1. Chapter 15 Planning: Forecasting and Budgeting

2. Planning The process of –Establishing goals –Identifying courses of action (strategies) –Planning the need for funds –Their amounts and timing

3. Asset Requirements Assets that fluctuate over time Assets that fluctuate with sales Assets that are independent of the level of sales

4. Asset Requirements

6. Forecasting: Percent of Sales Identification of assets and liabilities that spontaneously fluctuate with sales Expressing those assets and liabilities as a percent of sales Using the percentage to forecast the level of thoseassets and liabilities

7. Forecasting: Percent of Sales The primary assets and liabilities that spontaneously fluctuate with sales are –Account receivable –Inventory –Accruals –Accounts payable

8. Forecasting: Percent of Sales Cash may also vary with sales Plant and equipment varies depending if the firm is operating at capacity

9. Forecasting: Percent of Sales The percent of sales as an equation using inventory as an illustration: I = b S I inventory b the percentage S sales

10. Forecasting: Percent of Sales The percent of sales illustrated in a figure using inventory:

11. Forecasting: The Need for External Finance Forecasted expansion in assets is a use of funds Forecasted expansion in liabilities is a source of funds

12. Forecasting: The Need for External Finance If the forecasted expansion in assets exceeds the forecasted expansion in liabilities, the firm will need funds One possible source is the retention of earnings

13. Forecasting: The Need for External Finance If the forecasted increase in assets exceeds the forecasted increase in liabilities and retained earnings, the firm will need external finance

14. Forecasting: The Need for External Finance In equation form: EFR = [A(  S) - L(  S)] - (PS 1 )R S S

15. EFR External Funds Requirement S sales A assets L liabilities  S change in sales S 1 projected total sales P profit margin on sales R proportion of earnings retained

16. Forecasting: Regression Analysis Instead of expressing assets and liabilities as a percent of sales and using that percent to forecast Express the relationship between those assets and liabilities as a simple,linear equation: Y = a + bX

17. Forecasting: Regression Analysis I = a + bS I inventory S sales a: the Y-intercept b: the slope of the line The equation is used to forecast the level of inventory at any level of inventory

18. Forecasting: Regression Analysis

19. Importance of Correlation The closer the individual data points lie near the estimated line, the closer the fit Closer fit implies better predictive power

20. The Coefficient of Determination (r 2 ) Gives the proportion of the variation in the dependent variable (e.g., inventory) explained by the variation in the independent variable (e.g., sales)

21. Forecasting: Changes in Fixed Assets Previous methods isolated assets and liabilities that change with sales Plant and equipment may expand in discrete units

22. The Cash Budget Forecasts cash receipts and cash disbursements Income statement summarizes revenues and expenses

23. The Cash Budget Items may appear on a cash budget but not on an income statement (e.g., repayment of a loan) Items may appear on an income statement but not on a cash budget (e.g., depreciation)

24. The Cash Budget A table relating receipts and disbursements over time Bottom line: forecast of excess cash, which may beinvested, or cash shortage

25. The Cash Budget Part 1: The Receipts Cash sales Collections of accounts receivable Other cash receipts Sum of the receipts

26. The Cash Budget Part 2: The Disbursements Variable cash payments Fixed cash payments Other cash payments Sum of the disbursements

27. The Cash Budget Part 3: Determination of Excess Cash or Cash Shortage Cash gain/loss Beginning cash position Ending cash position Desired level of cash Cumulative cash

28. Monthly Cash Budget Part 1MayJuneJuly 1.Anticipated sales $15,000$20,000$30,000 2.Cash sales 4,5006,0009,000 3.Accounts collected (one-month lag) 9,45012,600 4.Accounts collected (two-month lag) 1,050 5.Other cash receipts 10,000 6.Total cash receipts 4,50025,45022,650

29. Monthly Cash Budget Part 2MayJuneJuly 7.Variable cash disbursements 3,00025,00038,000 8.Fixed cash disbursements 3,000 9.Other cash disbursements 10.Total cash disbursements 6,00028,00041,000

30. Monthly Cash Budget Part 3MayJuneJuly 11.Cash gain (or loss) during the month (line 6 minus line 10) (1,500)(2,550)(18,350) 12.Cash position at beginning of month 12,00010,5007,950 13.Cash position at end of month (line 12 minus line 11) 10,5007,950(10,400) 14.Less desired level of cash (10,000) 15.Cumulative excess (or shortage) of cash (line 13 minus line 14 500(2,050)(20,400)

31. Monthly Cash Budget Indicates need for $2,050 in June Need increases in July by $18,350 Total need for funds in July: $20,400