Adex Week 04a-Financial Planning.

7/29/2019 Adex Week 04a-Financial Planning.

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IV. FINANCIAL PLANNING

I. INTRODUCTION

II. CASH BUDGET

III. FUNDS FLOW STATEMENT

CASES: ENTRAC INCALKA A.S.

MICRODRIVE CORPORATION


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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 measurethe current value and to investigate the impact ofproposed changes in strategy and operations.

2. ToPlan for financing that will be required toexecute the operating plans.

3. To provide a basis for a compensation plan


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PLANNING PROCESS

I. Formulating corporate objectivesII. Formation ofcorporate goalsIII. Stating the corporate strategiesIV. Stating corporate policies

a. Marketing

b. Manufacturingc. Finance ( Working capital policy, dividend policy, capital structure policy)

V. Preparing Longterm strategic plansVI. Financial Budgets

a.Projected financial statementsb.Capital budgetc.Cash budgetd.External financing plan


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FINANCIAL PLAN

The financial planning model can be used to test the feasibility of theplanned growth rate.

INGREDIENTS OF A FINANCIAL PLANNING MODEL

I.Macroeconomic Variables : Industry growth, inflation rate, FXforecasts, interest rate forecasts

2.Industry Variables : Industry growth rate, market share, rate ofchange in the industry.

3.Firm variables:a.capacity constraintsb.restrictions on debt policy,current ratio and coverage ratiosc.constraints in funds availabilityd.constraints in skilled personnel

4.Sales forecasts which are converted to sales plans whenjudgements are added.


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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 ofsales 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 expensesestimated to reach the forecasted sales levels7.Prepare a sales plan using a breakdown by geographical areas and

by products


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OUTPUTS OF FINANCIALPLANNING:

1. Projected Balance Sheet2. Projected Income Statement3. Cash Flow Statement4. Cash Budget5. Financing Plan

Projected financial statements are used to analyze the effects of the operating plans on the projected profits and financial ratios. to determine the amount of external funds needed to establish a system of controls governing the allocation and use of funds to develop a feedback loop which triggers modification of plans in case of unexpected

changes To establish a performance based compensation system

To determine the value of the company using the free cash flows generated from theforecasted statements.

The projected statements can be analyzed to determine how much value the plancreates for shareholders.The price of the stock as of the end of the forecasted yearshould be estimated. If the statements do not meet the targets,that is, if the value is not

acceptable ,then the elements of the plan should be studied to see if changes shouldbe made.


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Qualitative Factors Analysts ShouldConsider When Evaluating a Companys

Future Financial Performance1. 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 asingle supplier?

4. What percentage of the companys business isgenerated overseas?

5. Competition6. Future Prospects7. Legal and regulatory environment


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CASH BUDGETS

Forecasting future cash needs is called a cash budget.The cash budget is the tabulationof the plans of the firm in terms of their impact on the receipts and disbursements ofcash.The basic aim is to predict when and in what quantity payments of cash will bemade.

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 tobreak the forecast down into weekly or even daily periods.

The most critical estimate in cash flow forecasting is the forecast of sales.Most cashreceipts 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 cashflows,with cash needs and with excess cash.


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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 profitableuse.

The cash budget is closely related to the sales plan,

expense budgets, and capital expenditures budget.


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PURPOSES OF THE CASHBUDGET

The purposes of preparing cash budgets may be summarized as:

1.To indicate the probable cash position as a result of plannedoperations.

2. To indicate cash excess and shortages

3.To indicate the need for borrowing or the availability of idle cash forinvestment.4.To coordinate cash with (1) total working capital (2) sales

(3)investment (4) debt5.To establish a sound basis for credit6.To establish a sound basis for control of the cash position.

The cash budget is concerned with timing of cash inflows andoutflows whereas other budgets are concerned with the timing oftransactions.( accrual basis).This is the basic distinction of cashbudgets form other projected statements.


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TIME HORIZONS IN CASHPLANNING

1.Longterm: The timing is in accord (1)with the time dimensions of the capitalexpenditure projects(2) time dimension of

the 5 year plan.

2.Shortterm: The timing is in accord withtha annual profit plan.It forms the basis for

assessing the credit needs and for cashcontrol during the year.


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CONTROL OF THE CASHPOSITION

The deviations of actual cash balance from the budgets may resultfrom:1.variation in factors affecting cash2.unexpected changes influencing operations3.lack of cash control

Cash control can be based on two procedures:

1.A continuous evaluation of both present and probable cash positionon a monthlybasisThis involves reporting monthly actual cash position to date which

helps reprojection of cash flows taking into consideration theunexpected developments.

2.Evaluation of daily cash fluctuations.This is useful in companies having widely fluctuating cash demands.


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INPUTS OF CASH BUDGETS

The main inputs of the cash budgets are:

1. Sales forecasts

2. The percentage of credit sales

3. Receivables collection policy

4. Payments for purchases policy

5. Capital expenditures for the year that are generated fromcapital budgets.

6. Dividend payment policy7. Cash inflows from rent, dividend receipts, sales of assets

8. Outflows revealed by the expense budgets


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BASIC PROBLEMS IN EFFECTIVECASH FORECASTING

1.An important limitation to effective cash forecasting is the needfor comprehensive and detailed planning data.

2.The difficulty of predicting the future due to high variability.

As the degree of uncertainty increases ,

the management should recognize margins for error inherent in itsforecasts

cash budgets can be prepared based on different scenarios withvarying underlying assumptions.

simulation techniques can be used with clear definition of theassumptions upon which forecasts are based.


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Cash Budget: Purpose and Timing

Purpose: Forecasts cash inflows, outflows,and ending cash balances. Usedto plan loans needed or funds

available to invest.Timing: Daily, weekly, or monthly,

depending upon purpose offorecasts. Monthly for annualplanning, daily for actual cashmanagement.


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A. Other Potential Cash Inflows Besides Collections:

1. Proceeds from sale of fixed assets

2. Proceeds from stock and bond sales

3. Interest earned4. Court settlements

B. How can interest earned or paid be incorporated in the

cash budget?1. Interest earned: Add line in the collections section.

2. Interest paid: Add line in the payments section.

3. 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 debtlosses.


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III. SOURCES AND USES OFFUNDS STATEMENT

A funds flow statement is a useful aid to a financial manager ora creditor in evaluating the use of funds by a firm and indetermining how these uses are financed.The analyst canevaluate the future flows by means of a projected funds flowstatement which is based on forecasts.Such a statement

provides an efficient method for assessing the growth of thefirm, and its resulting needs and to determine the best way tofinance those needs.

Funds may be defined in several ways depending on the

purpose of analysis.Although they are mostly defined ascash,many analysts treat funds as working capital.

The flow of funds is a continuous process. The assets of thefirm represent net uses of funds; its liabilities and net worth

represent net sources.


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A cash flow cycle for a typical manufacturing company:

EQUITY ASSETS

asset Asset Purchases sales CASHRAW MATERIALSWIP FINISHEDStock repurchases

CASH SALES GOODS

COLLECTIONS CREDIT SALES

(A/R)DEBT

A finished good is produced by a variety of inputs-raw material, net fixedassets, and labor.These inputs are paid in cash. The product is sold eitherfor cash or on credit. A credit sale involves a receivable, when collectedbecomes cash.The reservoir of cash fluctuates over time with theproduction schedule, sales, collections, capital expenditures and financing.


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STATEMENT OF CASH FLOWS

Cash flow statement is a means by which we study the net funds flowbetween two points in time. These two points conform to thebeginning and ending financial statement dates for whatever

examinationperiod is relevanta quarter, a year, or five years.The cash flow

statementrepresents the net rather than gross changes between two comparablestatements at two different dates.

A statement of cash flows is prepared by :

1.Classifying net balance sheet changes that ocur between two pointsin time into changes that increase cash and changes that decreasecash

2.Classifying from the income statement the factors that increase anddecrease cash.

3.Consolidating the changes into a financial statement form.


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SOURCES OF CASH:1.A net decrease in any asset other than cash or fixed

assets

2.A gross decrease in fixed assets3.A net increase in any liability4.Proceeds from sale of common stock5.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 liability4.Dividend payments5.Net losses


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The statement separates the activities into three categories:

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 assets3.Financing activities,which includes raising cash by selling short-term

investments, or by issuing short-term debt, long-term debt or stock.Dividendspaid, retirement of bonds are transactions that are included.

When the total sources of cash is subtracted from total uses , the differenceshould be equal to the change in cash between the two statement dates.If itdoes not, the analyst should search for the discrepancy. Frequently, it is due tothe surplus adjustments.

Depreciation is not a source of funds, for funds are generated only fromoperations. Depreciation is a noncash outlay and because it was deducted from

revenues, it should be added back as a source of funds.Accumulateddepreciation account in the balance sheet is treated as a liability account and anincrease in accumulated depreciation is a source of funds.To avoid doublecounting, gross changes in fixed assets are considered.


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Conversion of net income from accrual to cash basis: ( An example)

Reported net income xxxxAdd:

Depreciation

Amortization of intangiblesLosses on sale of assetsDecrease in accounts receivableDecrease in prepaid expensesIncrease in income taxes payable

Deduct:Increase in inventoriesDecrease in accounts payableGains from sale of assets

Equals:Net income on cash basis

An increase in retained earnings account may be the result of:1.Net income only2.Net income minus dividends

3.Net income dividends+/- corrections of prior years earnings4.Some similar combination.


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IMPLICATIONS OF CASH FLOWSTATEMENT

A financial manager may detect imbalances in the use of funds andundertake appropriate action. An out of proportionate growth in one ofthe assets relative to sales, uncovers inefficiencies in assetmanagement.

Another use of cash flow statement is its use in evaluation of

financing.An analysis of the major sources of funds reveals what portionis financed externally.In addition, the kind of financing policy that themanagement adopts is identified and evaluated in terms of its impact oncorporate return and risk.

The cash flow statement also reveals if the company has expanded at a

very fast rate and whether financing is strained.The kind of financingused at present will restrict the future financing policies .

An analysis of forecasted cash flow statement is valuable to the managerin planning intermediate and longterm financing of the firm. It revealsthe firms total prospective need for funds, and the investments for

which they will be used.


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CASES

CASE I : ENTRAC COMPANY

CASE II : ALKA A..

CASE III: MICRODRIVE CORPORATION


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CASH BUDGET : ENTRACCOMPANY

Entrac Company is preparing its cash budget for the first six months of Year 2.The salesdata for Year 1 and the sales forecasts for January through July of Year 2 are :

Actual Sales, Year 1 Sales forecast, Year 2November $350December 400 January $450

February 500March 700

April 800May 600

June 450July 300

All sales are made on credit,with 70% collected in the first month following the sale and30% collected in the second month.Purchases are 60% of the following months sales andare paid in the following month.Monthly expenses equal to 30% of the current monthssales and are paid in the current month.Beginning cash is $ 100 and should not bepermitted to fall below this level in any of the following months.Bank borrowing is used tobring cash to this level when necessary.Whenever cash exceeds $100 level ,the excesscash is used to pay off bank loans outstanding.Prepare the cash budget for this companyfor the first six months of Year 2 .


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SOLUTION

ENTRAC COMPANY


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Cash BudgetEntrac Company

January February March April May June July

Sales 450 500 700 800 600 450 300

Collections:

one month 280 315 350 490 560 420 315

two months 105 120 135 150 210 240 180

Total 385 435 485 640 770 660 495Purchases 300 420 480 360 270 180

Cash Payments

for Purchases270 300 420 480 360 270 180

Expenses 135 150 210 240 180 135 90

Total Payments 405 450 630 720 540 405 270

Net Gain (Loss)(20) (15) (145) (80) 230 255 225

Beginning Cash 100 80 65 -80 -160 70 325

Cumulative Cash 80 65 (80) (160) 70 325 550

Less:Desired Level

of Cash-100 -100 -100 -100 -100 -100 -100

Loans needed (20) (35) (180) (260) (30)

Surplus 225 450


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ALKA A..NAKT BTES

ALKA A.. letmesinin nakit btesine temel tekil eden baz varsaymlarndkm yaplmtr. deiik senaryo iin gelitirilen varsaymlarkullanlarak nakit bteleri hazrlanmaktadr. ncelikle nakit akmlarhesaplanm, bte hazrlanmas srasnda gerekli yerlerde tahsilat, demeplan gibi temel politikalarda baz deiiklikler yaplmtr. letme her aykasada 10,000 TL nakit bulundurmay hedeflemektedir. Bu miktar aannakit menkul kymetlere yatrlacak, bunun altnda kalmas halindebankadan ksa vadeli borlanma yaplacaktr.

KOULLAR

VARSAYIMLAR En kt Normal En iyi

Sat gelirleri %5 azalr Geen yl ile ayn %10 artar

Kredili Satlar Satlarn%95'i Satlarn %90' Satlarn %85'i

Tahsilatlar %80'i 30 gnde %85'i 30 gnde %100' 30 gnde

%10'u 60 gnde %10'u 60 gnde

%10 tahsil edilemeyen %5'i tahsil edilemeyen

Harcamalar %5 artar Geen yl ile ayn %3 der

Yatrm Giderleri 0 100,000 150,000

(ubat'ta) (ubat'ta)

ALKA A


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ALKA A..NAKT BTES*

1.1.20X1 30.6.20X1(Normal Koullar Altnda)

I. GELRLER OCAK UBAT MART NSAN MAYIS HAZRAN

Balang nakit 20,000 16,000 (63,000) (3,000) (5,000) 25,000

Nakit Satlar ve Tahsilatlar 50,000 65,000 75,000 65,000 75,000 65,000

Kira 25,000

Kar Pay ve Faiz 5,000 2,000 5,000 2,000

Toplam Nakit Girii 55,000 67,000 100,000 70,000 75,000 67,000

Mevcut Toplam Nakit 75,000 83,000 37,000 67,000 70,000 92,000

II. NAKT IKILARI

cretler 23,000 25,000 25,000 25,000 25,000 25,000

Maalar 5,000 5,000 5,000 5,000 5,000 5,000

Hammadde demeleri 4,000 16,000 10,000 15,000 15,000 10,000

Kar Pay 2,000 2,000

Gelir Vergisi 25,000 25,000

Yeni Makina 100,000

Toplam Nakit k 59,000 146,000 40,000 72,000 45,000 40,000

Nakit (A) Fazlas 16,000 (63,000) (3,000) (5,000) 25,000 52,000

* Veriler ekonominin normal koullar altnda olduu varsaymna dayaldr.


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ALKA A..DZELTLM NAKT BTES

1.1.20X1 30.6.20X1I. NAKT GRLER OCAK UBAT MART NSAN MAYIS HAZRAN

Balang Nakit 20,000 10,000 10,000 10,000 10,000 10,000

Tahsilat 50,000 65,000 75,000 65,000 75,000 65,000

Kar Pay 25,000

Kar Pay ve Faiz 5,000 2,000 5,000 2,000Vadesi Gelen MenkulKy.* 10,100* 43,531* 498 30,803

Toplam Nakit Girii 55,000 77,100 143,531 70,000 75,498 97,803

Toplam Nakit Mevcudu 75,000 87,100 153,531 80,000 85,498 107,803

II. NAKT IKILARI

cret 23,000 25,000 25,000 25,000 25,000 25,000

Maa 5,000 5,000 5,000 5,000 5,000 5,000

Hammadde 4,000 16,000 10,000 15,000 15,000

Kar Pay 2,000 2,000

Vergi 25,000 25,000

Bor Faizi** 2,506**

Yeni Makina 100,000

Toplam Nakit k 55,000 34,000 146,000 69,506 45,000 45,000

Nakit (A) Fazlas 20,000 53,100 7,531 10,494 40,498 62,803

Minimum Nakit 10,000 10,000 10,000 10,000 10,000 10,000

Nakit (A) Fazlas 10,000 43,100 (2,469) 494 30,498 52,803

*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.


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CASE:

MICRODRIVE CORPORATION


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MICRO DRIVE INC.BALANCE SHEETS ( ml $) ASSETS LIABILITIES AND EQUITY YEAR 2 YEAR 1 YEAR 2 YEAR 1 Cash and Equivalents 10 15 Accounts Payable 60 30 Short Term Investments 0 65 Notes Payable 110 60 Accounts Receivable 375 315 Accruals 140 130 Inventories 615 415 Total Current Liabilities 310 220

Total Current Assets 1000 810 Long Term Bonds 754 580 Total Debt 1064 800 Preferred Stock

(400,000shares) 40 40 Common Stock

(50mil.shares) 130 130 Retained Earnings 766 710 Net Plant and Equipment 1000 870 Total Equity 896 840 Total Assets 2000 1680 Total Liabilities and Equity 2000 1680

MICRO DRIVE INCOME STATEMENTS YEAR 2 YEAR 1

Net Sales 3000.0 2850.0 Costs Excluding Depreciation 2616.2 2497.0 Depreciation 100.0 90.0 Total Operating Costs (2716.2) (2587.0 ) Earnings Before Interest and Taxes 283.8 263.0 Interest (88.0 ) (60.0) Earninge Before Taxes 195.8 203.0

Taxes (40%) (78.3) (81.0) Net Income Before Preferred Dividends 117.5 122.0 Preferred Dividends (4.0) (4.0) Earnings Available to Shareholders 113.5 118.0 Common Dividends (57.5) (53.0) Addition to Retained Earnings 56.0 65.0 Per Share Data Common Stock Price $ 23.00 $26.00 Earnings Per Share 2.27 2.36 Dividends per Share 1.15 1.06 Book Value Per Share 17.92 16.80


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Source Use

Decrease in cash 5Decrease in shortterm investments 65

Increase in receivables 60Increase in inventories 200Gross increase in fixed assets 230Increase in accumulated depreciation 100

Increase in accounts payable 30Increase in notes payable 50Increase in accruals 10Increase in long-term debt 174Increase in retained earnings 56 _______Total $ 490 $ 490

MICRODRIVE STATEMENT OF CASH FLOWSYEAR 2


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YEAR 2

Cash Flow from Operating Activities:

Net Income $ 117.5Additions to net income:

Depreciation 100.0Changes in net working capital:Increase in accounts payable 30.0Increase in accruals 10.0Increase in accounts receivable (60.0)Increase in inventories (200.0)

Net cash provided by operations $ (2.5)

LongTerm Investments:Fixed asset investments (230.0)

Financing Activities:Sale of short-term investments 65.0Increase in notes payable 50.0

Increase in bonds outstanding 174.0Dividend payments (61.5)

Net cash provided by Financing Activities $ 227.5

Summary:Net change in cash (5.0)Cash at the beginning of the year 15.0

Cash at the end of the year 10.0

The most important item in the cash flow statement is the cash fromti A b t fit b ti t ti S


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poperations.A company may boost profits by accounting tactics . So, acompany may report profits until the time it declares bankruptcy. In suchcases , the cash flow from operations start deteriorating much earlier andanalysts can predict trouble by analyzing the trend in cash provided byoperations. 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 debtand some by short-term debt which may be risky if the firm can notgenerate funds in the short run. However, financing with short-term fundsmay reduce costs , assuming short-term interest rates are below long-termrates.

As can be seen in the above statements , the company makes excessiveinvestment in current assets ,especially in inventories, which cause thecash flow from operations to be negative despite the increases in payablesand accruals.

*The company had positive operating profits which increased by 8%, butEVA was negative because of the faster increase (26%) in the cost offinancing . So, the company should improve its ROIC and/or reduce itscost of capital. A reduction in asset investment may reduce TOC andimprove EVA while improving asset turnover and profitability of the firmas well. Lower investment in working capital can help improve the cashflow from operations.

Adex Week 04a-Financial Planning.

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Transcript of Adex Week 04a-Financial Planning.