1. BBA, MBA(Finance), London, UK
Topic # 05
Cash Flow &
Financial Planning
Zulfiqar Hasan
BBA, MBA(Finance), London, UK
Associate Professor

2. Contents
Financial Planning and Forecasting, Definition of Financial planning, Short Term Financial Plan & Long-Term Financial Plan, Sales Forecasts, Pro Forma Financial Statements, Analyzing the firms cashflow, Depreciation and MACRS, Types of firm’s cash flows, Determination of different cash flows: Operating Cash Flows, NCAI, NFAI and FCF
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3. Financial Planning Steps in Financial Forecasting Forecast sales
Financial Planning is the process of estimating the capital required and determining it’s competition. It is the process of framing financial policies in relation to procurement, investment and administration of funds of an enterprise.
The projection of sales, income, and assets based on alternative production and marketing strategies, as well as the determination of the resources needed to achieve these projection is called financial planning.
Steps in Financial Forecasting
Forecast sales
Project the assets needed to support sales
Project internally generated funds
Project outside funds needed
Decide how to raise funds
See effects of plan on ratios and stock price
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4. Objectives of Financial Planning
Determining capital requirements- This will depend upon factors like cost of current and fixed assets, promotional expenses and long- range planning. Capital requirements have to be looked with both aspects: short- term and long- term requirements.
Determining capital structure- The capital structure is the composition of capital, i.e., the relative kind and proportion of capital required in the business. This includes decisions of debt- equity ratio- both short-term and long- term.
Framing financial policies with regards to cash control, lending, borrowings, etc.
Maximum Utilization of Scares Resources: A finance manager ensures that the scarce financial resources are maximally utilized in the best possible manner at least cost in order to get maximum returns on investment.
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5. Importance of Financial Planning
Ensuring Adequate Funds: Financial planning is important because it ensures the adequate funds available to meet the needs of future, and present.
Preparing Good Budget: It helps to prepare a good budget
Assessing Financial Situation: Financial planning assess business' financial situation
Formulating Financial Strategies: It determines its objectives and formulating financial strategies of how to achieve them.
Performance Evaluation: Financial planning should become a continuous activity where the plan is reviewed regularly and performance measured against specific devised targets
Balance Between Outflow and Inflow of Funds: Financial Planning helps in ensuring a reasonable balance between outflow and inflow of funds so that stability is maintained.
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6. Importance of Financial Planning
Easy Investment Environment for Fund Suppliers: Financial Planning ensures that the suppliers of funds are easily investing in companies which exercise financial planning.
Making Growth and Expansion Programs: Financial Planning helps in making growth and expansion programs which helps in long-run survival of the company.
Facing Market Challenges Easily: Financial Planning reduces uncertainties with regards to changing market trends which can be faced easily through enough funds.
Reducing The Uncertainties: Financial Planning helps in reducing the uncertainties which can be a hindrance to growth of the company. This helps in ensuring stability an d profitability in concern.
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7. Financial Planner
An investment professional who helps individuals set and achieve their long-term financial goals, through investments, tax planning, asset allocation, risk management, retirement planning, and estate planning. The role of a financial planner is to find ways to increase the client's net worth and help the client accomplish all of his/her financial objectives.
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8. Financial Planning Types
Long-Term (Strategic) Financial Plans: An investment plan or strategy with a term of usually longer than one year. A long-term financial plan involves more uncertainty than anything short-term because, typically, market trends are more easily predictable in the short term. On the other hand, planning for the long-term is necessary in order to enjoy financial security in retirement. Thus, while planning for the long term is necessary, one's plan must be flexible to account for the uncertainty inherent to it.
Operating (Short-Term) Financial Planning: A financial plan outlining investment and other financial goals for the coming fiscal year. Short-term financial plans involve less uncertainty than long-term financial plans because, generally speaking, market trends are more easily predictable in the short term. Likewise, short-term financial plans are more easily amendable as a result of the short time frame. Short-term financial plans usually invest in short-lived securities, such as T-bills. A short-term financial plan aims to achieve goals that would be beneficial for one's long-term financial plan.
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9. 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.
Firms that are exposed to a high degree of operating uncertainty tend to use shorter plans.
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:
Proposed fixed asset investments
Research and development activities
Marketing and product development
Capital structure
Sources of financing
These plans are generally supported by a series of annual budgets and profit plans.
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10. 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 1- to 2-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.
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11. Pro Forma Financial Statements
Sales forecasts
Percent of sales method
Three important uses:
Forecast the amount of external financing that will be required
Evaluate the impact that changes in the operating plan have on the value of the firm
Set appropriate targets for compensation plans
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12. Depreciation
Depreciation: The systematic charging of a portion of the costs of fixed assets against annual revenues over time is called Depreciation. This is a historical cost of fixed assets over time.
Depreciable life of an Asset :The time period over which an asset is depreciated is called depreciable life of that asset.
The depreciable value of an asset (the amount to be depreciated) is its full cost, including outlays for installation. No adjustment is required for expected salvage value.
Example: Orin Corporation acquired a new machine at a price of $38000 and installation costs of $2000. What is the depreciable value of the machine?
Now, the Depreciable Value is: $40000
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13. MACRS: What is it?
One of the depreciation methods is MACRS which stands for Modified Accelerated Cost Recovery System. It is used to determine the depreciation of assets for tax purpose.
Some other depreciation methods are: Straight-line; Double-Declining balance and sum-of-the-year-digits.
First Four Property Classes Under MACRS
3 years: Research equipment and certain special tools.
5 years: Computers, typewriters, copiers, duplicating equipment, cars, light duty trucks, qualified technological equipment, and similar assets.
7 years: Office furniture, fixtures, most manufacturing equipment, railroad track, and single-purpose agricultural and horticultural structures.
10 years Equipment used in petroleum refining or in the manufacture of tobacco products and certain food products.
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14. Rounded Depreciation %age by recovery year using MACRS
3 years
5 years
7 years
10 years 1
33%
20%
14%
10% 2
45%
32%
25%
18% 3
15%
19% 4 7%
12% 5 9% 6 5% 8% 7 8 4% 6% 9 10 11
Total
100%
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15. Example 01: Calculating Depreciation using MACRS
Year
Cost
%age
Depreciation 1
$40000
20%
$8000 2 32
12800 3 19
7600 4 12
4800 5 6
2000
Total
100%
Boca Corporation purchased a machine having a cost of $40000 including installation cost and recovery period of 5 years. Find out the depreciation in each year.
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16. Practice 01: Calculating Depreciation
On March 20, 2009, Norton Systems acquired two new assets. Asset A was research equipment costing $17000 and having a 3-year recovery period. Asset B was duplicating equipment having an installed cost of $45000 and a 5-year recovery period. Using MACRS depreciation percentages,
Prepare a depreciation schedule for each of these assets.
Prepare a yearly total depreciation schedule for the organization
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17. Practice 02: Calculating Depreciation
On January, 2011, BIU acquired two new assets. Conference Table costing Tk with a carrying charge of Tk 1500 and having a 5-year recovery period. BIU Also purchased an AC from Singer costing Taka having an installed cost of Tk 3000 and a 5-year recovery period.
Using MACRS depreciation percentages, Prepare a yearly total depreciation schedule for the organization
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18. Firm’s Cash Flows Operating Cash Flow
Cashflow directly related to sale and production of the firm’s products and services.
Investment Cash Flow
Cashflow associated with purchase and sale of both fixed assets and business interests.
Financing Cash Flows
Cashflows that result from debt and equity financing transactions; includes incurrence and repayment of debt, cash inflow from the sale of stock, and cash outflows to pay cash dividends or repurchase stock.
Free cash flows
The amount of cashflow available to investors after the firm has met all operating needs and paid for investments in net fixed assets and not current assets.
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19. Baker Corporation Income Statement, 2010
Sales revenue $ 1700
Less: Cost of Goods Sold (1000)
Gross Profit $ 700
Less: Operating Expenses:
Selling Expenses ($ 110)
Lease exp ($120)
Depreciation exp ($100)
Total Operating Exp ($ 330)
Earnings Before Interest and Taxes (EBIT) $ 370
Less Interest Exp ($ 70)
Earnings Before Taxes (EBT) $ 300
Less: 40% ($ 120)
Net Profit After Taxes $180
Less: Preferred stock dividend ($ 10)
Earnings Available to Common stockholders $170
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20. Example 01: Calculating Operating Cashflow
A firm’s operating cash flow (OCF) is the cash flow it generates from its normal operations—producing and selling its output of goods or services
Calculate Baker Corporation’s Operating cashflow for 2008 from the given income statement.
Solution:
OCF = EBIT – Taxes + Depreciation
OCF = $370 – $120 + $100
OCF = $350
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21. FCF = OCF – NFAI – NCAI Free cash Flows
The firm’s free cash flow (FCF) represents the amount of cash flow available to investors—the providers of debt (creditors) and equity (owners)—after the firm has met all operating needs and paid for investments in net fixed assets and net current assets. It represents the summation of the net amount of cash flow available to creditors and owners during the period.
FCF = OCF – NFAI – NCAI
Here, NFAI = Net Fixed Asset Investment
NCAI = Net Current Asset Investment
NFAI = Change in net fixed Assets + Depreciation
NCAI = Change in Current Assets – Change in Accounts payable - Change in Accruals
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22. Example 02: Calculating NFAI
The Baker Corporations 2009 fixed asset was $1000 and 2010 fixed asset was $1200 and the depreciation for 2010 was $100. Find out the Baker’s NFAI.
Solution:
Fixed Assets in = $ 1200
Fixed Assets in = $ 1000
Change in Net Fixed Asset = $200
So,
NFAI = Change in net fixed Asset + Depreciation
= $ $ 100
= $ 300
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23. Example 03: Calculating NCAI
The following information is available for Baker Company’s 2010 and Balance Sheet statement.
2010
2009
Change
Current Asset
$2000
$1900 ?
Accounts Payable
$700
$500
Accruals
$100
$200
NCAI = Δ in Current Assets – Δ in A/P - Δ in Accruals)
NCAI = $ $ 200-(-$100) = $ 0
Example 04: Calculating FCF
From the previous example 01, 02 and 03, calculate the Free Cash Flow for Baker Company.
Solution:
FCF = OCF – NFAI – NCAI
FCF = $350 - $ $ 0 = $ 50
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24. A Sample Cash Flow Statement
Cash Flow from Operating Activities
Net profits after taxes (Net Income) $180
Depreciation
Decrease in accounts receivable
Decrease in inventories
Increase in accounts payable
Decrease in accruals (100)
Cash provided by operating activities $780
Cash Flow from Investment Activities
Increase in gross fixed assets ($300)
Changes in business interests 0
Cash provided by investment activities ( 300)
Cash Flow from Financing Activities
Decrease in notes payable ($100)
Increase in long-term debts
Changes in stockholders’ equity 0
Dividends paid (80)
Cash provided by financing activities
Net increase in cash and marketable securities $500
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25. Earnings before interests and Taxes (EBIT) 130 133.3
Practice: 01
Calculate FCF for 2010 from the following information:
Sales $1500 $1435
Cost of goods sold (1230) (1176.7)
Depreciation (50) (40)
Earnings before interests and Taxes (EBIT)
EBT
Taxes (40%) (36.0) (39.3)
Net income
Total Current Assets $
Total Fixed Assets
Total Assets $ $750.0
===== =====
Accounts payable $70.0 $60.0
Accruals
Long term bonds
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26. Practice: 02
The Bangla-Longla Company has purchased an asset which cost Taka and an installation charge of Taka 10,000 in the year of 2007 with five years of working life. The following information are given for Bangla-Longla Company. Calculate the FCF from the given information for 2009.
2009
2008
EBIT
Tk 27500
Depreciation
Tk ??????
Current Assets
Tk 8200
Tk 6800
Fixed Assets
Tk 14800
Tk 15000
Accounts Payable
Tk 1600
Tk 1500
Accruals
Tk 200
Tk 300
Taxes
Tk 933
Net Profit
Tk 1400
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27. Practice: 03
The Bangla-Longla Company has purchased an asset which cost Taka and an installation charge of Taka 10,000 in the year of 2008 with five years of working life. The following information are given for Bangla-Longla Company. Calculate the FCF from the given information for 2010.
2010
2009
EBIT
Tk 27500
Depreciation
Tk ??????
Current Assets
Tk 8200
Tk 6800
Fixed Assets
Tk 14800
Tk 15000
Accounts Payable
Tk 1600
Tk 1500
Accruals
Tk 200
Tk 300
Taxes
Tk 933
Net Profit
Tk 1400
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28. Practice 04: FCF Calculation
During the year, Xero, Ltd. Experienced an increase in net fixed assets of Tk and had depreciation of Tk It also experienced an increase in current assets of Tk and an increase in accounts payable of Tk If operating cash flow (OCF) for the year was Tk , Calculate the firm’s free cash flow (FCF) for the year.
NFAI = Change in net fixed Assets + Depreciation
= Tk Tk = Tk
NCAI = Change in Current Assets – Change in Accounts payable - Change in Accruals)
= Tk – Tk – Tk 0 = Tk 75000
FCF = OCF – NFAI – NCAI
So, FCF = Tk – Tk – Tk 75000
FCF = Tk
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29. Example 06: Accounting Cash Flow
A firm had earnings after taxes of $50,000 in Depreciation charges were $28,000, and a $2,000 charge for amortization of a bond discount was incurred. What was the firm’s accounting cash flow from operations during 2009?
Cash flow from operations = Net profits after taxes + Depreciation + other noncash charges
Solutions:
Earnings after taxes $50,000
Plus: Depreciation 28,000
Plus: Amortization 2,000
Cash flow from operations $80,000
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30. Practice 05: Depreciation and accounting cash flow
A firm in the third year of depreciating its only asset, which originally cost $180,000 and has a 5-year MACRS recovery period, has gathered the following data relative to the current year’s operations.
Accruals $ 15,000
Current assets ,000
Interest expense ,000
Sales revenue ,000
Inventory ,000
Total costs before depreciation, interest, and taxes 290,000
Tax rate on ordinary income %
Use the relevant data to determine the accounting cash flow from operations for the current year.
Explain the impact that depreciation, as well as any other noncash charges, has on a firm’s cash flows.
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31. Solution: Depreciation and accounting cash flow
a. Cash flow from operations:
Sales revenue $400,000
Less: Total costs before depreciation,
interest, and taxes ,000
Depreciation expense ,200
Interest expense ,000
Net profits before taxes $ 60,800
Less: Taxes at 40% ,320
Net profits after taxes $ 36,480
Plus: Depreciation ,200
Cash flow from operations $ 70,680
b. Depreciation and other noncash charges serve as a tax shield against income, increasing annual cash flow.
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32. Home Practice 01
Consider the balance sheets and selected data from the income statement of Keith Corporation that follow.
Calculate the firm’s accounting cash flow from operations for the year ended December 31, 2003,
Calculate the firm’s operating cash flow (OCF) for the year ended December 31, 2003,
Calculate the firm’s free cash flow (FCF) for the year ended December 31, 2003,
Interpret, compare, and contrast your cash flow estimates in parts a, b, and c.
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