few months that it is able to carry them during the “off-season.” There are two main issues that seasonality brings up: 1. although cost of goods sold fluctuate proportionally with sales, other costs do not, and 2. Net working capital changes are more pronounced. Tracking seasonalities in the firm can bring to light patterns of occurrence giving the firm ample time to secure financial help during a deficit period.

Negative cash flow shocks
A negative cash flow shock occurs when a company encounters circumstances in which cash flows are temporarily negative for an unexpected reason. These can be similar to seasonalities in that they can create short-term financing needs. A common industry example of a negative cash flow shock is if a piece of machinery breaks and must be replaced.

Positive cash flow shocks
Although a positive cash flow is always a good thing, it still creates the need for short-term financial planning. A new expansion can create increased revenues but may create deficits beforehand due to increases in marketing expenses and capital expenditures.

The Matching Principle
Because there is no such thing as a perfect capital market, important market frictions exist, like transaction costs. Firms can increase their value by adopting a policy that minimized transaction costs, which is where the matching principle comes into play. The matching principle states that short-term cast needs should be financed with short-term debt and long-term cash needs should be financed with long-term sources of funds.

Permanent working capital
Permanent working capital is the amount that a firm must keep invested in its shot-term assets to support its continuing operations. This constitutes a long-term investment. Following the matching principle, the firm should finance this long term debt with long-term financing. This long-term financing would have lower transaction costs than short-term sources of funds.

Temporary working capital
Temporary working capital is the difference between the firm’s actual level of investment in short-term working capital needs and its permanent working capital requirements. These needs represent short-term needs and should, as the matching principle states, should be funded by short-term debt.

Financing policy choices
The matching principle tries to lower transaction cost by “matching” debt to financing. However, a firm does not have to do this it could finance long-term debt with short-term financing. Doing so exposes the firm to an interest rate risk because it will have to re-issue the loan and take whatever new interest rate is available at that time.

Aggressive financing policy
An aggressive financing policy is when the firm finances part or all of the permanent working capital with short-term debt. Is the yield curve is sloping upward, the interest rate on short-term debt is lower than the rate on long-term debt, this may make it seem that it is cheaper than long-term debt. However, the short-term debt savings is offset by the risk that the firm will have to refinance the debt in the future at a higher rate. This results in the equity cost of capital to rise to offset any benefit from the lower borrowing rate. So why would a firm use an aggressive policy if such a risk exists? This kind of policy might be useful if the market imperfections, such as agency costs and asymmetric information, are important. Short-term debt is less sensitive to the firm’s credit quality than long-term debt, so its value will be less affected by management’s actions or information. The funding risk the the risk the firm incurring financial distress costs should it not be able to refinance its debt in a timely manner or at a reasonable rate.

Conservative financing policy
A conservative financing policy is when a firm finances its short-term needs with long-term debt. This does not mean that no short-term financing is used; it is just used very sparingly to meet peak seasonal needs.

Short-Term Financing with Bank Loans
Bank loans are one of the primary sources of short-term financing, especially for small businesses. These bank loans are usually initiated with a promissory note, which is a written statement that indicates the amount of the loan, the date of payment, and the interest rate.

Single, end-of-period payment loan
This is the most straightforward type of bank loan. This type of loan requires that the firm pay interest on the loan and pay back the principal in one lump sum at the end of the loan period. The interest stated can be either a fixed or variable rate. A variable rate is usually compared against the prime rate. The prime rate is the rate banks charge their most creditworthy customers. The London Inter-Bank Offered Rate (LIBOR) is another benchmark rate. The LIBOR is the rate of interest at which banks borrow funds from each other in the London interbank market.

Line of credit
This is another common bank loan arrangement. A line of credit is where a bank agrees to lend a firm any amount up to a stated maximum. This allows the firm to draw upon the line of credit whenever it chooses. Firms use lines of credit to finance season needs. An uncommitted line of credit is an informal agreement that does not legally bind the bank to provide the funds. A committed line of credit consists of a legally binding written agreement that obligates the bank to provide funds to a firm regardless of the financial condition of the firm as long as the firm satisfies any restrictions in the agreement. This policy ensures that the firm does not use the short-term financing to finance its long-term obligations. A revolving line of credit is a committed line of credit, which a company can use as needed, that is a solid commitment for a longer period of time. A revolving line of credit with no fixed maturity is called evergreen credit.

Bridge loan
A bridge loan is a short-term bank loan that is often used to “bridge the gap” until a firm can arrange for long-term financing. These are often quoted as discount loans with fixed interest rates. In a discount loan, the borrower is required to pay the interest at the beginning of the loan period.

Common loan stipulations and fees
Commitment fees
Commitment fees associated with a committed line of credit increase the effective cost of the loan to the firm. This “fee” is basically another interest charge hiding behind a different name.

Loan origination fee
A loan origination fee is what a bank charges to cover credit checks and legal fees that a borrower much pay to initiate a loan. The firm pays this fee when the loan is initiated; similar to a discount loan, it reduces the amount of usable proceeds that he firm receives. This makes it essentially an additional interest charge.

Compensate balance requirements
This is a separate component that the bank may include in the loan agreement. A compensating balance requirement reduces the usable loan proceeds. This is because the compensating balance requirement means that the firm must hold a certain percentage of the principle of the loan in an account at the bank. Most banks require that this balance be held in a non-interest baring account, but others allow the balance to be held in an account that pays a small amount of interest to offset pay of the interest expense of the loan.

Short-Term Financing with Commercial Paper
Commercial paper is short-term, unsecured debt used by large corporations that is usually a cheaper source of funds than a short-term bank loan. This is rated by credit rating agencies. The interest is typically paid by selling it at an initial discount. The average maturity period is 30 days and the maximum period is 270 days. Any amount of time after 270 days requires the registration with the SEC, which increases issue costs and creates a time delay in the sale of the issue. There are two types of paper; direct and dealer. With direct paper, the firm sells the security directly to investors. With dealer paper, sealers sell the paper to investors in exchange for a spread (fee) for their services. This spread decreases the proceeds that the issuing firm receives, this increases the effective cost of the paper.

Short-Term Financing with Secured Financing
Business can get short-term financing with a secured-loan, a type of corporate loan in which specific assets are pledged as collateral.

Accounts receivable of collateral
Pledging of accounts receivable
In a pledging of accounts receivable agreement, the lender reviews the invoices that represent the credit sales of the borrowing firm and decides which credit accounts it will accept as collateral for the loan. The lender typically lends some percentage of the value of the accepted invoices. If the borrowing firm’s customers default on their bills, the firm is still in debt to the lender.

Factoring of accounts receivable
In a factoring of accounts receivable arrangement, the firm sells receivables to the lender, and the lender agrees to pay the firm the amount due from its customers at the end of the firm’s payment period. The customers of the firms are usually instructed to make payments directly to the lender. Financing arrangements may be with recourse or without recourse. With recourse means that the lender can seek payment from the borrower should the customers default on their bills. Without recourse is a case in which the lender’s claim on the borrower’s assets in the event of a default is limited to only explicitly pledged collateral.

Inventory as collateral
Floating lien
A floating lien uses the firm’s entire inventory to secure the loan. This is the riskiest setup form the lender’s standpoint because the value of the collateral used to secure the loan falls as inventory is sold. This type of loan bears a higher interest rate than the next two discussed.

Trust receipt
A trust receipt loan has distinguishable inventory that are held as collateral for the loan. When these items are sold, the firm gives the proceeds to the lender in repayment of the loan.

Warehouse arrangement
In a warehouse arrangement, the inventory held as collateral is sorted in an actual warehouse. This is the least risky arrangement for the lender. There are two different ways this can be set up: public and field warehouses. A public warehouse is where a business exists for the sole purpose of storing and tracking the inflow and outflow of the inventory. This means that as inventory is sold, the firm must go to the inventory to the warehouse to get it. This arrangement provides the lender with the tightest control over the inventory. A field warehouse is operated by a third party set up on the borrower’s premises in a separate area so the inventory is kept apart from the main plant. This is more convenient for the borrower but still gives the lender the added security of having the inventory that serves as collateral controlled by a third party. This type of arrangement is expensive. The method of collateralization will affect the ultimate cost of the loan.

There isn’t any sort of business that wouldn’t benefit from short-term financing. The analysis identifies two decisions facing the financial manager: what to do with excess cash generated, and how to deal with cash deficits. Securing a loan is an important step in obtaining financing, either short- or long-term. Plus, a firm can help insure financing by backing the loan with collateral; either with receivables or inventory.