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FINANCIAL PLANNING
I. INTRODUCTION II. CASH BUDGET III. FUNDS FLOW STATEMENT
CASES: ENTRAC INC ALKA A.S. MICRODRIVE CORPORATION
FINANCIAL PLANNING
Value creation is impossible unless the company has a well articulated plan. Projected financial statements have three important uses: 1.To Estimate the free cash flows to measure the current value and to investigate the impact of proposed changes in strategy and operations. 2. To Plan for financing that will be required to execute the operating plans. 3. To provide a basis for a compensation plan
PLANNING PROCESS
I. II. III. IV. Formulating corporate objectives Formation of corporate goals Stating the corporate strategies Stating corporate policies
a. Marketing b. Manufacturing c. Finance ( Working capital policy, dividend policy, capital structure policy)
V. Preparing Long term strategic plans VI. Financial Budgets a.Projected financial statements b.Capital budget c.Cash budget d.External financing plan
FINANCIAL PLAN
The financial planning model can be used to test the feasibility of the planned growth rate. INGREDIENTS OF A FINANCIAL PLANNING MODEL I.Macroeconomic Variables : Industry growth, inflation rate, FX forecasts, interest rate forecasts 2.Industry Variables : Industry growth rate, market share, rate of change in the industry. 3.Firm variables: a.capacity constraints b.restrictions on debt policy,current ratio and coverage ratios c.constraints in funds availability d.constraints in skilled personnel 4.Sales forecasts which are converted to sales plans when judgements are added.
SALES PLANS
1.Review sales over the past 5-10 years. 2.Estimate the level of economic activity and demand . 3.Estimate market share for each product line in each market under consideration taking into account the firms constraints, competitors capacities and pricing strategies.So , a combination of sales units and prices lead to estimation of the growth rate in sales. 4.Forecast the exchange rates , government policies on trade etc. for foreign markets. 5. Estimate the need for advertising campaigns, promotions, determine credit terms. 6.Decide if the firm resources can meet the marketing expenses estimated to reach the forecasted sales levels 7.Prepare a sales plan using a breakdown by geographical areas and by products
Qualitative Factors Analysts Should Consider When Evaluating a Companys Future Financial Performance
1. Are the companys revenues tied to one key customer? 2. To what extent are the companys revenues tied to one key product? 3. To what extent does the company rely on a single supplier? 4. What percentage of the companys business is generated overseas? 5. Competition 6. Future Prospects 7. Legal and regulatory environment
CASH
BUDGETS
Forecasting future cash needs is called a cash budget.The cash budget is the tabulation of the plans of the firm in terms of their impact on the receipts and disbursements of cash.The basic aim is to predict when and in what quantity payments of cash will be made. In most cash forecasts , receipts and payments are broken down by months.If uneven inflows and outflows are anticipated within the monthly intervals, it may be necessary to break the forecast down into weekly or even daily periods. The most critical estimate in cash flow forecasting is the forecast of sales.Most cash receipts and payments are closely related with sales. Cash budgeting involves projection of cash inflows, outflows and financing needs.Cash budgeting is directly linked with the lag between transactions and the related cash flows,with cash needs and with excess cash.
CASH
BUDGETS
A cash budget consists of two parts: 1.The planned cash receipts 2.The planned cash disbursements Evaluation of the cash position may indicate: 1.The need for financing to cover the cash deficit 2.The need for planning to put excess cash to profitable use. The cash budget is closely related to the sales plan, expense budgets, and capital expenditures budget.
A. 1. 2. 3. 4.
B. 1. 2. 3.
Other Potential Cash Inflows Besides Collections: Proceeds from sale of fixed assets Proceeds from stock and bond sales Interest earned Court settlements
How can interest earned or paid be incorporated in the cash budget? Interest earned: Add line in the collections section. Interest paid: Add line in the payments section. Calculation: Interest rate x surplus or loan of cash budget for preceding month.
C. How are bad debts included in cash budget? Collections would be reduced by the amount of the bad debt losses.
EQUITY ASSETS asset Asset Purchases sales CASHRAW MATERIALSWIP FINISHED Stock repurchases CASH SALES GOODS COLLECTIONS CREDIT SALES (A/R) DEBT A finished good is produced by a variety of inputs-raw material, net fixed assets, and labor.These inputs are paid in cash. The product is sold either for cash or on credit. A credit sale involves a receivable, when collected becomes cash.The reservoir of cash fluctuates over time with the production schedule, sales, collections, capital expenditures and financing.
SOURCES OF CASH: 1.A net decrease in any asset other than cash or fixed assets 2.A gross decrease in fixed assets 3.A net increase in any liability 4.Proceeds from sale of common stock 5.Funds provided by operations.( Net income+ Depreciation) USES OF CASH: 1.Any net increase in any asset other than cash or fixed assets. 2.A gross increase in fixed assets. 3.A net decrease in any liability 4.Dividend payments 5.Net losses
1.Operating activities, which include net income,changes in current assets and current liabilities other than cash,short-term investments and short-term debt. 2.Investing activities, which includes investments in or sales of fixed assets 3.Financing activities,which includes raising cash by selling short-term investments, or by issuing short-term debt, long-term debt or stock.Dividends paid, retirement of bonds are transactions that are included.
When the total sources of cash is subtracted from total uses , the difference should be equal to the change in cash between the two statement dates.If it does not, the analyst should search for the discrepancy. Frequently, it is due to the surplus adjustments.
Depreciation is not a source of funds, for funds are generated only from operations. Depreciation is a noncash outlay and because it was deducted from revenues, it should be added back as a source of funds.Accumulated depreciation account in the balance sheet is treated as a liability account and an increase in accumulated depreciation is a source of funds.To avoid double counting, gross changes in fixed assets are considered.
Conversion of net income from accrual to cash basis: ( An example) Reported net income Add: Depreciation Amortization of intangibles Losses on sale of assets Decrease in accounts receivable Decrease in prepaid expenses Increase in income taxes payable Deduct: Increase in inventories Decrease in accounts payable Gains from sale of assets Equals: Net income on cash basis An increase in retained earnings account may be the result of: 1.Net income only 2.Net income minus dividends 3.Net income dividends+/- corrections of prior years earnings 4.Some similar combination. xxxx
CASES
CASE I : ENTRAC COMPANY CASE II : ALKA A.. CASE III: MICRODRIVE CORPORATION
All sales are made on credit,with 70% collected in the first month following the sale and 30% collected in the second month.Purchases are 60% of the following months sales and are paid in the following month.Monthly expenses equal to 30% of the current months sales and are paid in the current month.Beginning cash is $ 100 and should not be permitted to fall below this level in any of the following months.Bank borrowing is used to bring cash to this level when necessary.Whenever cash exceeds $100 level ,the excess cash is used to pay off bank loans outstanding.Prepare the cash budget for this company for the first six months of Year 2 .
March
700 350 135 485 480 420 210 630 (145) 65 (80) -100 (180)
April
800 490 150 640 360 480 240 720 (80) -80 (160) -100 (260)
May
600 560 210 770 270 360 180 540 230 -160 70 -100 (30)
June
450 420 240 660 180 270 135 405 255 70 325 -100
July
300 315 180 495
225
450
*Nakit fazlasnn aylk olarak %1 faizden yatrld varsaylmtr. **Borlanma bir ay iin yaplm ve faiz aylk %1.5 olarak hesaplanarak Nisan aynda geri denmitir. Bir nceki btedeki baz varsaymlar deitirilmitir. 1-Yatrm ubat ayndan Mart ayna alnmtr. 2-Hammadde demeleri 30 gn geciktirilmitir. 3-letme her ay en az 10,000 TL kasa bulundurmay hedeflemektedir.
MICRO DRIVE INC.BALANCE SHEETS ( ml $) ASSETS YEAR 2 YEAR 1 Cash and Equivalents Short Term Investments Accounts Receivable Inventories Total Current Assets 10 0 375 615 1000 15 65 315 415 810
YEAR 2
Accounts Payable Notes Payable Accruals Total Current Liabilities Long Term Bonds Total Debt Preferred Stock (400,000shares) Common Stock (50mil.shares) Retained Earnings Total Equity Total Liabilities and Equity 60 110 140 310 754 1064 40 130 766 896 2000
YEAR 1
30 60 130 220 580 800 40 130 710 840 1680
1000 2000
870 1680
MICRO DRIVE INCOME STATEMENTS Net Sales Costs Excluding Depreciation Depreciation Total Operating Costs Earnings Before Interest and Taxes Interest Earninge Before Taxes Taxes (40%) Net Income Before Preferred Dividends Preferred Dividends Earnings Available to Shareholders Common Dividends Addition to Retained Earnings Per Share Data Common Stock Price Earnings Per Share Dividends per Share Book Value Per Share
YEAR 2 3000.0 2616.2 100.0 (2716.2) 283.8 (88.0 ) 195.8 (78.3) 117.5 (4.0) 113.5 (57.5) 56.0 $ 23.00 2.27 1.15 17.92
YEAR 1 2850.0 2497.0 90.0 (2587.0 ) 263.0 (60.0) 203.0 (81.0) 122.0 (4.0) 118.0 (53.0) 65.0 $26.00 2.36 1.06 16.80
Source Decrease in cash 5 Decrease in short term investments 65 Increase in receivables Increase in inventories Gross increase in fixed assets Increase in accumulated depreciation 100 Increase in accounts payable 30 Increase in notes payable 50 Increase in accruals 10 Increase in long-term debt 174 Increase in retained earnings 56 Total $ 490
Use
60 200 230
_______ $ 490
(230.0)
The most important item in the cash flow statement is the cash from operations.A company may boost profits by accounting tactics . So, a company may report profits until the time it declares bankruptcy. In such cases , the cash flow from operations start deteriorating much earlier and analysts can predict trouble by analyzing the trend in cash provided by operations. Microdrive has $ 2.5 million of cash shortfall from operations. It covered this shortfall by liquidating marketable securities and borrowing long-term and short-term loans.
Microdrive finances some portion of its fixed assets by long-term debt and some by short-term debt which may be risky if the firm can not generate funds in the short run. However, financing with short-term funds may reduce costs , assuming short-term interest rates are below long-term rates. As can be seen in the above statements , the company makes excessive investment in current assets ,especially in inventories, which cause the cash flow from operations to be negative despite the increases in payables and accruals.
*The company had positive operating profits which increased by 8%, but EVA was negative because of the faster increase (26%) in the cost of financing . So, the company should improve its ROIC and/or reduce its cost of capital. A reduction in asset investment may reduce TOC and improve EVA while improving asset turnover and profitability of the firm as well. Lower investment in working capital can help improve the cash flow from operations.