Short-term financial planning is concerned with the management of the firm's short-term, or current, assets and liabilities. The most important current assets are cash, marketable securities, accounts receivable, and inventory. The most important current liabilities are short-term loans and accounts payable. The difference between current assets and current liabilities is called (net) working capital.

The nature of the firm's short-term financial planning problem is determined by the amount of long-term capital it raises. A firm that issues large amounts of long-term debt or common stock, or that retains a large part of its earnings, may find it has permanent excess cash. In such cases there is never any problem paying bills, and short-term financial planning consists of managing the firm's portfolio of marketable securities. A firm holding a reserve of cash is able to buy itself time to react to a short-term crisis. This may be important for growth firms that find it difficult to raise cash on short notice. However, large cash holdings can lead to complacency. We suggest that firms with permanent cash surpluses ought to consider returning the excess cash to their stockholders.

Other firms raise relatively little long-term capital and end up as permanent short-term debtors. Most firms attempt to find a golden mean by financing all fixed assets and part of current assets with equity and long-term debt. Such firms may invest cash surpluses during part of the year and borrow during the rest of the year.

The starting point for short-term financial planning is an understanding of sources and uses of cash. Firms forecast their net cash requirements by estimating collections on accounts receivable, adding other cash inflows, and subtracting all cash outlays. If the forecasted cash balance is insufficient to cover day-to-day operations and to provide a buffer against contingencies, the company will need to find additional finance. The search for the best short-term financial plan inevitably proceeds by trial and error. The financial manager must explore the consequences of different assumptions about cash requirements, interest rates, sources of finance, and so on. Firms use computerized financial models to help in this process. These models range from simple spreadsheet programs that merely help with the arithmetic to linear programming models that search for the best financial plan.

Short-term financial planning focuses on the firm's cash flow over the coming year. But the financial manager also needs to consider what financial actions will be needed to support the firm's plans for growth over the next 5 or 10 years. Most firms, therefore, prepare a long-term financial plan that describes the firm's strategy and projects its financial consequences. The plan establishes financial goals and is a benchmark for evaluating subsequent performance.

The process that produces this plan is valuable in its own right. First, planning forces the financial manager to consider the combined effects of all the firm's investment and financing decisions. This is important because these decisions interact and should not be made independently. Second, planning requires the manager to consider events that could upset the firm's progress and to devise strategies to be held in reserve for counterattack when unhappy surprises occur.

There is no theory or model that leads straight to the optimal financial strategy. As in the case of short-term planning, many different strategies may be projected under a range of assumptions about the future. The dozens of separate projections that may need to be made generate a heavy load of arithmetic. We showed how you can use a simple spreadsheet model to analyze Dynamic Mattress's long-term strategy.