10. short term financial planning
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This chapter discusses short-term financial planning. It covers key concepts like developing a financial plan using the percentage of sales approach and preparing a cash budget. The chapter outlines the financial planning process, including making assumptions for scenarios. It provides examples of how to create pro forma financial statements, determine external financing needs, and construct a cash budget with collections and disbursement schedules. The cash budget helps the company plan for cash surpluses and shortfalls over the planning period.
10. short term financial planning
- 1. Chapter 10 •Short-Term Financial Planning McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
- 2. Key Concepts and Skills • Understand the financial planning process and how decisions are interrelated • Be able to develop a financial plan using the percentage of sales approach • Be able to prepare a cash budget • Understand the various options for short- term financing 4-2
- 3. Chapter Outline • What is Financial Planning? • Financial Planning Models: A First Look • The Percentage of Sales Approach • External Financing and Growth • The Cash Budget 4-3
- 4. Elements of Financial Planning • Investment in new assets – determined by capital budgeting decisions • Degree of financial leverage – determined by capital structure decisions • Cash paid to shareholders – determined by dividend policy decisions • Liquidity requirements – determined by net working capital decisions 4-4
- 5. Financial Planning Process • Planning Horizon - divide decisions into short-run decisions (usually next 12 months) and long-run decisions (usually 2 – 5 years) • Aggregation - combine capital budgeting decisions into one big project • Assumptions and Scenarios • Make realistic assumptions about important variables • Run several scenarios where you vary the assumptions by reasonable amounts • Determine at least a worst case, normal case and best case scenario 4-5
- 6. Role of Financial Planning • Examine interactions – help management see the interactions between decisions • Explore options – give management a systematic framework for exploring its opportunities • Avoid surprises – help management identify possible outcomes and plan accordingly • Ensure feasibility and internal consistency – help management determine if goals can be accomplished and if the various stated (and unstated) goals of the firm are consistent with one another 4-6
- 7. Financial Planning Model Ingredients • Sales Forecast – many cash flows depend directly on the level of sales (often estimated sales growth rate) • Pro Forma Statements – setting up the plan as projected financial statements allows for consistency and ease of interpretation • Asset Requirements – the additional assets that will be required to meet sales projections • Financial Requirements – the amount of financing needed to pay for the required assets • Plug Variable – determined by management decisions about what type of financing will be used (makes the balance sheet balance) • Economic Assumptions – explicit assumptions about the coming economic environment 4-7
- 8. Example: Historical Financial Statements Gourmet Coffee Inc. Gourmet Coffee Inc. Balance Sheet Income Statement December 31, 2004 For Year Ended December 31, 2004 Assets 1000 Debt 400 Revenues 2000 Equity 600 Costs 1600 Total 1000 Total 1000 Net Income 400 4-8
- 9. Example: Pro Forma Income Statement • Initial Assumptions Gourmet Coffee Inc. • Revenues will grow at Pro Forma Income 15% (2000*1.15) Statement • All items are tied directly to sales and For Year Ended 2005 the current Revenues 2,300 relationships are optimal • Consequently, all other Costs 1,840 items will also grow at 15% Net Income 460 4-9
- 10. Example: Pro Forma Balance Sheet Gourmet Coffee Inc. • Case I Pro Forma Balance Sheet • Dividends are the plug Case 1 variable, so equity increases at 15% Assets 1,150 Debt 460 • Dividends = 460 NI – 90 Equity 690 increase in equity = 370 Total 1,150 Total 1,150 • Case II Gourmet Coffee Inc. • Debt is the plug variable Pro Forma Balance Sheet and no dividends are paid Case 1 • Debt = 1,150 – (600+460) = Assets 1,150 Debt 90 90 • Repay 400 – 90 = 310 in Equity 1,060 debt Total 1,150 Total 1,150 4-10
- 11. Percent of Sales Approach • Some items vary directly with sales, while others do not • Income Statement • Costs may vary directly with sales - if this is the case, then the profit margin is constant • Depreciation and interest expense may not vary directly with sales – if this is the case, then the profit margin is not constant • Dividends are a management decision and generally do not vary directly with sales – this affects additions to retained earnings • Balance Sheet • Initially assume all assets, including fixed, vary directly with sales • Accounts payable will also normally vary directly with sales • Notes payable, long-term debt and equity generally do not because they depend on management decisions about capital structure • The change in the retained earnings portion of equity will come from the dividend decision 4-11
- 12. Example: Income Statement Tasha’s Toy Emporium Tasha’s Toy Emporium Income Statement, 2004 Pro Forma Income Statement, 2005 % of Sales 5,500 Sales Sales 5,000 Costs 3,300 Costs 3,000 60% EBT 2,200 Taxes 880 EBT 2,000 40% Net Income 1,320 Taxes 800 16% (40%) Dividends 660 Net Income 1,200 24% Add. To RE 660 Dividends 600 Assume Sales grow at 10% Add. To RE 600 Dividend Payout Rate = 50% 4-12
- 13. Example: Balance Sheet Tasha’s Toy Emporium – Balance Sheet Current % of Pro Current % of Pro Sales Forma Sales Forma ASSETS Liabilities & Owners’ Equity Current Assets Current Liabilities Cash $500 10% $550 A/P $900 18% $990 A/R 2,000 40 2,200 N/P 2,500 n/a 2,500 Inventory 3,000 60 3,300 Total 3,400 n/a 3,490 Total 5,500 110 6,050 LT Debt 2,000 n/a 2,000 Fixed Assets Owners’ Equity Net PP&E 4,000 80 4,400 CS & APIC 2,000 n/a 2,000 Total Assets 9,500 190 10,450 RE 2,100 n/a 2,760 Total 4,100 n/a 4,760 Total L & OE 9,500 10,250 4-13
- 14. Example: External Financing Needed • The firm needs to come up with an additional $200 in debt or equity to make the balance sheet balance • TA – TL&OE = 10,450 – 10,250 = 200 • Choose plug variable • Borrow more short-term (Notes Payable) • Borrow more long-term (LT Debt) • Sell more common stock (CS & APIC) • Decrease dividend payout, which increases the Additions To Retained Earnings 4-14
- 15. Cash Budget • Forecast of cash inflows and outflows over the next short-term planning period • Primary tool in short-term financial planning • Helps determine when the firm should experience cash surpluses and when it will need to borrow to cover working-capital costs • Allows a company to plan ahead and begin the search for financing before the money is actually needed 4-15
- 16. Example: Cash Budget Information • Pet Treats Inc. specializes in gourmet pet treats and receives all income from sales • Sales estimates (in millions) • Q1 = 500; Q2 = 600; Q3 = 650; Q4 = 800; Q1 next year = 550 • Accounts receivable • Beginning receivables = $250 • Average collection period = 30 days • Accounts payable • Purchases = 50% of next quarter’s sales • Beginning payables = 125 • Accounts payable period is 45 days • Other expenses • Wages, taxes and other expense are 30% of sales • Interest and dividend payments are $50 • A major capital expenditure of $200 is expected in the second quarter • The initial cash balance is $80 and the company maintains a minimum balance of $50 4-16
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- 18. Example: Cash Budget – Cash Collections • ACP = 30 days, this implies that 2/3 of sales are collected in the quarter made and the remaining 1/3 are collected the following quarter • Beginning receivables of $250 will be collected in the first quarter • Q1 Q2 Q3 Q4 • Beginning Receivables 250 167 200 217 • Sales 500 600 650 800 • Cash Collection 583 567 633 750 • Ending Receivables 167 200 217 367 4-18
- 19. Example: Cash Budget – Cash Disbursements • Payables period is 45 days, so half of the purchases will be paid for each quarter and the remaining will be paid the following quarter • Beginning payables = $125 • Q1 Q2 Q3 Q4 • Payment of accounts 275 313 362 338 • Wages, taxes and other expenses 150 180 195 240 • Capital expenditures 200 • Interest and dividend payments 50 50 50 50 • Total cash disbursements 475 743 607 628 4-19
- 20. Example: Cash Budget – Net Cash Flow and Cash Balance Q1 Q2 Q3 Q4 • Total cash collections 583 567 633 750 • Total cash disbursements475 743 607 628 • Net cash inflow 108- 176 26 122 • Beginning Cash Balance 80 188 12 38 • Net cash inflow 108 -176 26 122 • Ending cash balance 188 12 38 160 • Minimum cash balance -50 -50 -50 -50 • Cumulative surplus • (deficit) 138 -39 -14 107 4-20
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- 22. Example: Cash Budget – Cash Collections • ACP = 30 days, this implies that 2/3 of sales are collected in the quarter made and the remaining 1/3 are collected the following quarter • Beginning receivables of $250 will be collected in the first quarter 4-22
- 23. Chapter 4 •End of Chapter McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.