29 Financial planning McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

Figure 29.1 firm’s cumulative capital requirement The diagram shows cumulative capital requirements of a firm over time. Working-capital management requires a lot of time and effort. Three strategies are discussed. Strategy A: provides a permanent cash surplus. Strategy B: The firm is a short-term lender for part of the year and borrower for remainder. Strategy C: A permanent short-term borrower. There is a quick payback when good policies are implemented. Line A: Permanent cash surplus Line B: Short-term lender for part of year, borrower for remainder Line C: Permanent short-term borrower

Figure 29.2 cash as percent of assets, U.S. nonfinancial firms On average, firms in the United States hold a much higher proportion of their assets in cash and marketable securities than was once the case.

Table 29.1 income statement, dynamic mattress, 2012 ($ millions) This is an example that shows Dynamic Mattress Company’s balance sheet statement.

Table 29.2 year-end balance sheets, dynamic mattress ($ Millions) This is an example that shows Dynamic Mattress Company’s income statement.

Table 29.3 statement of cash flows, dynamic mattress , 2012 ($ millions) This table shows the changes in cash balance of the firm through sources and uses of cash statement.

29-2 tracing changes in cash Example Sources of cash flows for Dynamic Mattress Earned $60m net income (operating activity) Set aside $20m as depreciation Depreciation is not cash outlay, must be added back in order to obtain cash flow (operating activity) Released $5m in inventory (operating activity) Increased accounts payable, borrowed $25m from suppliers (operating activity) Issued $30m long-term debt (financing activity) The complete list of sources of cash is presented. For a short-term financial plan, the uses and sources of cash must be established.

29-2 tracing changes in cash Example, continued Uses of cash flows for Dynamic Mattress Expanded accounts receivable by $25 million (operating activity) Invested $30 million (investing activity) Paid $30 million dividend (financing activity) Purchased $25 million marketable securities (financing activity) Repaid $25 million short-term bank debt (financing activity) As a follow-up to the previous slide, the uses of cash are presented.

29-2 tracing changes in cash Simple Cycle of Operations The diagram shows a simple cash cycle.

29-2 tracing changes in cash Cash Cycle The component parts of the cash cycle are presented and calculated. Each has its name next to the formula and will be used in ratio analysis.

29-3 Cash budgeting Steps to Prepare Cash Budget Forecast sources of cash Forecast uses of cash Calculate whether firm is facing cash shortage or surplus Spreadsheet programs are very useful for preparing a cash budget. It basically involves three steps. Sales forecast is the input for developing a cash budget.

29-3 Cash budgeting Example Dynamic Mattress forecasted sources of cash Accounts receivable ending balance = accounts receivable beginning balance + sales - collections Quarterly sales forecasts for Dynamic Mattress Company are given.

Table 29.4 collections on accounts receivable ($ millions) The next four frames show how to develop a quarterly cash budget using sales forecasts. Large firms prepare forecasts monthly, weekly, or even daily. Eighty percent of sales are collected the same month, and 20 percent of current month sales are collected the following month. This pattern differs from firm to firm. Normally, this is based on historical collection practices. The increase or decrease in receivables is equal to (sales − collections).

29-3 Cash budgeting Example Forecasted uses of cash for Dynamic Mattress Payment of accounts receivable Labor, administration, and other expenses Capital expenditures Taxes, interest, and dividend payments The uses of cash depend on many other factors like capital expenditures, payment on accounts payable, labor, administrative and other expenses, and payments like taxes, interest, and dividend payments. A firm might stretch accounts payables to following months.

Table 29.5 cash budget for 2013, dynamic mattress company ($ Millions) The table shows sources and uses of cash. Other cash flows might be from selling land or an expected tax refund, etc.

Table 29.6a dynamic mattress financing plan ($ millions) This shows the first financing plan. But coming up with the final plan is a trial-and-error process. Many short-term financial planning models are also available for large firms.

Table 29.6b dynamic mattress financing plan ($ millions) This is a continuation of the previous slide data.

29-5 long-term financial planning Planning Horizon Time horizon for financial plan Departments often asked to submit three alternatives Optimistic Expected Pessimistic Financial plans ensure plans stay consistent with capital budgets All plans must have a time horizon. Review the nature of why one selects a specific time frame and note the subjectivity involved in such a decision.

29-5 long-term financial planning Why Build Financial Plans? Contingency planning Considering options Forcing consistency Here is a good place to review a list of why you need a plan. PMIH (Planning Makes It Happen). Have the students give you a list of their reasons, beyond the list provided.

29-5 long-term financial planning Inputs Current financial statements, forecasts of key variables Planning Model Equations specifying key relationships Outputs Projected financial statements (pro forma), financial ratios, sources and uses of funds Inputs Planning Model Outputs Walk through each step in the process and review where the inputs and outputs come from. If you have to write an example on the board, do so. It is important for students to know the source of their data.

29.7 condensed year-end balance sheet, dynamic mattress ($ millions) a When only net working capital appears on firm’s balance sheet, this figure is referred to as total capitalization Start with the condensed year-end balance sheets for 2012 and 2011 for Dynamic Mattress Company. This is where we begin to create our plan.

Table 29.8 actual (2012) and forecasted operating cash flows, dynamic mattress Present a list of forecasted income statements. We often call this a pro forma. Take time to explain the subjective nature of this and why we may find errors.

Table 29.9 actual (2012) and forecasted required external capital From the income statement forecast and the balance sheet, we can see where our cash will come from. If we do not have internal money, we will need to raise external funds. If we have excess funds, we must decide to pay a dividend or not. This slide shows the flow of cash.

Table 29.10 actual (2012) and pro forma balance sheets, dynamic mattress Here we see how the use of capital translates into fixed assets, debt, and equity. If we have constraints on any of these items, they should be dealt with on this slide.

29-5 long-term financial planning Pro Formas Projected or forecasted financial statements Percentage of Sales Model Sales forecasts are driving variable, most other variables proportional to sales Balancing Item Variable that adjusts to maintain consistency of financial plan, also called plug The terms used previously are defined here. We have already employed all these items and now attach names.

29-5 long-term financial planning Planners Beware Many models ignore realities such as depreciation, taxes, etc. Percent of sales methods not realistic because fixed costs exist Most models generate accounting numbers, not financial cash flows Adjustments must be made to consider these and other factors These are warnings for planners.

29-6 growth and external financing Sustainable Growth Rate Steady rate at which firm can grow without changing leverage Growth comes from reinvestment. This shows the methods used to determine the level of growth.