Financial Analysis, Planning and Forecasting Theory and Application

1. Financial Analysis, Planning and ForecastingTheory and Application Chapter 18 Short-term Financial Analysis and Planning By Alice C. Lee San Francisco State University John C. Lee J.P. Morgan Chase Cheng F. Lee Rutgers University

2. Outline • 18.1 Introduction • 18.2 The components of working capital • 18.3 The concept of cash flow • 18.4 Cash flow vs. funds flow • 18.5 Organizing for short-term financial planning principles • 18.6 The cash flow cycle and its calculation • 18.7 Cash flow forecasting, budgeting, and planning • 18.8 The cash budget • 18.9 Demand-driven, capital-driven, and cost-driven cash budgets • 18.10 Users of cash forecasts and business plans • 18.11 Planning horizons and time intervals of cash budgets • 18.12 From forecasting to budgeting to planning • 18.13 Summary • Appendix 18A. Time-series components of sales

3. 18.1 Introduction

4. 18.2 The components of working capital

5. Investment flow Marketable Securities Financial Flow Excess cash Sources (Inflows) Uses (Outflows) Productive Capital Bank loans Trade credit Term loans Commercial paper Bonds Equity Building Equipment Labor Raw material Other Cash Inventory Uses (Outflows) Sources (Inflows) Taxes Interest Dividends Principal payments Accounts receivable Cash sales Collection of A/ R 18.3 The concept of cash flow Exhibit 18-1 Flow of Funds

6. 18.4 Cash flow vs. funds flow

7. 18.5 Organizing for short-term financial planning principles Exhibit 18-2 Cash Planning and Management Resources

8. $ Short-term Financing Variable Short-term Assets Long-term Financing Permanent Long-term Assets Time 18.5 Organizing for short-term financial planning principles Figure 18-1 Matching Maturities of Financing Sources and Assets

9. 18.5 Organizing for short-term financial planning principles Exhibit 18-3 Problems Associated with Balancing Liquidity and Profitability

10. 18.5 Organizing for short-term financial planning principles Exhibit 18-3 Problems Associated with Balancing Liquidity and Profitability (Cont.)

11. 18.6 The cash flow cycle and its calculation (18-1) where average inventory ＝ (beginning inventory＋ending inventory)/ 2; average accounts receivable（AR）＝（beginning AR＋ending AR）/2; and average accounts payable（AP）＝（beginning AP＋ending AP）/2.

12. 18.6 The cash flow cycle and its calculation managerial actions ＝ inventory financing, collateral for loans, liquidation ＋ factoring, pledging, altering credit terms, tightening collection, policies, speeding up billing procedures － change payment frequency, stretch out payables （forego discounts） (18-2)

13. 18.6 The cash flow cycle and its calculation Exhibit 18-4 Speedy Maintenance, Inc., Financial Statement

14. 18.6 The cash flow cycle and its calculation Exhibit 18-4 Speedy Maintenance, Inc., Financial Statement (Cont.)

15. 18.6 The cash flow cycle and its calculation Exhibit 18-5 Financing Costs of Speedy’s Cash Flow Cycle

16. 18.6 The cash flow cycle and its calculation Exhibit 18-6 speedy Maintenance Contract XYZ Total contract ＝＄120,000 for one year Payment terms ＝＄10,000 on the last day of each month Cost of supplies per month ＝＄2,000 Cost of labor per month ＝＄7,500 (workers paid weekly)

17. 18.6 The cash flow cycle and its calculation Exhibit 18-6 speedy Maintenance Contract XYZ (Cont.)

18. 18.7 Cash flow forecasting, budgeting, and planning

19. 18.8The cash budget

20. 18.9 Demand-driven, capital-driven, and cost-driven cash budgets Table 18-1

21. 18.10 Users of cash forecasts and business plans

22. 18.11 Planning horizons and time intervals of cash budgets Exhibit 18-7 Cash Flow Budgets and Planning Intervals

23. 18.11 Planning horizons and time intervals of cash budgets Exhibit 18-7 Cash Flow Budgets and Planning Intervals (Cont.)

24. 18.12 From forecasting to budgeting to planning Exhibit 18-8 Assumptions for Cash Inflows and Outflows

25. 18.12 From forecasting to budgeting to planning Exhibit 18-9 Six-Month Cash Flow Forecast

26. 18.12 From forecasting to budgeting to planning Exhibit 18-9 Six-Month Cash Flow Forecast (Cont.)

27. 18.12 From forecasting to budgeting to planning Exhibit 18-9 Six-Month Cash Flow Forecast (Cont.)

28. 18.12 From forecasting to budgeting to planning Exhibit 18-10 Six-Month Most-Likely Cash Flow Plan* * It is assumed that the marketable securities are invested for one month at one percent interest (12﹪/12 months = 1﹪/ month) 10,000 × 1.01 = ＄10,100 for February ** It is assumed that the borrowing is done for one month at 1.5 percent interest (18﹪/12 months = 1.5﹪/ month) 2,469 × 1.015 = ＄2,506 for April

29. 18.13 Summary In Chapter 18, we have identified and defined cash flow and related it to the accounting-based concept of funds flow. The short-term financial manager is much more concerned with the actual cash flowing through the firm on a day-to-day basis than the long-term funds flow perspective. A three-scenario approach to short-term financial planning (using worst, most-likely, and best-case scenarios) is recommended because future events cannot always be forecasted with accuracy. For this reason, the initial step of the planning process involves making educated guesses about future cash flows that cover a reasonable range of possible situations. In both budgeting and planning, the cash flow manager should ask the following questions: Dose this plan makes sense in light of my own experience? Does it coincide with what I expect to happen during the coming year?

30. 18.13 Summary Throughout the planning process, there should be a feedback mechanism that enables the short-term financial planner to update the forecast in light of new information and/or a new understanding of the situation that may come about from actually preparing the budget and the plan. Cash flow managers must understand that the process itself is the most important aspect of short-term financial management. The final plan is not definitive. It serves only to guide future courses of action and decisions and is subject to continual revision. The final part of the chapter demonstrated the interrelationship of forecasting, budgeting, and planning. Once the problems have been defined, a financial planner must generate alternatives that will lead to satisfactory solutions. The material in the next two chapters expands on the possible alternatives available to the financial planner. In most cases, there is more than one way to solve a problem. Sometimes, it is worth the extra effort to look for the optimal solution; sometimes it is not. With experience, the financial manager learns when to use a satisfactory solution that may not be the best one theoretically. It makes little sense to spend a lot of time and make many improvements on a plan that will only marginally improve performance.

31. Sales ($) Years 1 2 3 4 5 6 (A) Trend-Cycle (c) Appendix 18A. Time-series components of sales Figure 18A-1

32. Sales ($) Quarters 1 2 3 4 5 6 (B) Seasonal (s) Appendix 18A. Time-series components of sales Figure 18A-1 (Cont.)

33. Sales ($) Years 1 2 3 4 5 6 (C) Irregular (I) Appendix 18A. Time-series components of sales Figure 18A-1 (Cont.)

34. Appendix 18A. Time-series components of sales （18A-1） Table 18A-1

35. Appendix 18A. Time-series components of sales Table 18A-2

36. Appendix 18A. Time-series components of sales

37. Appendix 18A. Time-series components of sales Table 18A-3