1. 1 Financial Planning & Forecasting Timothy R. Mayes, Ph.D. FIN 3300: Chapter 4

2. 2 The Ingredients of a Financial Plan v A financial plan consists of several ingredients Expectations about the economic environment A sales forecast Pro forma (forecasted) financial statements Asset requirements Required new financing Cash Budget v We will focus on developing the pro formas and the cash budget

3. 3 Forecasting: The % of Sales Method v The most basic method of forecasting financial statements (income statements and balance sheets) is the percent of sales method v This method assumes that certain expenses, assets, and liabilities maintain a constant relationship to the level of sales v There are two inputs to this method: A sales forecast (exogenous) The percentages which are assumed to be constant

4. 4 Forecasting the Income Statement No change

5. 5 Types of Assets and Liabilities v There are two types of assets: Current assets are the firm’s short-term assets and can generally be expected to vary directly with sales Fixed assets are the firm’s long-term assets and generally do not vary directly with sales v There are two types of liabilities: Spontaneous liabilities are those that occur naturally during the ordinary course of doing business. These sources vary directly with sales Discretionary liabilities are those that require a special effort for the firm to obtain. These sources do not vary directly with sales

6. 6 Forecasting the Balance Sheet

7. 7 Discretionary Financing Needed v Ordinarily, the pro-forma balance sheet will not balance! v This is intentional, and the amount needed to make it balance is referred to as the Discretionary Financing Needed, DFN (or External Financing Needed, EFN) v This is a “plug figure” that represents the amount of discretionary financing that the firm will need to obtain in order to support its forecasted level of sales

8. 8 The Cash Budget v A cash budget is a document which shows the expected cash inflows and outflows for a chosen time period (say, 6 or 9 months). v The benefits of the cash budget are: It provides an estimate of the ending cash balance in each month It provides estimates and sources of the cash inflows and outflows It provides a basis of comparison against which managers can be evaluated

9. 9 Parts of the Cash Budget v In a simple cash budget, there are three parts: The Worksheet Area The Inflows and Outflows The calculation of the ending cash balance v Essentially, a cash budget starts with the beginning cash balance, adds expected cash inflows, and subtracts any expected cash outflows. The result is the expected ending cash balance.

10. 10 Cash Budget: An Example v Here is the information required to assemble the cash budget for Bithlo Barbecues: Expected sales are on the next slide 40% of sales are for cash. Of the remainder, 75% is collected the following month, and 25% is collected two months after the sale. Inventory purchases are equal to 50%of the next month’s sales. 60% of purchases are paid for the following month, and the remainder one month later. Wages are 20% of sales. Leasing expenses is $10,000 per month. Interest payments of $30,000 are due in June and September. A $50,000 dividend payment will be made in June. Taxes of $25,000 are due in June and September. A $200,000 capital improvement will be paid for in July. The company must keep a minimum cash balance of $15,000.

11. 11 Cash Budget: Worksheet Area v The worksheet area is where we gather certain key numbers which will be used in the rest of the cash budget.

12. 12 Cash Budget: Inflows & Outflows v This section shows all of the cash collections and disbursements. Note that these are only cash inflows and outflows. The cash budget is not the same as the income statement.

13. 13 Cash Budget: The Ending Cash Balance v This section is where we calculate the ending cash balance and determine if we will need to borrow for each month. Note that Bithlo Barbecues will need to borrow in June and July, and will have excess cash in August and September.