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FINANCIAL MANAGEMENT a sources and uses of funds statement or a statement of

First Trimester 2016 changes in financial position.
By Alfredo M. Ofrecio III
The financial manager makes decisions to ensure that the firm has
sufficient funds to meet financial obligations when they are due and to
Course Overview: take advantage of investment opportunities.
1. Introduction to Financial Management
2. Valuation
3. Financial Analysis and Planning
 Funds are cash (and cash equivalents)
4. Capital Management and Investment
 It includes all of the firm’s investments and claims (against
5. Cost of Capital, Capital Structure and Dividend
those investments) allows us to capture all of these
transactions as both sources and uses of funds.
6. Zero Base Budget Setup
 The balance sheet is a statement of financial position (or
“funds position”). On it we have arrayed all of the firm’s
investments (assets) and claims (liabilities and shareholders’
PART 7. FINANCIAL ANALYSIS AND PLANNING equity) against these investments by creditors and by the
“Analysis and Planning” owners.
 The firm’s flow of funds therefore comprises the individual
changes in balance sheet items between two points in time.
Chapter Overview:
 The differences in the individual balance sheet account items
A. Flow of Funds (Sources and Uses) Statement
represent the various “net” funds flows resulting from
B. Accounting Statement of Cash Flows
decisions made by management during the period.
C. Cash-Flow Forecasting
D. Range of Cash-Flow Estimates
E. Forecasting Financial Statements

A flow of funds statement (also known as a sources and uses of funds
We prepare a basic, bare-bones funds statement by
statement or a statement of changes in financial position) is a valuable
1) determining the amount and direction of net balance sheet
aid to a financial manager or a creditor in evaluating the uses of funds
changes that occur between two balance sheet dates,
by a firm and in determining how the firm finances those uses.
2) classifying net balance sheet changes as either sources or uses
of funds, and
The cash flow statement now officially replaces the flow of funds
3) Consolidating this information in a sources and uses of funds
statement in annual reports.
statement format.
The purpose of the cash flow statement is to report a firm’s cash inflows
In the first of these steps, we simply place one balance sheet beside the
and outflows – not its flow of funds – segregated into three categories:
other, compute the changes in the various accounts, and note the
operating, investing, and financing activities. Although this statement
direction of change – an increase (+) or decrease (−) in amount.
certainly serves as an aid for analyzing cash receipts and disbursements,
important current period investing and financing noncash transactions
are omitted. Therefore the analyst will still want to prepare a flow of
funds statement in order to more fully understand the firm’s funds

The cash budget, is indispensable to the financial manager in
determining the short-term cash needs of the firm and, accordingly, in
planning its short-term financing. When cash budgeting is extended to
include a range of possible outcomes, the financial manager can
evaluate the business risk and liquidity of the firm and plan for a realistic
margin of safety. The financial manager can adjust the firm’s liquidity
cushion, rearrange the maturity structure of its debt, arrange a line of
credit with a bank, or do some combination of the three.

The preparation of forecast balance sheets and income statements
enables the financial manager to analyze the effects of various policy
decisions on the future financial condition and performance of the firm.
Such statements may derive from the cash budget or be based on past
or projected financial ratios and/or other assumptions.

Here we determine whether the sales growth objectives of the company
are consistent with its operating efficiency and with its financial ratios.
This powerful tool of analysis allows us to simulate the likely effects of
changes in target ratios when we move from a steady-state


Flow of funds statement. A summary of a firm’s changes in
financial position from one period to another; it is also called

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funds are generated from operations. accruals. It Recognize Profits and . ANALYZING THE SOURCES AND USES OF FUNDS STATEMENT Implications of Funds Statement Analysis. payments during a period of time segregated into three categories:  Besides helping us derive funds provided by operations. ACCOUNTING STATEMENT OF CASH FLOWS will list depreciation as a source under net income.  Imbalances in the uses of funds can be detected and appropriate actions taken. The cash flow statement’s biggest shortcoming is that important current period noncash transactions that may affect cash flow in future periods are omitted from the statement itself. whether the increased investment is primarily for inventories. and financing activities. (1) a company’s ability to generate future net cash inflows from operations to pay debts. you can determine the expected closing cash capital. in cash is a residual. where direct should keep in mind that depreciation does not really create estimates of the future cash flows are made.and long-term financing of the firm. you will want to evaluate the ratio of dividends to earnings relative to the firm’s total need for funds. In evaluating the firm’s financing. But we need to add it back to net income to reverse the effect of the accounting entry that originally removed it.  An analysis of a funds statement for the future will be ADJUSTMENTS extremely valuable to you as the financial manager in planning intermediate. assets against income but does not involve any movement of  In addition. it is there more as a reversing entry than as a real source of funds in its Statement of cash flows. Given this information. A summary of a firm’s cash receipts and cash own right. interest. This noncash expense actually helps conceal the full position of the firm simply by adjusting the beginning cash operating funds flow from us. you can arrange the firm’s financing more  Depreciation is a bookkeeping entry that allocates the cost of effectively. The analysis of funds statements gives us insight into the financial operations of a firm that will be especially valuable to you if you assume the role of a financial manager examining past and future expansion plans of the firm and their impact on liquidity. We positions of the firm through a cash budget. Financial Analysis and Planning– alfred. funds. reveals the firm’s total prospective need for funds. An analysis of the major sources of funds in the past reveals what portions of the firm’s growth were financed internally and externally. and dividends (2) a company’s need for external financing (3) the reasons for differences between net income and net cash flow from operating activities (4) The effects of cash and noncash investing and financing transactions. operating. You can determine whether trade credit from suppliers (accounts payable) has increased out of proportion to increases in current assets and to sales. It is also revealing to analyze the mix of short. the projected change usually not expressed directly on the income statement. fixed assets. If trade credit has increased at a significantly faster rate. investing.Part 6. you can forecast future cash  To find it. we must add back depreciation to net profit.and long-term financing in relation to the funds needs of the firm.  Another use of funds statements is in the evaluation of the firm’s financing. and their nature – that is. along with the expected changes in trade payables and the various Recognize Depreciation and Gross Change in Fixed Assets. So although we B. the expected timing of these needs. and so forth. In essence. What we really want to know is balance for the change in cash reflected on the projected something called funds provided by operations – something sources and uses statement. Alternatively. If these needs are primarily for fixed assets and permanent increases in current assets. you would wish to evaluate the consequences of increased slowness in trade payments on the credit standing of the firm Page 2 of 5.  Funds statements are also useful in judging whether the firm has expanded at too fast a rate and whether the firm’s financing capability is strained.ofrecio@gmail. adding back depreciation as a source of funds allows us to explain the gross additions (or reductions) to fixed assets as It should help the financial manager to assess and identify: opposed to merely the change in net fixed assets. you might be disturbed if a significant portion of total financing came from short-term sources. and its ability to finance in the future.

com . Financial Analysis and Planning– alfred.ofrecio@gmail.Part 6.Page 3 of 5.

cash receipts may arise from external financing as well effort should be devoted to the collection of receivables? If there is an as investment income. what additional purchases will be required. This allowance is particularly necessary for firms whose business is relatively unstable in character. it is desirable to work out additional cash budgets. significant trends in the economy and in the industry are overlooked. COLLECTIONS AND OTHER CASH RECEIPTS USE OF PROBABILISTIC INFORMATION The expected cash position plus the distribution of possible outcomes give us a considerable amount of information. and financing transactions involving cash. FORECASTING FINANCIAL STATEMENTS Forecast financial . At the very least. and borrowing levels necessary to give the firm a margin of safety. it is likely to be caught flat-footed if there is a significant deviation from the expected outcome. how flexible are our Cash receipts may arise from the sale of assets. CASH-FLOW FORECASTING the assumption of the maximum probable increase in business. RANGE OF CASH-FLOW ESTIMATES DEVIATIONS FROM EXPECTED CASH FLOWS To take into account deviations from expected cash flows. insight into the efficiency and flexibility of the firm under a variety of conditions. in cash may be difficult to finance on short notice. The basic problem with an internal approach is that it can be too myopic. We can also analyze the firm’s ability to adjust to deviations from the expected outcomes. investing. or both. We can see the additional funds required or the funds released under various possible outcomes. If the firm bases its plans on expected cash flows only. enables management to plan for contingencies than information giving only single-point estimates of monthly cash flows. Often. Expected future financial statements based on conditions that management expects to exist and actions it expects to take. D. it is far better to allow for a range of possible outcomes than to rely solely on the expected outcome. Financial Analysis and Planning– alfred. A final sales forecast based on both internal and external analyses is usually more accurate than either an internal or an external forecast by itself. as well as from product expenses? What can be cut? By how much? How quickly? How much sales. the external forecast should serve as a foundation for the final sales forecast. A forecast of a firm’s future cash flows arising from It is clear that the type of information portrayed in Figure 7. This information enables us to determine more accurately the minimum cash balance. If sales should fall off. In addition.1 better collections and disbursements. not modified initially by internal constraints. Page 4 of 5. unexpected increase in business.ofrecio@gmail. usually on a monthly basis. This forecast can be based on an internal analysis. such as physical capacity. an external one.Part 6. From the standpoint of internal planning. In general. The final sales forecast should be based on prospective demand. THE SALES FORECAST The key to the accuracy of most cash budgets is the sales forecast. Cash budget. A major benefit of the statement of cash flows (especially under the direct method) is that the user gets a reasonably detailed picture of a company’s operating. we might want to base one cash forecast on the assumption of a maximum probable decline in business and another on C.ANALYZING THE STATEMENT OF CASH FLOWS NET CASH FLOW AND CASH BALANCE Implications of Cash Flow Statement Analysis. and when? Can labor be expanded? Can the present plant CASH DISBURSEMENTS handle the additional demand? How much in funds will be needed to finance the buildup? Answers to these questions provide valuable Production Outlays. E. An unforeseen deficit Other Disbursements. often modified by the internal forecast. maturity structure of debt.

the receivable balance may be estimated on the basis of a receivable turnover ratio. Rather than use the production schedule. estimates of future inventory can be based on an inventory turnover ratio. Page 5 of 5. This ratio is applied in the same manner as for receivables. Accounts payable are estimated by adding projected purchases for January through June. The analyst may wish to evaluate each component of the cost of goods sold. Often. In addition. production-based wages. less total projected credit collections for the period. Accrued income taxes are estimated by adding the taxes due on forecasted income for the six-month period to the December 31 balance and subtracting the actual payment of taxes. and overhead costs is likely to produce the most accurate forecasts. less the amount of dividends paid. is based on the sales forecast. Financial Analysis and Planning– alfred. Forecasting Liabilities and Shareholders’ Equity. which.ofrecio@gmail. however. USE OF RATIOS AND IMPLICATIONS Continual revision of these forecasts keeps the firm alert to changing conditions in its environment and in its internal operations. We have Future net fixed assets are estimated by adding planned expenditures to existing net fixed assets and subtracting from this sum the book value of any fixed assets sold along with depreciation during the period. less total projected cash payments for purchases for the period.FORECAST INCOME STATEMENT The forecast income statement is a summary of a firm’s expected revenues and expenses over some future period. and administrative expenses are estimated next. Income taxes are then computed – based on the applicable tax rate(s) – and deducted to arrive at estimated net income after taxes. A detailed analysis of purchases. Receivables at June 30 can be estimated by adding to the receivable balance at December 31 the total projected credit sales from January through June.Part 6. particularly to reductions in sales in the very short run. estimates of them are fairly accurate. Shareholders’ equity at June 30 would be equity at December 31 plus profits after taxes for the period. general. forecast statements can even be constructed with selected items taking on a range of probable values rather than single-point estimates. except that now we solve for the ending inventory position. ending with the net income (loss) for the period. Because these expenses are usually budgeted in advance. FORECAST BALANCE SHEET Forecasting Assets. costs of goods sold are estimated on the basis of past ratios of cost of goods sold to sales. these expenses are not overly sensitive to changes in sales. in turn. we estimate other income and expenses as well as interest expenses to obtain net income before . Next. If a cash budget is not available. The estimated investment in inventories at June 30 may be based on the production schedule. Selling. to the December 31 balance. Typically. The calculation of accrued wages and expenses is based on the production schedule and the historical relationship between these accruals and production.