Financial Planning

Financial Planning

Financial Planning Portions taken from Emery and Finnerty: Corporate Financial Management – Chapter 22 Edited and expanded by Del Hawley

The Financial Planning Process A firm’s financial plan involves decisions about: • Liquidity • Working Capital • Inventories • Capital Budgeting • Capital Structure • Dividends

3 Rules of Financial Management What are the three primary rules of successful financial management?

3 Rules of Financial Management What are the three primary rules of successful financial management? • Get the cash • Get the cash • Get the cash

The Cash Plumbing System Equity LT Debt Taxes Dividends

The Cash Plumbing System Equity Operating Expenses LT Debt Taxes Dividends

The Cash Plumbing System Equity Operating Expenses LT Debt Taxes ST Debt Mkt’l Sec Dividends

The Cash Plumbing System Equity Operating Expenses LT Debt Taxes ST Debt Mkt’l Sec Dividends Accts Pay’l Fixed Assets Materials/Inventory Sale Labor Finished Goods

The Cash Plumbing System Equity Operating Expenses LT Debt Taxes ST Debt Mkt’l Sec Dividends Accts Pay’l Accounts Rec’l Fixed Assets Materials/Inventory Sale Labor Finished Goods

Cash Conversion Cycle Collect Acct. Receivable Purchase Inventory Sale on Credit Inventory Conversion Period Receivables Collection Period Time Cash Conversion Cycle Payment of Accts. Payable Payables Deferral Period

The Financial Plan • Financial planning is the process of evaluating the impact of alternative investing and financing decisions of the firm. • Every financial plan has three components: • A model • Inputs • Outputs

The Financial Plan • The model is a set of mathematical relationships between the inputs and the outputs. • Inputs to the model may include: • Projected sales • Collections • Costs • Interest rates • Exchange rates

The Financial Plan • The outputs of the financial plan are: • Cash Budget • Pro forma (projected) financial statements • Projections for external funding requirements

Components of the Financial Plan Every financial plan should have: • Clearly stated strategic, operating and financial objectives. • Assumptions on which the plan is based. • Description of underlying strategies. • Contingency plansto deal with the variances from expectations.

Benefits of Financial Planning • Future (strategic) orientation • Identify and quantify assumptions • Prepare for contingencies (risk analysis) • Identify funding requirements • Assess performance

Cash Budgets • Cash budgets • project and summarize cash inflows and outflows • show monthly cash balances • show any short-term borrowing needed to cover cash shortfalls • Are based on sales forecasts. • Are usually constructed on a monthly basis.

Preparing a Cash Budget Prepare a cash budget for Tyler Paints for the months of April, May and June, given the information in the information provided in the following slides.

Sales – Recent and Forecast The recent and projected sales for the company are:

Sales – Recent and Forecast The recent and projected sales for the company are: For your project, the sales projections are the culmination of the marketing analysis.

Collections Forecast On average, 20% of the company’s sales are for cash and the rest is carried as accounts receivable with 45% of a given month’s sales collected one month following the sale and the remainder collected two months following the sale.

Collections on Sales • Collections in April are: 20% of April Sales 45% of March Sales 35% of February Sales 20%($1,200,000) = $240,000 45%($600,000) = $270,000 35%($500,000) = $175,000 $685,000

Collections on Sales

Collections on Sales For your project, you will need to think about the timing of collections. You may sell everything for cash, or you may give your customers payment terms.

Pro-Forma Accounts Receivable Uncollected sales at the end of April (Accounts Receivable) will be: = 35%(March Sales) + (80% of April Sales) = 35%($600,000) + 80%($1,200,000) = $1,170,000 A/R for May = $1,220,000 A/R for June = $1,150,000

Payment Forecasts • The cost of production materials averages 50% of sales. Payment is made for the materials one month after purchase. • Wages average 20% of sales. • Fixed costs are $120,000 per month • A quarterly tax payment of $200,000 is due in April

Cash Payments Cash Payments in April = Materials 50%(March Sales) + Wages 20%(April Sales) + Other Fixed Expenses of $120,000 50% x $600,000 + 20% x $1,200,000 + $120,00 $920,000

Cash Payments

Cash Payments Here’s where you will have LOTS of fun! You have to think of all of the ways that money will need to be spent, list and justify all assumptions, and project it all out for at least three years.

Cash Budget

Cash Budget • Tyler will have to borrow $125,000 in April. • Tyler can repay $30,000 in May, leaving an outstanding loan balance of $155,000. • The short-term loan can be fully repaid in June.

SPREADSHEET The next lesson is on creating a spreadsheet model for the Tyler Paints cash budget. Intstructions are on the class web page.

Cash Budget We will also work with Problem C-1 (linked on the web page) in a spreadsheet to build a model that produces a cash budget, an income statement, and a balance sheet that are all integrated.

Pro Forma Financial Statements Pro Forma Statements: • Show the effect of the firm’s decisions on its future financial statements. • Effects of alternative decisions and sensitivity to changes in assumptions can be examined.

Percent of Sales Forecasting Method • Assumes that some IS/BS items stay constant as a percent of sales as sales vary. • In general, Accounts Receivable, Inventory, Accounts Payable (on the balance sheet), and cost of goods sold and some operating expenses (on the income statement) vary with sales (maintain the same percentage of sales) or cost of goods sold. • Other items are either fixed with respect to changes in sales or they are “plug” figures.

Percent of Sales Forecasting Method • Sales growth results in: • increase in current and fixed assets • increase in spontaneous short-term financing • increase in profitability • The increase in current assets must be financed from internally generated funds or external funds. Note WELL: You can go BUST by letting GROWTH outrun your CASH.

Financial Planning