1. Corporate Finance, Concise
Principles of
Corporate Finance, Concise
Second Edition
Chapter 19
Financial Planning
Slides by
Matthew Will
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 1 1 1 1 2 1

2. Topics Covered
Links Between Long-Term and Short-Term Financing Decisions
Tracing Changes in Cash
Cash Budgeting
Short-Term Financing Plan
Long-Term Financing Plan
Growth and External Financing 2 2 2 2 3 2

3. Firm’s Cumulative Capital RequirementB C
Year 2
Year 1
Dollars
Cumulative
capital requirement
Time
Lines A, B, and C show alternative amounts of long-term finance.
Strategy A: A permanent cash surplus
Strategy B: Short-term lender for part of year and borrower for remainder
Strategy C: A permanent short-term borrower

4. Balance Sheet
Example - Dynamic Mattress Company 21

5. Income Statement
Example - Dynamic Mattress Company 22

6. Changes in Cash Flows
Example - Dynamic Mattress Company 23

7. Changes in Cash Flows Example - Dynamic Mattress Company
Dynamic sources of cash flows
It earned $60 million of net income (operating activity).
It set aside $20 million as depreciation. Remember that depreciation is not a cash outlay. Thus, it must be added back in order to obtain Dynamic’s cash flow (operating activity).
It reduced inventory, releasing $5 million (operating activity).
It increased its accounts payable, in effect borrowing an additional $25 million from its suppliers (operating activity).
It issued $30 million of long-term debt (financing activity). 24

8. Changes in Cash Flows Example - Dynamic Mattress Company
Dynamic uses of cash flows
It allowed accounts receivable to expand by $25 million (operating activity). In effect, it lent this additional amount to its customers.
It invested $30 million (investing activity). This shows up as the increase in gross fixed assets in Table 29.2.
It paid a $30 million dividend (financing activity). (Note: The $30 million increase in Dynamic’s equity in Table 29.2 is due to retained earnings: $60 million of equity income, less the $30 million dividend.)
It purchased $25 million of marketable securities (financing activity).
It repaid $25 million of short-term bank debt (financing activity)). 24

9. Working Capital Simple Cycle of operations Cash Raw materials
Receivables
Finished goods 4

10. The Cash Cycle 14

11. Cash Budgeting Steps to preparing a cash budget
Step 1 - Forecast the sources of cash.
Step 2 - Forecast uses of cash.
Step 3 - Calculate whether the firm is facing a cash shortage or surplus. 25

12. Cash Budgeting
Example - Dynamic Mattress Company Dynamic forecasted sources of cash AR ending balance = AR beginning balance + sales - collections 26

13. Cash Budgeting
Example - Dynamic Mattress Company Dynamic collections on AR 27

14. Cash Budgeting Example - Dynamic Mattress Company
Dynamic forecasted uses of cash
Payment of accounts payable
Labor, administration, and other expenses
Capital expenditures
Taxes, interest, and dividend payments 28

15. Cash Budgeting
Example Dynamic cash budget 29

16. A Short Term Financing Plan
Example - Dynamic Mattress Company- Financing Plan continued 32

17. A Short Term Financing Plan
Example - Dynamic Mattress Company- Financing Plan 32

18. Financial Planning
Planning Horizon - Time horizon for a financial plan.
Departments are often asked to submit 3 alternatives
Optimistic case = best case
Expected case = normal growth
Pessimistic case = retrenchment
Financial plans help managers ensure that their financial strategies are consistent with their capital budgets. They highlight the financial decisions necessary to support the firm’s production and investment goals. 8

19. Financial Planning Why Build Financial Plans? Contingency planning
Considering options
Forcing consistency 9

20. Financial Planning Steps
Inputs
Planning Model
Planning Model - Equations specifying key relationships.
Outputs
Outputs - Projected financial statements (pro forma). Financial ratios. Sources and uses of funds.
Inputs - Current financial statements. Forecasts of key variables (such as sales or interest rates). 12

21. Dynamic Mattress Financial Plan
Condensed year-end balance sheets for
2009 and 2008 for Dynamic Mattress
Company (figures in $ millions).

22. Dynamic Mattress Financial Plan
Latest and forecasted operating cash flows for Dynamic Mattress Company (figures in $ millions).

23. Dynamic Mattress Financial Plan
Latest and forecasted amounts of external capital required for Dynamic Mattress Company
(figures in $ millions).

24. Dynamic Mattress Financial Plan
Latest and pro forma balance sheets for Dynamic Mattress Company (figures in $ millions).

25. Financial Planning Models
Pro Formas - Projected or forecasted financial statements.
Percentage of Sales Model - Planning model in which sales forecasts are the driving variable and most other variables are proportional to sales.
Balancing Item - Variable that adjusts to maintain the consistency of a financial plan. Also called plug. 13

26. Planners Beware
Many models ignore realities such as depreciation, taxes, etc.
Percent of sales methods are 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. 17

27. Growth & External Financing
Sustainable growth rate - Steady rate at which a firm can grow without changing leverage 20

28. Web Resources Click to access web sites Internet connection required