Professional Documents
Culture Documents
Tony Stanger
Learning Objectives
Importance of cash flow to business survival Describe the firms cash flow statement, operating cash flow and free cash flow Understand the financial planning process Discuss cash planning process and budgets Prepare pro forma financial statements Evaluate the approaches to pro forma financial statement preparation
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
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[3.5]
NCAI = net current asset investment = change in current assets change in (accounts payable and accruals)
[3.7]
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
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Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
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Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
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Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Options
Develop, analyse and compare different scenarios in a consistent way
Avoiding surprises
Develop contingency plans in case assumptions about the future seriously wrong
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
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Cash planning
Components of the cash budget Sales forecast
external f t l forecast t
observable relationships between sales and e.g. GDP, new housing starts, unemployment rate
internal forecast
firms view on sales as per sales manager and production limitations
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia 24
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Cash planning
Components of the cash budget (cont.)
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
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Cash planning
Components of the cash budget (cont.)
cash receipts - forecast sales - cash sales - collections of A/R - lagged - other
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
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Cash planning
Components of the cash budget (cont.)
cash disbursements - cash dividends - purchases - rent - wages - tax - non current assets - interest/principal
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia 27
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Cash planning
Interpreting the cash budget
net cash flow
combined effect of operating, investing and financing activities
ending cash
beginning balance + net cash flow = ending balance
Cash planning
Evaluating the cash budget
meeting a cash shortfall
issue debt or equity, short or long term?
Profit planning
Profit planning: projecting the firms overall financial position
pro forma statements are used (p j p (projections) )
estimations involved and assume relationships in past FS will apply this period
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Profit planning
Preparing the pro forma income statement
percent-of-sales method, e.g. Vectra Manufacturing 31/12/2007 (pp.117-20)
( (cost of goods sold) / ( l ) t f d ld) (sales) (operating expenses) / (sales) (interest expense) / (sales) = 80% = 10% = 1%
Profit planning
Preparing the pro forma income statement (cont.)
fixed costs may exist in reality
fixed over a relevant range of sales e.g. depreciation, administrative and sales staff?
variable costs
factory labour, materials, power, taxes
Profit planning
Preparing the pro forma balance sheet to determine external funds required
Judgmental approach most popular and incorporates:
percent-of-sales method which assumes
Most BS accounts tied directly to sales The current levels of all assets are optimal for the current sales level
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Profit planning
Preparing the pro forma balance sheet to determine external funds required (cont.)
Judgmental approach most popular and incorporates:
estimation of others specific management action or discretion required
NCA if no excess capacity, but investment lumpy NCL will long-term debt (e.g. notes payable, bonds, term loans) change? SHE will Issued Capital change? NCL and Issued Capital are sources of discretionary financing used to maintain the accounting equation A = L + OE
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia 34
Profit planning
Preparing the pro forma balance sheet to determine external funds required (cont.)
If A > L+OE additional financing needed (AFN) is the plug figure in the Balance Sheet p g g
AFN can be sourced from
CL e.g. bank bills, overdraft NCL e.g. notes payable, bonds, term loans
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
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Profit planning
Evaluating the pro forma statements/ limitations of the percent-of-sales method
Benefit of method is its simplicity But assumes we can accurately forecast future financial items like assets as a given % of sales
This may be valid assumption where e.g. inventory levels rise and fall in direct proportion to sales volume But, depending on nature of firm operations and types of assets used, this 1-to-1 relationship may not hold
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
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Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Profit planning
Evaluating the pro forma statements/ limitations of the percent-of-sales method
Non-current assets
Large-scale equipment may need to be purchased or built well beyond the capacity required i.e. lumpy assets y p y q py Where excess capacity exists, investment may not increase for a given level of sales
Current assets
Are assumed values of some variables realistic?
Cash, debtors and inventories may be hard to control
e.g. interest rates reduce business optimism and affect debtor payments huge price rises for commodities in mining sector
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia 37
Profit planning
Evaluating the pro forma statements/ limitations of the percent-of-sales method
Current assets
Relationships between sales and other accounts may change beyond a relevant range e.g.
quantity discounts impacting inventory and COGS Some firms purchase finished goods inventories daily on demand, while others maintain a base level which grows less rapidly than sales, so the ratio of inventory to sales declines
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia 38
Profit planning
Determinants of a sustainable growth rate Profit margin Dividend policy Financial policy Total asset turnover
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia 39
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia
Quiz
1. If EBIT = $2,700, taxes = $200 and depreciation = $500, then operating cash flow equals: A) $2,900 B) $2,500 C) $2,200 D) $3,000 2. 2 All of the following are used in cash planning EXCEPT: A) internal forecasts B) external forecasts C) accruals D) sales forecasts 3. A pro forma statement summarises: A) the firm's projected income and/or balance sheet B) the current level of retained earnings C) inventory holdings D) the balance sheet
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia 40
Quiz
4. When preparing the pro forma income statement, the use of past ratios: A) maximises net profits after taxes B) is legally compulsory C) tends to overstate profits when sales are falling D) cannot distinguish between fixed and variable costs 5. Under the judgemental approach to pro forma statements: A) a t e items a e eco o et ca y modelled ) all the te s are econometrically ode ed B) some of the items are set by the governing authorities C) none of the revenue items can be entered D) some values are estimated and others are calculated 6. The firm will often use different methods of depreciation for tax reporting than for internal reporting because: A) it wants to avoid triple taxation on dividends B) the objectives of financial reporting are different from those of tax legislation C) there is no incentive to encourage investors to increase their shareholding D) to lower the cost of equity financing for the company
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia 41
Week 3 Tutorial
Review Questions and Problems from Chapter 3 to be covered in the Week 3 Tutorial:
Review Questions 3.4, 3.11, 3.13, 3.14 & 3.17 Problems 3.10, 3.14 & 3.24
Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e: 2008 Pearson Education Australia
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Gitman, Juchau, Flanagan, Principles of Managerial Finance 5e : 2008 Pearson Education Australia