Cash Flow and Financial Planning Chapter 2 Cash Flow and Financial Planning

Primary focus of the financial manager in managing day-to-day finances and in planning and making strategic decisions is Cash Flow. Cash flow - the lifeblood of the firm.

Analyzing the Firm’s Cash Flows Cash flow (as opposed to accounting “profits”) is the primary focus of the financial manager. An important factor affecting cash flow is depreciation. Financial managers are much more concerned with cash flows rather than profits.

Depreciation is the systematic charging of a portion of the costs of fixed assets against annual revenues over time. Allocation of historical cost over time is called depreciation. A variety of depreciation methods are available for financial reporting purposes. Depreciation for tax purpose is determined by using the written down value (WDV).

Cash Flow Statement All firms prepare a statement called as Cash Flow Statement. From an accounting perspective, cash flow is summarized in a firm’s statement of cash flows. The statement of cash flows (cash flow statement)summarizes the firm’s cash flow over a given period of time.

The statement of cash flows is divided into three sections: Operating flows Investment flows Financing flows

OPERATING FLOWS: Cash flows directly related to sale and production of the firm’s products and services. INVESTMENT FLOWS: Cash flows associated with purchase and sale of both fixed assets and business interests. FINANCING FLOWS: Cash flows that result from debt and equity financing transactions.

Financial planning Financial planning provides road maps for guiding, coordinating and controlling the firm’s actions to achieve its objectives. Two key aspects of financial planning are cash planning and profit planning. Cash planning involves the preparation of the firm’s cash budget. Profit planning involves the preparation of both cash budgets and pro forma financial statements.

Cash budget and the pro forma statements are useful for internal financial planning. The financial planning process begins with long-term, or strategic, financial plans these in turn guides the formulation of short-term or operating plans and budget. Generally the short-term plans and budgets implement the firm’s long-term strategic objectives.

Long-Term (Strategic) Financial Plans Long-term strategic financial plans lay out a company’s planned financial actions and the anticipated impact of those actions over periods ranging from 2 to 10 years. These plans are one component of a company’s integrated strategic plan (along with production and marketing plans) that guide a company toward achievement of its goals.

Long-term financial plans consider a number of financial activities including: a) Proposed fixed asset investments b) Research and development activities c) Marketing and product development d) Capital structure e)Sources of financing These plans are generally supported by a series of annual budgets and profit plans.

Short-Term (Operating) Financial Plans Short-term (operating) financial plans specify short-term financial actions and the anticipated impact of those actions and typically cover a one to two year operating period. Key inputs include the sales forecast and other operating and financial data. Key outputs include operating budgets, the cash budget, and pro forma financial statements.

Short-term financial planning begins with a sales forecast. From this sales forecast, production plans are developed that consider lead times and raw material requirements. From the production plans, direct labor, factory overhead, and operating expense estimates are developed. From this information, the pro forma income statement and cash budget are prepared—ultimately leading to the development of the pro forma balance sheet.

Cash Budgets The cash budget or cash forecast is a statement of the firm’s planned inflows and outflows of cash that is used to estimate its short-term cash requirements. It is used to estimate short-term cash requirements with particular attention to anticipated cash surpluses and shortfalls.

Surpluses must be invested and deficits must be funded. The cash budget is a useful tool for determining the timing of cash inflows and outflows during a given period. Typically, monthly budgets are developed covering a 1-year time period.