Chapter 22
Financial
Planning
Emery and Finnerty: Corporate Financial Management
Edited by Hawley
The Financial Planning Process
A firm’s financial plan involves decisions
about:
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Liquidity
Working Capital
Inventories
Capital Budgeting
Capital Structure
Dividends
The Financial Plan
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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
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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
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The outputs of the financial plan are:
• Pro forma (projected) financial
statements
• A set of budgets
Components of the Financial Plan
Every financial plan should have:
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Clearly stated strategic, operating and
financial objectives.
Assumptions on which the plan is
based.
Description of underlying strategies.
Contingency plans to deal with the
variances from expectations.
Benefits of Financial Planning
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Future (strategic) orientation
Identify and quantify assumptions
Preparing for contingencies (risk
analysis)
Identify funding requirements
Assess performance
Cash Budgets
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Cash budgets
• project and summarize cash inflows and
outflows
• show monthly cash balances
• show any short-term borrowing needed
to cover cash shortfalls
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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 handout.
Collections on Sales
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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
April
Sales
May
$1,200,000 $1,000,000
June
$1,000,000
t: 20%
t-1: 45%
t-2: 35%
$240,000
$270,000
$175,000
$200,000
$540,000
$210,000
$200,000
$450,000
$420,000
Total
$685,000
$950,000
$1,070,000
Collections on Sales
Uncollected sales at the end of June
(Accounts Receivable)
= 35%(May Sales) + (80% of June Sales)
= 35%($1,000,000) + 75%($1,000,000)
= $1,100,000
Cash Disbursements
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Cash Disbursements in April =
Purchases of 60%(May Sales)
+ Wages of 20%(April Sales)
+ Other Fixed Expenses of $120,000
60%($1,000,000)
+ 20%($1,200,000)
+ $120,000
$960,000
Cash Disbursements
April
Sales
Purchases
Wages
Other
Taxes
Total
May
$1,200,000 $1,000,000
June
$1,000,000
$600,000
$240,000
$120,000
$0
$600,000
$200,000
$120,000
$0
$300,000
$200,000
$120,000
$200,000
$960,000
$920,000
$820,000
Cash Budget
March
April
May
June
Collections
Disbursements
Net Cash Flow
$685,000
$960,000
($275,000)
$950,000
$920,000
$30,000
$1,070,000
$820,000
$250,000
Beginning Bal
+ Net Cash Flow
+ Draw (Pay) Loans
+ Sell (Buy) Mkt Sec
Ending Balance
$100,000
$100,000
($275,000)
$225,000
$50,000
$100,000
$100,000
$30,000
($30,000)
$100,000
$100,000
$250,000
($195,000)
($55,000)
$100,000
$0
$50,000
$225,000
$0
$195,000
$0
$0
$55,000
Total Loans
Total Mkt Sec
Cash Budget
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Tyler will have to borrow $225,000 in
April.
Tyler can repay $30,000 in May,
leaving an outstanding loan balance
of $195,000.
The short-term loan can be fully
repaid in June.
Cash Budget
MODEL problem C-1 (linked on the
web page) in a spreadsheet, using
input cells for the major
assumptions and good visual
formatting throughout. Check your
solution against the one provided
on the class web page.
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
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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
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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.
Percent of Sales Forecasting Method
If internally generated funds are
insufficient to finance the growth,
the firm may:
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Reduce the growth rate
Sell assets not required to run the firm
Obtain new external financing
Reduce or stop paying cash dividends.
Additional Financing Needed (AFN)
Let:
A/S = the increase in assets per dollar
increase in sales.
L/S = the increase in spontaneous
liabilities per dollar increase in sales.
S0 = current level of sales.
g = projected growth rate in sales.
M = net profit margin on sales.
D = cash dividends planned for common
stock.
Additional Financing Needed (AFN)
Additional Financing Needed (AFN) =
Required increase in assets
- Increase in (spontaneous)
liabilities
- Increase in retained earnings
NOTE: This a PERMANENT increase
in the funding requirement.
Additional Financing Needed (AFN)
Additional Financing Needed (AFN) =
Required increase in assets
- Increase in (spontaneous) liabilities
- Increase in retained earnings
AFN = (A/S)gS0 - (L/S)gS0 - [M(1+g)S0 - D]
Note: A/S, L/S, and AFN/g are NOT
CONSTANTS and MAY NOT BE
LINEAR or CONTINUOUS.
Additional Financing Needed
Peak Plastics expects rapid sales growth next year.
Sales for the current year were $4 million, and are
expected to grow by 20% next year. Peak wants to
estimate the external capital that will be required to
finance this growth. The firm estimates that
additional assets equal to 50% of the increase in
sales will be required. Liabilities will increase by
18% of sales. The net profit margin is 6% and Peak
expects to pay $84,000 in dividends to its common
stockholders.
Additional Financing Needed
(A/S)gS0 = $400,000
(L/S)gS0 = $144,000
M(1+g)S0 - D = $204,000
AFN = $52,000
Do problems 5 and 6 in the Smart text