1. Chapter 22 Financial Planning Emery and Finnerty: Corporate Financial Management Edited by Hawley

2. The Financial Planning Process Liquidity Liquidity Working Capital Working Capital Inventories Inventories Capital Budgeting Capital Budgeting Capital Structure Capital Structure Dividends Dividends A firm’s financial plan involves decisions about:

3. The Financial Plan Financial planning is the process of evaluating the impact of alternative investing and financing decisions of the firm. Financial planning is the process of evaluating the impact of alternative investing and financing decisions of the firm. Every financial plan has three components: Every financial plan has three components: A modelA model InputsInputs OutputsOutputs

4. The Financial Plan The model is a set of mathematical relationships between the inputs and the outputs. The model is a set of mathematical relationships between the inputs and the outputs. Inputs to the model may include: Inputs to the model may include: Projected salesProjected sales CollectionsCollections CostsCosts Interest ratesInterest rates Exchange ratesExchange rates

5. The Financial Plan The outputs of the financial plan are: The outputs of the financial plan are: Pro forma (projected) financial statementsPro forma (projected) financial statements A set of budgetsA set of budgets

6. Components of the Financial Plan Every financial plan should have: Clearly stated strategic, operating and financial objectives. Clearly stated strategic, operating and financial objectives. Assumptions on which the plan is based. Assumptions on which the plan is based. Description of underlying strategies. Description of underlying strategies. Contingency plans to deal with the variances from expectations. Contingency plans to deal with the variances from expectations.

7. Benefits of Financial Planning Future (strategic) orientation Future (strategic) orientation Identify and quantify assumptions Identify and quantify assumptions Preparing for contingencies (risk analysis) Preparing for contingencies (risk analysis) Identify funding requirements Identify funding requirements Assess performance Assess performance

8. Cash Budgets Cash budgets Cash budgets project and summarize cash inflows and outflowsproject and summarize cash inflows and outflows show monthly cash balancesshow monthly cash balances show any short-term borrowing needed to cover cash shortfallsshow any short-term borrowing needed to cover cash shortfalls Are based on sales forecasts. Are based on sales forecasts. Are usually constructed on a monthly basis. Are usually constructed on a monthly basis.

9. Preparing a Cash Budget Prepare a cash budget for Tyler Paints for the months of April, May and June, given the information in the handout.

10. Collections on Sales Collections in April are: Collections in April are: 20% of April Sales 45% of March Sales 35% of February Sales 20%($1,200,000) = $240,000 45%($600,000) = $270,000 35%($500,000) = $175,000 $685,000 $685,000

11. Collections on Sales

12. Uncollected sales at the end of June (Accounts Receivable) Uncollected sales at the end of June (Accounts Receivable) = 35%(May Sales) + (80% of June Sales) = 35%($1,000,000) + 75%($1,000,000) = $1,100,000

13. Cash Disbursements Cash Disbursements in April = Cash Disbursements in April = Purchases of 60%(May Sales) Purchases of 60%(May Sales) + Wages of 20%(April Sales) + Other Fixed Expenses of $120,000 60%($1,000,000) 60%($1,000,000) + 20%($1,200,000) + $120,000 $960,000 $960,000

14. Cash Disbursements

15. Cash Budget

16. Tyler will have to borrow $225,000 in April. Tyler will have to borrow $225,000 in April. Tyler can repay $30,000 in May, leaving an outstanding loan balance of $195,000. Tyler can repay $30,000 in May, leaving an outstanding loan balance of $195,000. The short-term loan can be fully repaid in June. The short-term loan can be fully repaid in June.

17. Cash Budget MODEL problem C-1 (linked on the web page) in a spreadsheet, using input cells for the major assumptions and good visual formatting throughout. Check your solution against the one provided on the class web page. MODEL problem C-1 (linked on the web page) in a spreadsheet, using input cells for the major assumptions and good visual formatting throughout. Check your solution against the one provided on the class web page.

18. Pro Forma Financial Statements Pro Forma Statements: Pro Forma Statements: Show the effect of the firm’s decisions on its future financial statements.Show the effect of the firm’s decisions on its future financial statements. Effects of alternative decisions and sensitivity to changes in assumptions can be examined.Effects of alternative decisions and sensitivity to changes in assumptions can be examined.

19. Percent of Sales Forecasting Method Assumes that some IS/BS items stay constant as a percent of sales as sales vary. Assumes that some IS/BS items stay constant as a percent of sales as sales vary. In general, Accounts Receivable, Inventory, Accounts Payable (on the balance sheet), and cost of goods sold and some operating expenses (on the income statement) vary with sales (maintain the same percentage of sales) or cost of goods sold. In general, Accounts Receivable, Inventory, Accounts Payable (on the balance sheet), and cost of goods sold and some operating expenses (on the income statement) vary with sales (maintain the same percentage of sales) or cost of goods sold. Other items are either fixed with respect to changes in sales or they are “plug” figures. Other items are either fixed with respect to changes in sales or they are “plug” figures.

20. Percent of Sales Forecasting Method Sales growth results in: Sales growth results in: increase in current and fixed assetsincrease in current and fixed assets increase in spontaneous short-term financingincrease in spontaneous short-term financing increase in profitabilityincrease in profitability The increase in current assets must be financed from internally generated funds or external funds. The increase in current assets must be financed from internally generated funds or external funds. Note WELL: You can go BUST by letting GROWTH outrun your CASH. Note WELL: You can go BUST by letting GROWTH outrun your CASH.

21. Percent of Sales Forecasting Method If internally generated funds are insufficient to finance the growth, the firm may: If internally generated funds are insufficient to finance the growth, the firm may: Reduce the growth rate Reduce the growth rate Sell assets not required to run the firm Sell assets not required to run the firm Obtain new external financing Obtain new external financing Reduce or stop paying cash dividends. Reduce or stop paying cash dividends.

22. Additional Financing Needed (AFN) Let: A/S = the increase in assets per dollar increase in sales. L/S = the increase in spontaneous liabilities per dollar increase in sales. S 0 = current level of sales. g = projected growth rate in sales. M = net profit margin on sales. D = cash dividends planned for common stock.

23. Additional Financing Needed (AFN) Additional Financing Needed (AFN) = Required increase in assets Required increase in assets - Increase in (spontaneous) liabilities - Increase in retained earnings NOTE: This a PERMANENT increase in the funding requirement. NOTE: This a PERMANENT increase in the funding requirement.

24. Additional Financing Needed (AFN) Additional Financing Needed (AFN) = Required increase in assets Required increase in assets - Increase in (spontaneous) liabilities - Increase in retained earnings AFN = (A/S)gS 0 - (L/S)gS 0 - [M(1+g)S 0 - D] Note: A/S, L/S, and AFN/g are NOT CONSTANTS and MAY NOT BE LINEAR or CONTINUOUS.

25. Additional Financing Needed Peak Plastics expects rapid sales growth next year. Sales for the current year were $4 million, and are expected to grow by 20% next year. Peak wants to estimate the external capital that will be required to finance this growth. The firm estimates that additional assets equal to 50% of the increase in sales will be required. Liabilities will increase by 18% of sales. The net profit margin is 6% and Peak expects to pay $84,000 in dividends to its common stockholders.

26. Additional Financing Needed (A/S)gS 0 = $400,000 (L/S)gS 0 = $144,000 M(1+g)S 0 - D = $204,000 AFN = $52,000 Do problems 5 and 6 in the Smart text