Managing short-term cash flows involves minimizing costs. The two major costs are carrying costs, the return forgone by keeping too much invested in short-term assets such as cash, and shortage costs, the cost of running out of short-term assets. The objective of managing short-term finances and doing short-term financial planning is to find the optimal trade-off between these two costs.

The starting point for good cash flow management is developing a cash flow projection. To forecast short-term cash flows, a financial manager needs to:

• Determine minimum cash balances.
• Identify the typical cash inflows and outflows of the company.
• Develop a cash forecasting system.

Monitoring cash uses and levels means keeping a running score on daily cash flows.

• The most important task is to collect cash flow information on a timely basis.
• Establish a target cash balance for each bank.
• Use short-term investments and borrowing to help with cash position management.
• Consider other factors, such as seasonal factors, upcoming mergers and acquisition, etc.

Practice Question 1

Which of the following is the most appropriate technique for forecasting cash flow for the short term?

A. Statistical models
B. Simple projections
C. Projection models and averages

Correct Answer: B

Simple projections are used to forecast short-term needs. Projection models and averages are normally used to forecast medium-term cash flow needs. Statistical models are normally used to forecast long-term needs, not short-term cash flow needs.