Tutorial Chapter III Cash Flow and Financial Planning

Cash Flow and Financial Planning - Goals Tax depreciation procedures The firm’s statement of cash flows Financial planning process (short-term and long-term) Cash-planning process (cash budget) The pro forma income statement The pro forma balance sheet

Depreciation = systematic charging of a portion of costs of Fixed Assets against revenues over time. -The amount is determined by using Modified Accelerated Cost Recovery System (MACRS) -Depreciable value -Depreciable life

Statement of CF -Summarizes the firm‘s CF over a given period of time CF is divided into- operating flows - investment flows - financing flows Inflows – Decrease in A, Increase in Liab., EAT, Depreciation, Sale of stock Outflows – Inc. in A, Dec. in Liab., Net loss, Dividends paid, Repurchase of stock

Formulas CF from operations = EAT + Depreciation Operating CF = EBIT*(1-T) + Depreciation = NOPAT + Depreciation FCF = OCF – NFAI – NCAI NFAI = Change in net fixed A + Depreciation NCAI = Change in current A – Change in (accounts payable + accruals)

Financial planning process Long-term financial plans – cover a 2 to 10 years period, Strategic decisions Short-term financial plans – cover 1 to 2 years period, Operating financing Cash Budget = a statement of a firm‘s planned inflows and outflows of cash. As a basis is used the sales forecast provided by the marketing department.

Financial planning process Profit planning – Pro-Forma Statements Pro-Forma Statements = projected income statements and balance sheets, two inputs are needed - the sales forecast and the financial statements for the preceding year. Preparing Pro-Forma Income Statement – percent-of-sales method Preparing Pro-Forma Balance Sheet – judgmental approach

Exercise Determine OCF Sales of $2,500,000 Cost of goods sold $ 1,800,000 Operating expenses $300,000 Depreciation expenses $200,000 Tax rate 35%

Exercise 3 – 3 Solution OCF = [EBIT * (1-t)] + Depreciation EBIT = $2,500,000 - $1,800,000 - $300,000 = $400,000 OCF = [$400,000 * ( )] + $200,000 = $460,000

Exercise Calculate FCF Increase in fixed assets $300,000 Depreciation $200,000 Increase in current assets $150,000 Increase in accounts payable $75,000 OCF was $700,000

Exercise 3 – 4 Solution FCF = OCF - NFAI - NCAI NFAI = change in fixed assets + depreciation NFAI = $300,000 + $200,000 = $500,000 NCAI = change in current assets - change in (acc. payable + accruals) NCAI = $150,000 - $75,000 = $75,000 OCF = $700,000 FCF = $700,000 - $500,000 - $75,000 = $125,000

Exercise Estimate net profits before taxes Sales forecast of $650,000 Fixed costs of $250,000 Variable costs 35% of Sales Operating expenses include fixed costs of $28,000 and variable costs 7,5% of sales Interest expenses are $20,000

Exercise 3 – 5 Solution

Problem Accounting cash flow Earnings after taxes $50,000 Depreciation $28,000 Amortization $2,000 What was the firms accounting cash flow from operations?

Problem 3 – 2 Solution Earnings after taxes $50,000 Plus: Depreciation $28,000 Plus: Amortization $ 2,000 Cash Flow from operations $80,000 Note: Deprec. and Amor. are non-cash charges. Depreciation is charged against tangible assets, amortization is charged against intangible assets.

Problem Depreciation and accounting Cash Flow Asset original cost of $180,000 has a 5-year MACRS recovery period, now in 3rd year (19%) Accruals $15,000 Current assets $120,000 Interest expense $15,000 Sales revenue $400,000 Inventory $70,000 Total cost before deprec., int. and tax $290,000 Tax rate on ordinary income 40%

Problem 3 – 4 Solution

Problem 3 - 5

Problem 3 – 5 Solution

Problem Cash receipts Sales of $65,000 in April, $60,000 in May Sales of $70,000 in June, $100,000 in July and in August Half of sales are for cash and the other half is collected evenly over next 2 months What are firms expected cash receipts for June, July and August? Use Excel sheet (Problem 3-7.xlsx)

Problem 3 – 7 Solution

Problem Cash disbursement schedule for April, May and June Sales from February: $500,000 $500,000 $560,000 $610,000 $650,000 $650,000 Purchases: 60% of next month’s sales, 10% in cash, 50% after 1 month, 40% after 2 month Rent: $8,000 per month Wages and Salaries: Fixed $6,000/month + 7% of sales Taxes: $54,500 due in June Fixed asset outlays: New equipment in April for $75,000 Interest payments: A payment of $30,000 is due in June Cash dividends: $12,500 will be paid in April Principal payments and retirements: None Use Excel sheet (Problem 3-8.xlsx)

Problem 3 – 8 Solution

Problem Pro forma income statement Use the percent of sales method to prepare a pro forma income statement Use fixed and variable cost data to develop a pro forma income statement Use Excel sheet (Problem 3-14.xlsx)

Problem 3 – 14 Solution a)

Problem 3 – 14 Solution b) Using fixed and variable costs higher profit is projected Percent of sales method is more conservative, but fixed and variable costs method is more accurate

Problem Pro forma balance sheet Analyze expected performance and financing needs for yrs ahead Prepare pro forma balance sheet dated Dec Discuss the financing changes suggested by the statement prepared Use Excel sheet (Problem 3-17.xlsx)

Problem 3 – 17 Solution Company must arrange for additional financing of at least $775,000 over the next two years based on the given constraints and projections