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Financial Planning. Financial Planning. Portions taken from Emery and Finnerty: Corporate Financial Management – Chapter 22 Edited and expanded by Del Hawley. The Financial Planning Process. A firm’s financial plan involves decisions about:. Liquidity Working Capital Inventories

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Financial planning2 l.jpg

Financial Planning

Portions taken from Emery and Finnerty: Corporate Financial Management – Chapter 22

Edited and expanded by Del Hawley


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The Financial Planning Process

A firm’s financial plan involves decisions about:

  • Liquidity

  • Working Capital

  • Inventories

  • Capital Budgeting

  • Capital Structure

  • Dividends


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3 Rules of Financial Management

What are the three primary rules of successful financial management?


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3 Rules of Financial Management

What are the three primary rules of successful financial management?

  • Get the cash

  • Get the cash

  • Get the cash


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The Cash Plumbing System

Equity

LT Debt

Taxes

Dividends


The cash plumbing system7 l.jpg
The Cash Plumbing System

Equity

LT Debt

Taxes

Dividends


The cash plumbing system8 l.jpg
The Cash Plumbing System

Equity

LT Debt

Taxes

Dividends


The cash plumbing system9 l.jpg
The Cash Plumbing System

Equity

LT Debt

Taxes

Dividends


The cash plumbing system10 l.jpg
The Cash Plumbing System

Equity

LT Debt

Taxes

Dividends


The cash plumbing system11 l.jpg
The Cash Plumbing System

Equity

Operating

Expenses

LT Debt

Taxes

Dividends


The cash plumbing system12 l.jpg
The Cash Plumbing System

Equity

Operating

Expenses

LT Debt

Taxes

ST Debt

Mkt’l Sec

Dividends


The cash plumbing system13 l.jpg
The Cash Plumbing System

Equity

Operating

Expenses

LT Debt

Taxes

ST Debt

Mkt’l Sec

Dividends

Accts Pay’l

Fixed

Assets

Materials/Inventory

Sale

Labor

Finished Goods


The cash plumbing system14 l.jpg
The Cash Plumbing System

Equity

Operating

Expenses

LT Debt

Taxes

ST Debt

Mkt’l Sec

Dividends

Accts Pay’l

Fixed

Assets

Materials/Inventory

Sale

Labor

Finished Goods


The cash plumbing system15 l.jpg
The Cash Plumbing System

Equity

Operating

Expenses

LT Debt

Taxes

ST Debt

Mkt’l Sec

Dividends

Accts Pay’l

Fixed

Assets

Materials/Inventory

Sale

Labor

Finished Goods


The cash plumbing system16 l.jpg
The Cash Plumbing System

Equity

Operating

Expenses

LT Debt

Taxes

ST Debt

Mkt’l Sec

Dividends

Accts Pay’l

Fixed

Assets

Materials/Inventory

Sale

Labor

Finished Goods


The cash plumbing system17 l.jpg
The Cash Plumbing System

Equity

Operating

Expenses

LT Debt

Taxes

ST Debt

Mkt’l Sec

Dividends

Accts Pay’l

Accounts Rec’l

Fixed

Assets

Materials/Inventory

Sale

Labor

Finished Goods


The cash plumbing system18 l.jpg
The Cash Plumbing System

Equity

Operating

Expenses

LT Debt

Taxes

ST Debt

Mkt’l Sec

Dividends

Accts Pay’l

Accounts Rec’l

Fixed

Assets

Materials/Inventory

Sale

Labor

Finished Goods


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Cash Conversion Cycle

Collect Acct. Receivable

Purchase Inventory

Sale on Credit

Inventory Conversion Period

Receivables Collection Period

Time

Cash Conversion Cycle

Payment of Accts. Payable

Payables Deferral Period


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Cash Conversion Cycle

Collect Acct. Receivable

Purchase Inventory

Sale on Credit

Inventory Conversion Period

Receivables Collection Period

Time

Cash Conversion Cycle

Payment of Accts. Payable

Payables Deferral Period


Cash conversion cycle21 l.jpg
Cash Conversion Cycle

Collect Acct. Receivable

Purchase Inventory

Sale on Credit

Inventory Conversion Period

Receivables Collection Period

Time

Cash Conversion Cycle

Payment of Accts. Payable

Payables Deferral Period


Cash conversion cycle22 l.jpg
Cash Conversion Cycle

Collect Acct. Receivable

Purchase Inventory

Sale on Credit

Inventory Conversion Period

Receivables Collection Period

Time

Cash Conversion Cycle

Payment of Accts. Payable

Payables Deferral Period


Cash conversion cycle23 l.jpg
Cash Conversion Cycle

Collect Acct. Receivable

Purchase Inventory

Sale on Credit

Inventory Conversion Period

Receivables Collection Period

Time

Cash Conversion Cycle

Payment of Accts. Payable

Payables Deferral Period


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The Financial Plan

  • Financial planning is the process of evaluating the impact of alternative investing and financing decisions of the firm.

  • Every financial plan has three components:

    • A model

    • Inputs

    • Outputs


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The Financial Plan

  • The model is a set of mathematical relationships between the inputs and the outputs.

  • Inputs to the model may include:

    • Projected sales

    • Collections

    • Costs

    • Interest rates

    • Exchange rates


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The Financial Plan

  • The outputs of the financial plan are:

    • Cash Budget

    • Pro forma (projected) financial statements

    • Projections for external funding requirements


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Components of the Financial Plan

Every financial plan should have:

  • Clearly stated strategic, operating and financial objectives.

  • Assumptions on which the plan is based.

  • Description of underlying strategies.

  • Contingency plansto deal with the variances from expectations.


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Benefits of Financial Planning

  • Future (strategic) orientation

  • Identify and quantify assumptions

  • Prepare for contingencies (risk analysis)

  • Identify funding requirements

  • Assess performance


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Cash Budgets

  • Cash budgets

    • project and summarize cash inflows and outflows

    • show monthly cash balances

    • show any short-term borrowing needed to cover cash shortfalls

  • Are based on sales forecasts.

  • Are usually constructed on a monthly basis.


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Preparing a Cash Budget

Prepare a cash budget for Tyler Paints for the months of April, May and June, given the information in the information provided in the following slides.


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Sales – Recent and Forecast

The recent and projected sales for the company are:


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Sales – Recent and Forecast

The recent and projected sales for the company are:

For your project, the sales projections are the culmination of the marketing analysis.


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Collections Forecast

On average, 20% of the company’s sales are for cash and the rest is carried as accounts receivable with 45% of a given month’s sales collected one month following the sale and the remainder collected two months following the sale.


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Collections on Sales

  • 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



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Collections on Sales

For your project, you will need to think about the timing of collections. You may sell everything for cash, or you may give your customers payment terms.


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Pro-Forma Accounts Receivable

Uncollected sales at the end of April (Accounts Receivable) will be:

= 35%(March Sales) + (80% of April Sales)

= 35%($600,000) + 80%($1,200,000)

= $1,170,000

A/R for May = $1,220,000

A/R for June = $1,150,000


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Payment Forecasts

  • The cost of production materials averages 50% of sales. Payment is made for the materials one month after purchase.

  • Wages average 20% of sales.

  • Fixed costs are $120,000 per month

  • A quarterly tax payment of $200,000 is due in April


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Cash Payments

Cash Payments in April =

Materials 50%(March Sales)

+ Wages 20%(April Sales)

+ Other Fixed Expenses of $120,000

50% x $600,000

+ 20% x $1,200,000

+ $120,00

$920,000



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Cash Payments

Here’s where you will have LOTS of fun! You have to think of all of the ways that money will need to be spent, list and justify all assumptions, and project it all out for at least three years.





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Cash Budget

  • Tyler will have to borrow $125,000 in April.

  • Tyler can repay $30,000 in May, leaving an outstanding loan balance of $155,000.

  • The short-term loan can be fully repaid in June.


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SPREADSHEET

The next lesson is on creating a spreadsheet model for the Tyler Paints cash budget. Intstructions are on the class web page.


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Cash Budget

We will also work with Problem C-1 (linked on the web page) in a spreadsheet to build a model that produces a cash budget, an income statement, and a balance sheet that are all integrated.


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Pro Forma Financial Statements

Pro Forma 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.


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Percent of Sales Forecasting Method

  • 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.

  • Other items are either fixed with respect to changes in sales or they are “plug” figures.


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Percent of Sales Forecasting Method

  • Sales growth results in:

    • increase in current and fixed assets

    • increase in spontaneous short-term financing

    • increase in profitability

  • 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.


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Percent of Sales Forecasting Method

If internally generated funds are insufficient to finance the growth, the firm may:

  • Reduce the growth rate

  • Sell assets not required to run the firm

  • Obtain new external financing

  • Reduce or stop paying cash dividends.


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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.

S0= current level of sales.

g = projected growth rate in sales.

M = net profit margin on sales.

D = cash dividends planned for common stock.


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Additional Financing Needed (AFN)

Additional Financing Needed (AFN) =

Required increase in assets

- Increase in (spontaneous) liabilities

- Increase in retained earnings

NOTE: This a PERMANENT increase in the funding requirement.


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Additional Financing Needed (AFN)

Additional Financing Needed (AFN) =

Required increase in assets

- Increase in (spontaneous) liabilities

- Increase in retained earnings

AFN = (A/S)gS0 - (L/S)gS0 - [M(1+g)S0 - D]

Note: A/S, L/S, and AFN/g are NOT CONSTANTS and MAY NOT BE LINEAR or CONTINUOUS.


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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.


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Additional Financing Needed

(A/S)gS0 = $400,000

(L/S)gS0 = $144,000

M(1+g)S0 - D = $204,000

AFN = $52,000


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Additional Financing Needed (AFN)

Note: Your book calls this EFR for External Funds Required. Same thing – Different name.


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Sustainable Growth Rate

How fast can a company’s sales grow before it runs out of financing, assuming that it can raise additional long term debt in the same proportion to equity that it currently has. New equity will come from retained earnings (net income less dividends paid).


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Sustainable Growth Rate

Specifically, the assumptions are:

The firm has only common stock (no preferred) and will issue no new shares.

S/A will remain constant

DPO (d) remains constant

A/E remains constant, implying that Total Liabilities (including LTD) can grow with Equity

Net Profit Margin (m) remains constant.



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Financial Planning

Portions taken from Emery and Finnerty: Corporate Financial Management – Chapter 22

Edited and Expanded by Del Hawley


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