Chapter 11 – Forecasting and Short-Term Financial Planning

1. Chapter 11 – Forecasting and Short-Term Financial Planning • Learning Objectives • Understand how sales forecasts are used to predict cash inflow • Understand how production costs are used to predict cash outflow • Prepare pro forma statements • Calculate a company’s cash conversion cycle • Explain ways to cover cash shortfall • Explain options for investing cash excess

2. Cash Budgets • Periodic analysis of cash flow to analyze shortfall or excess • See Figure 11.1, page 320 • All is well at end of period but shortfall during period must be funded (March is cash short) • Sources and Uses • Sources: (1) cash sales, (2) payments received, (3) sale of assets, or (4) borrowing • Uses: (1) cash purchases, (2) payments made, (3) wages, (3) rent, (4) utilities, (5) interest, (6) dividends, (7), retirement of debt, and (8) stock repurchases

3. Sales Forecasting • Two issues • When do sales occur? • When does the firm receive money from sales? • Predicting Sales • External Data • Internal Data • Predicting Cash timing from sales • Table 11.1, timing of sales receipts • January receipts come from three different sales months

4. Production Costs • Cash disbursements closely tied to sales forecasts for firms selling products • Products produced in anticipation of sale • Stored as inventory until sale • Cash outflow occurs before, during, and after production • Before: Purchas of supplies • During: Pay labor • After: Inventory and shipping costs • Individual months production cash outflow associated with several months of production

5. Pro Forma Statements • Pro Forma Statements • Relationship of various accounts to Sales or Assets • Income Statement – Percent of Total Sales • Balance Sheet – Percent of Total Assets • Predicting net income with Pro Forma • Take predicted sales and using percent of sales, fill in accounts on income statement • If relationships remain constant, pro forma income statement predicts net income for the period

6. Cash Conversion Cycle • Cash is an inventory item • Need to know how much you will need to complete daily transactions • Anticipate daily cash inflow • Plan for any short fall between outflow and inflow • Cash Conversion Cycle (CCC) • looks at the timing of cash flow or how long it takes the business to generate cash flow from a sale • Three cycles, (1) production, (2) collection, and (3) payment used to find CCC

7. Short-term Cash Flow Planning • CCC components (Figure 13.3, page 331) • Production cycle – from when product is started until customer “buys” the product • Collection cycle – from time customer “buys” the product until customer makes payment • Payment cycle – from the time company receives materials for production until the company makes payment to supplier • CCC = Production + Collection - Payment

8. Short-term Cash Flow Planning • Estimating production cycle • Find average inventory • Determine inventory turnover using COGS • Calculate production cycle • Example page 332…7.6 Days • Estimate collection cycle • Find average accounts receivable • Determine A/R turnover using credit sales • Calculate collection cycle • Example page 333…13.8 days

9. Short-term Cash Flow Planning • Estimate payment cycle • Find average accounts payable • Determine accounts payable turnover • Calculate payment cycle • Example page 334…7.0 days • CCC = 7.6 + 13.8 – 7.0 = 14.4 days • Must carry (finance) operations 15 days • To reduce CCC, speed up production or collection, or slow down payments…

10. Constructing Cash Budgets • Putting Together the timing of cash inflow and cash outflow • Cash Inflow…mainly sales and borrowing • Cash Outflow… • Accounts payable • Wages, Taxes, and other operating expenses • Capital expenditures • Long-term financing expenses (interest and dividends) • Example Table 11.5 • Monthly ups and downs of cash • Now to manage these ups (excess) and downs (shortfalls)

11. Deficits and Excess • Funding Deficits • Savings • Unsecured Loans – Letters of Credit • Prearranged borrowing • Like a credit card • Secured Loans • Other Sources • Commercial Paper (Business IOU) • Trade Credit (Borrow from your suppliers) • Banker’s Acceptance (Post dated check)

12. Deficits and Excess • Investing Excess • Savings Account or Marketable Securities • Short term investing • Repayment to Lenders • Pay down debt • Extra Dividend to Owners • Replace Assets • More maintenance activities • Invest in positive NPV projects – long term investing

13. Managing Accounts Receivable • Aging receivables • Identifies chronic late payers • Assigns late fees to proper accounts • Follow-up with late paying customers • Example 13.2 • Follow-up invoice with late fees • Late fees billed by individual invoices

14. Credit Terms, Float & Cash Management • Granting of credit to customers • Policy on qualifying customers for credit • Policy on payment plan • Policy on follow-up for late payments • Qualifying for credit • Credit screening • Increasing cost as more information required • Increasing cost usually match the increase in the size of the credit • Example 13.3 – Inflatable boats

15. Credit Terms, Float & Cash Management • Payment Policy • Methods to speed up receivables • Discount for speedy payment • Lock boxes for faster processing of payments • Wire transfers • Your Payment Policy (Accounts Payable) • Methods to slow down payables • Check payment • Playing the float with remote disbursements

16. Inventory Management • Keeping track of inventory • ABC Method • A goods are critical goods, or high priced goods • B goods are moderately priced or essential goods • C goods are low priced or non-essential goods • Most effort is spent on A goods • Little effort is spent on C goods • Economic Order Quantity – how much inventory to keep on hand

17. Homework • Problem 2 – Predicting Sales • Problem 6 – Sales Receipts • Problem 10 – Pro Forma Statement • Problem 12 – Pro Forma Statement • Problem 14 -- CCC

18. Problems – Second Set • Problem 13 – Credit Screening • Problem 15 – Credit Terms • Problem 17 – Economic Order Quantity