Professional Documents
Culture Documents
3.1 to 3.4
Contents
3.1 Overview of financial planning
3.2 Developing a long-term financial
plan
3.2.1 Spontaneous and discretionary
financing
3.2.2 Determining discretionary
financing needs
Percent of sales method
Judgmental method
3.2.3 Excess capacity adjustments
3.2.4 Growth rates
3.2.4.1 Internal growth rate
3.2.4.2 Sustainable growth rate
Contents
3.3 Developing a short-term financial plan
3.3.1 Kinds of budget
3.3.2 Cash budget
3.3.3 Master budget
3.3.3.1 Operating budgets
3.3.3.2 Financial budgets
3.4 Leverage
3.4.1 Business and financial risk
3.4.2 Types of leverage
3.4.2.1 Operating leverage
3.4.2.2 Financial leverage
3.4.2.3 Total leverage
Financial Planning
• also called value-based management
• a process of determining financial needs or goals and how
to achieve them in line with the company’s corporate goals,
strategies, and operating plan
• primary objective: estimate the future financing
requirements in advance of when the financing will be
needed
• results to the development of financial plan/s
Source: Pursuit of Passion dated Oct 15 2019
P312,000 to
1,020,000
annually
26,000 to 85,000 per month
Project assets
Project income Project sources of
Forecast sales needed to
statement financing
support sales
Decide how to
See effect of plan Estimate financing
raise/use needed/
on ratios needs
excess funds
Sales Forecast
• prediction of a firm’s sales over a given period
• key (most critical) input to the financial planning process
• based on external and/or internal data such as economic indicators,
consensus of salespeople, past trends (usually past 5 years), and any
anticipated events that might materially affect that trend
Sales forecast using historical growth rate
• compute historical growth rate using modified FV of a lump sum
equation as follows:
• Hence, a growth rate using sales trend for the past 5 years can be
computed as follows:
Sales forecast using historical growth rate
ACYFMG Inc.’s Sales for the past five years are as follows:
20xy P 78,600
20xx 75,000
20xw 76,570
20xv 72,100
20xu 70,080
Using these data, compute for ACYFMG historical growth rate and
projected sales for 20xz.
Pro-forma Financial Statements
• projected, or forecast, income statements and balance
sheets
• techniques in developing pro-forma financial statements:
Percent of sales method - expresses expenses, assets, and
liabilities for a future period as a percentage of sales
where, 70% is 20xy dividend payout while 31,200 is 20xy retained earnings
Pro-forma BS: Percent of sales
20xy % of sales Proj. 20xz 80,887.26 x 12.7226%
Accounts Payable ₱10,000 12.72% ₱10,290.99 Or
Notes Payable 10,000 x102.91%
2,500 no change 2,500
Accrued expenses
4,800 6.11% 4,939.67
Total current liabilities ₱17,300 ₱17,730.66
Long-term debt
22,000 no change 22,000
Total Liabilities
₱39,300 ₱39,730.66
Additional paid-in less treasury stock Based on projected
12,000 no change 12,000 20xz net income and
Retained Earnings 20xy dividend
31,200 beg + (rr*NI) 34,904.76 payout
Total Stockholders’ Equity
₱43,200 ₱46,904.76
Total Liabilities and SHE/ Projected
sources of financing ₱82,500 ₱86,635.42
84,900.66 –
Discretionary financing needs (plug figure) (1,734.76) 86,635.42
Total financing needs= total assets
₱84,900.66
Pro-forma Financial Statements
• Judgmental method – involves estimating the level of an
asset, liability, or expense for a future period based on a
certain set of assumptions
• assumes that past financial relationships (ratios) remain
constant
• assumes certain costs and expenses as fixed
• estimate values for certain balance sheet accounts
Pro-forma FS: Judgmental Approach
•using ACYFMG 20xy FS to project 20xz FS
•Income statement- additional information
Only 70% of CGS are variable
Only 40% of selling expenses are variable
Only 20% of General and admin expenses are variable
Interest expense is expected to be P50 lower than 20xy
Income tax rate is 25% of Earnings before tax
Other items remain constant regardless of change in sales
Pro-forma IS: Judgmental 20xy Proj. 20xz From Sales forecast
Sales ₱78,600 100% ₱80,887.17
Less: Cost of Goods Sold- variable (70%) 80,887.26 x 41.7684%
(32,830) -41.77% (33,785.32) Or
32,830 x 102.91%
Cost of Goods Sold- fixed (14,070) no change (14,070.00)
Gross Profit or Gross margin ₱31,700 ₱33,031.86 Same as 20xy amount
Less: Operating expenses
Selling expense- variable (40%) ₱1,572 2.00% ₱1,617.74
Selling expense- fixed 2,358 no change 2,358.00
General and admin expenses- variable (20%)
1,024 1.30% 1,053.80
General and admin expenses- fixed 4,096 no change 4,096.00
Depreciation and amortization expense 2,500 no change 2,500.00
Total operating expense -₱11,550 -₱11,625.54
Net Operating income ₱20,150 ₱21,406.32
Other Income 800 no change 800.00
Earning before interest and taxes (EBIT) ₱20,950 ₱22,206.32
Less: Interest expense 4,950 - 50
(4,950) P50 lower (4,900.00)
Earnings before taxes ₱16,000 ₱17,306.32
Less: Income tax expense (25%) 17,306.32 x 25%
(4,000) 25% of EBT (4,326.58)
Net Income ₱12,000 ₱12,979.74
Pro-forma FS: Judgmental Approach
•using ACYFMG 20xy FS to project 20xz FS
• Balance sheet- additional information
Minimum cash balance of P4,000
Accounts receivable on average represents 40 days of sales
Ending inventory should remain at a level of about P15,000
A fully depreciated asset costing P6,000 would be disposed next year
Purchases represent approximately 40% of sales and the firm targets to pay
its accounts payable within its credit terms of 60 days
The 2,500 notes payable would be repaid next year
Accrued expenses is expected to vary with sales
Dividend payout ratio of 0.70 will remain the same next year
No change in other accounts is expected
Pro-forma BS: Judgmental Approach
20xy info Proj. 20xz
Cash ₱4,250 minimum ₱4,000.00
Accounts Receivable 9,500 40 days 8,987.46 80,887.26 x 40/360
Inventories 13,750 target 15,000.00
Other current assets 5,000 no change 5,000.00
Total current assets ₱32,500 ₱32,987.46
Property, plant and equipment 58,400 – 6,000
₱58,400 -P6K ₱52,400.00
Less: Accumulated depreciation -P6K, -13,700 +6,000 -2,500
(13,700) +P2.5K (10,200.00)
Property, plant and equipment,
net ₱44,700.00 ₱42,200.00
Other non-current assets 5,300 no change 5,300.00
Total non-current assets ₱50,000 ₱47,500.00
Total Assets ₱82,500 ₱80,487.46
Pro-forma BS: Judgmental Approach
20xy info Proj. 20xz
Accounts Payable ₱10,000 60 days ₱5,392.48 (80,887.26 x 40%) x
Notes Payable (60/360)
2,500 -P2.5K -
Accrued expenses 4,800 6.11% 4,939.67
Total current liabilities ₱17,300 ₱10,332.15
Long-term debt 22,000 no change 22,000
Total Liabilities
₱39,300 ₱32,332.15
Paid-in capital less treasury stock
12,000 no change 12,000 31,200 + (12,979.74
Retained Earnings * (1-70%))
31,200 beg + (rr*NI) 35,093.92
Total Stockholders’ Equity
₱43,200 ₱47,093.92
Total Liabilities and SHE / Projected
sources of financing ₱82,500 ₱79,426.07
Discretionary financing needs (plug 80,487.46 –
figure) 1,061.39 79,426.07
Total financing needs= total assets
₱80,487.46
Use of Pro Forma Statements for financial
decisions
• Financial managers and lenders can use pro forma statements
to analyze the firm s inflows and outflows of cash, as well as its
liquidity, activity, debt, profitability, and market value.
• Various ratios can be calculated from the pro forma income
statement and balance sheet to evaluate performance.
• Cash inflows and outflows can be evaluated by preparing a pro
forma statement of cash flows.
• After analyzing the pro forma statements, the financial
manager can take steps to adjust planned operations to achieve
short-term financial goals.
Limitations of Pro-forma statements
• unrealistic assumptions: (1) past financial performance will not
be replicated in the future and (2) certain variables (cash, AR and
inventories) cannot be forced to take on certain “desired” values
•Unforeseen factors lead to inaccurate results and poor decisions
• Unknown and unavailable information requires the use of
estimates which might be inaccurate
• Using discretionary financing as a “plug” or balancing figure
tends to overlook projection errors
Additional Limitations of Pro-forma statements using
percentage of sales
•Ignored fixed expenses which tends to understate profits when
sales are increasing and vice versa
•assets may be purchased in larger quantities due to economies of
scale
•Some assets must be purchased in large, non-divisible quantities
(“lumpy assets”), like equipment. When newly purchased, there is
excess capacity until sales grow to the point where capacity is
fully utilized
•Firms might have to carry a minimum level of assets, such as
minimum level of inventory
Estimating Financing Needs
• Discretionary financing needs (“plug” figure)
-the amount needed to bring the statement into balance
• Once the firm determine the form of financing or the use available funds; the
pro forma balance sheet is modified to replace the “plug” figure with planned
increases/reductions in the debt and/or equity accounts
Discretionary financing needed (DFN)
• also known as External Funds Needed (EFN) and Additional
Funds Needed (AFN)
• if positive, is the amount of external capital (interest
bearing debt, preferred stock and common stock) that will be
necessary to acquire the required assets
• if negative, is the amount of internal funds in excess of total
financing needs to acquire assets
Discretionary financing needed (DFN)
•Two ways of computing
1. Plug figure in pro-forma balance sheet
2. Use equation as follows:
OR
DFN=(Assets0 x g) - (L0* x g) - [(NI0)x (1+g)x (1- DPR0)]
where, g is the sales growth rate
Interpreting DFN
• If positive, it means that firm will not generate enough
internal financing to support its forecast growth in assets;
hence, the firm must raise funds externally by: borrowing
(short-term or long-term), issuing of stocks, reducing
dividends, or a combination thereof
If all assets, except fixed assets, are sales driven and existing discretionary
financing do not change, the alternative DFN equation is revised as
follows:
•If forecasted sales (S1)are less than full capacity sales, then fixed
assets do not need to increase to support the forecasted sales level. In
this case, change in FA is 0 (nil).
Excess Capacity Adjustment
If ACYFMG fixed assets are sales driven, compute DFN if it was operating
at (a) full capacity, (b) 99% capacity and (c) 95% capacity in 20xy (use
percentage of sales to apply equation)
DFN = (A0* x g) + Δ Fixed assets+1 -(L0* x g) – [(NI0)x (1+g)x (1- DPR0)]
Δ Fixed assets+1 = (FA0/SFC x S1) - FA0
ΔA* + ΔFA - ΔL* - ΔRE = DFN
Full 37,800 x 44,700 x 2.91%= 1,300.72 14,800 x 12,000 x -1,734.76
SFC = 78,600 2.91%= 2.91% (1+2.91%) x 30%
1,100
99% 37,800 x ((44,700/79,394) x 14,800 x 12,000 x -2,194.77
SFC 2.91%= 80,887) – 44,700= 840.71 2.91% (1+2.91%) x 30%
=78,600/99%= 1,100
79,394
95% 37,800 x ((44,700/82,737) x 14,800 x 12,000 x -3,035.48
SFC = 2.91%= 80,887) – 44,700= 2.91% (1+2.91%) x 30%
78,600/95%= 1,100 (999.32) =0; hence, no
82,737 increase
Excess capacity computation
Miller Industries is planning its operations for next year. Ashton Miller,
the CEO, wants you to forecast the firm's additional funds needed (AFN).
Data for use in your forecast are shown below.
DFN = (A0* x g) + Δ Fixed assets+1 -(L0* x g) – [(NI0)x (1+g)x (1- DPR0)]
Current year's accounts
Current year's sales 330,000 P140,000
payable
Current year's notes
Sales growth rate 11% P50,000
payable
Current year's total assets P1,505,000 Current year's accruals P70,000
Current year’s Net Profit
20% Target payout ratio 65%
margin
If Miller was operating only at 95% capacity and fixed asset amounted to
970,000, how much is full capacity sales? How much is the required level
of fixed asset to support projected sales? Compute for the AFN with
excess capacity adjustment.
Financial Forecasting
Project assets
Project income Project sources of
Forecast sales needed to
statement financing
support sales
Decide how to
See effect of plan Estimate financing
raise/use needed/
on ratios needs
excess funds
Summarizing financial forecast
• ACYFMG used the judgmental approach of forecasting its FS,
and it has 3 financing options for the P1,061.39 DFN as follows:
1. the DFN will be fully financed by LT debt
2. the DFN will be financed by 50% LT debt and 50% equity
3. the DFN will be fully financed by common equity (sell stocks
at current market price)
Pro-forma BS: Judgmental Approach
Projected 20xz balances
Undecided DFN-Debt DFN-50/50 DFN-Equity
Accounts Payable ₱5,392.48 ₱5,392.48 ₱5,392.48 ₱5,392.48
Notes Payable - - - -
Accrued expenses
4,939.67 4,939.67 4,939.67 4,939.67
Total current liabilities ₱10,332.15 ₱10,332.15 ₱10,332.15 ₱10,332.15
Long-term debt
22,000 23,061.39 22,530.69 22,000
Total Liabilities
₱32,332.15 ₱33,393.54 ₱32,862.85 ₱32,332.15
Common Stock
12,000 12,000 12,531 13,061
Retained Earnings
35,093.92 35,093.92 35,093.92 35,093.92
Total Stockholders’ Equity ₱47,093.92 ₱47,093.92 ₱47,624.62 ₱48,155.31
Total Liabilities and SHE
₱79,426.07 ₱80,487.46 ₱80,487.46 ₱80,487.46
DFN “plug” figure
1,061.39
Financial Forecasting
Project assets
Project income Project sources of
Forecast sales needed to
statement financing
support sales
Decide how to
See effect of plan Estimate financing
raise/use needed/
on ratios needs
excess funds
Effect of plan on key ratios
• Assume that ACYFMG wants to consider the impact of their decision on
key ratios listed below:
20xy 20xz-LT debt 20xz-50/50 20xz-Equity
ROA* 14.77% 15.93% 15.93% 15.93%
ROE* 28.85% 28.75% 28.58% 28.42%
EPS* 1.20 1.30 1.29 1.29
Equity multiplier 1.91 1.71 1.69 1.67
(Est.) Market price
(using 20xy P/E 13.33) 16.00 17.31 17.25 17.19
M/B ratio* 3.70 3.67 3.63 3.59
*assuming same NI regardless of financing
decision; shares will be issued at their
20xy price of P16; hence 34 and 67 shares
issued for 2nd and 3rd financing options
Importance and Use of Financial Planning
• force managers to think systematically about the future
• Provides clearer long-term view of allocation of funds/ financial
needs
• Serves as a basis for financial decisions
• Measures the impact of the firm’s strategies on financial
statements, profit/loss and market value
• Evaluates financial viability and/or profitability of firm’s strategies
• Identifies which strategies or operating plan to prioritize
Summarizing financial forecast
ACYFMG used the judgmental approach of forecasting its FS, it
has 3 financing options for the P1,061.39 DFN.
ACYFMG CFO proposed that the firm simply reduce its cash
dividends for 20xz so that there’s no need for external
financing.
How much will dividend per share decrease?
Compute for the proposed dividend payout ratio.
Consider the impact of this on pro-forma B/S and key ratios.
Computing growth rates
Two growth rates in financial planning: internal and sustainable
Accurate if:
• all assets and spontaneous liabilities are sales driven
• existing discretionary financing do not change
Computing growth rates
Two growth rates in financial planning: internal and sustainable
Accurate if:
• ROE was computed as as follows: =NI/ Beg. SHE OR
=NI/ (SHE less Reinvested earnings)
• all assets are sales driven
• spontaneous liabilities are sales driven
Sustainable Growth Rate (SGR)
Using DFN equation:
DFN=(Assets0 x g) - (L0* x g) - [(NI0)x (1+g)x (1- DPR0)]
Look for g that would make D/E ratio the same as current year:
where, [debt = L0 + (L0* x g) + DFN] and {equity= SHE0+ [(NI0)x (1+g)x RR]}
• Solve for “ x“
• Excel goal seek
• Derived equation below- same with simplified equation
𝑅𝑂𝐸 × 𝑅𝑅 𝑁𝐼 × 𝑅𝑅
𝑆𝐺𝑅 = 𝑆𝐺𝑅 =
1 − 𝑅𝑂𝐸 × 𝑅𝑅 𝑆𝐻𝐸 − 𝑁𝐼 × 𝑅𝑅
Accurate if:
• ROE is computed as NI divide by ending SHE
• all assets are sales driven
• spontaneous liabilities are sales driven
IGR and SGR
• Since sustainable growth rate allows for external financing,
it is higher than the internal growth rate (except if firm has
zero D/E ratio).
Computing IGR and SGR
• Using ACYFMG 20xy FS, compute for IGR using percentage of sales
assumptions: 𝑁𝐼 × 𝑅𝑅
𝐼𝐺𝑅 =
20xy RR = 1-70% = 30% 𝐴 − 𝐿∗ − (𝑁𝐼 × 𝑅𝑅)
IGR = (12,000 x 30%)/ [82,500-10,000-4,800-(12,000 x 30%)]
IGR = 3,600/ 64,100
IGR= 5.6162%, where DFN is zero (nil)
Note: using the simplified formula would yield an IGR of 4.56% (or 4.43%
using ratios computed) and DFN of -675.29 (-759.88).
Computing IGR and SGR
• Using ACYFMG 20xy FS, compute for SGR using percentage of sales
assumptions: 𝑁𝐼 × 𝑅𝑅
𝑆𝐺𝑅 =
20xy RR = 1-70% = 30% 𝑆𝐻𝐸 − 𝑁𝐼 × 𝑅𝑅
SGR= (12,000 x 30%) / [43,200-(12,000 x 30%)]
SGR = 3,600 / 39,600
SGR= 9.0909%, where D/E is same with 20xy of 90.97%
Note: using the simplified formula would yield same SGR of 9.09% (or
8.65% using ratios computed) and D/E of 90.97% (90.27%)
IGR and SGR computation
Miller Industries is planning its operations for next year. Ashton Miller,
the CEO, wants you to know the firm's internal growth rate (IGR) and
sustainable growth rate (SGR). Data for use in your forecast are shown
below.
Current year's accounts
Current year's sales 330,000 P140,000
payable
Current year's notes
Debt to equity ratio 40% P50,000
payable
Current year's total assets P1,505,000 Current year's accruals P70,000
Current year’s Net Profit
20% Target payout ratio 65%
margin
𝑁𝐼 × 𝑅𝑅 𝑁𝐼 × 𝑅𝑅
𝐼𝐺𝑅 = 𝑆𝐺𝑅 =
𝐴 − 𝐿∗ − (𝑁𝐼 × 𝑅𝑅) 𝑆𝐻𝐸 − 𝑁𝐼 × 𝑅𝑅
3.3
Budgeting
Budget Purposes of Budgeting
a detailed plan, expressed in Systems
quantitative terms, that
specifies how resources will be1. Planning
acquired and used during a 2. Facilitating
specified period of time.
Communication and
Coordination
The procedures used to develop
3. Allocating Resources
a budget constitute a
Budgeting System 4. Controlling Profit and
Operations
5. Evaluating
Performance and
Providing Incentives
Advantages of Budgeting
Define goal
and objectives
Communicate Think about and
plans plan for the future
Advantages
Coordinate Means of allocating
activities resources
Uncover potential
bottlenecks
Common Budgeting Method
1. Incremental budgeting- last year’s actual figures and adds or
subtracts a percentage to obtain current year’s budget
2. Activity-based budgeting- top down budgeting that determines
the amount of inputs (in terms of activities) required to support
target output of the company
3. Value proposition budgeting- assesses each item in the budget
as to whether it creates value for customer, staff or other
stakeholder and if the value outweigh its cost; any unjustified cost
will be deleted
4. Zero-based budgeting- assumes that all department’s budget are
zero and must rebuilt from scratch wherein every single expense
must be justified for its continued usefulness
Kinds/Types of Budget
• By time period: short-term, long-term, or rolling budget
• By capacity: static or flexible budget
• By scope:
• Master Budget
• Operating Budget
• Sales Budget
• Production Budget
• Financial Budget
•Capital Expenditure Budget
• Cash Budget
Types of Budget (by time period)
0 1 2 3 4 5
1. Short-term budget- aka short-range budget, is a budget with a term of one year
or less
2. Long-term budget- aka long-range budget, covers periods longer than a year
3. Rolling budget- also called revolving, continuous, or perpetual budget, is
continually updated by periodically adding a new incremental time period (such
as a month or quarter), and dropping the period just completed. This approach
keeps managers focused on the future at least one period ahead.
Types of Budget (by capacity)
1. Static budget- is prepared for a single, planned level of activity. It
contains elements were expenditures remain unchanged with
variations to activity levels. Though suitable for planning, it is
inadequate for evaluating how well costs are controlled because the
actual level of activity is unlikely to equal the planned level of activity
Cash Budget
Budgeted Income
Statement
Budgeted Balance
Sheet
Budgeted Statement of
Cash Flows
Sales Budget
Ending
Inventory Production
Budget Budget
Work in Process
When the interactions of the elements of
and Finished
Goods
the masterDirect
Ending budget are expressed
Direct as
Overhead
a set of
Selling and
Inventory Materials relations,
Labor Administrative
Budget
mathematical
Budget Budget
it becomes
Budget a
Budget
financial planning model that can be used to
Direct Materials
1. Financial budget- is a plan that shows how the company will acquire its
financial resources, such as through the issuance of stock or incurrence of
debt. It is based on the operating budget comprising the budget for balance
sheet elements leading to the creation of the budgeted balance sheet and
the budgeted statement of cash flows.
Kinds of Budget (by scope)
• Most common functional budgets are:
• Sales Budget- aka Revenue Budget, provides an estimate of the volume
of goods and services (both in units and amounts) that a company
proposes to sell in a future period
• Production Budget- outlines the number of units the company need to
manufacture to meet the requirements of the sales budget
• Purchase Budget- contains the amount of inventory that a company
must purchase during each budget period to ensure sufficient inventory on
hand in satisfying customer demands/orders
Kinds of Budget (by scope)
• Most common functional budgets are:
• Selling and Administrative expense Budget- aka period expense
budget or operating expense budget, indicates the planned operating
expenses of the company during the budget period
• Capital (Expenditure) Budget is a plan that states the amount and
timing capital asset acquisitions, such as buildings and equipment. It
identifies the amount of investment in projects and long-term assets
• Cash Budget (Cash Forecast)- is a statement of the company’s planned
inflows and outflows of cash over the budget period.
Basic Operating Budget Steps
1. Prepare the revenues budget.
2. Prepare the production or purchase budget.
3. Prepare the direct materials usage budget and direct materials
purchases budget.
4. Prepare the direct manufacturing labor budget.
5. Prepare the manufacturing overhead costs budget.
6. Prepare the ending inventories budget.
7. Prepare the cost of goods sold budget.
8. Prepare the selling and administrative expense budget.
9. Prepare the budgeted income statement.
Basic Financial Budget Steps
Budgeted sales
volume 800 500 300 1600
Selling price 25 25 25 25
Gross Sales ₱20,000 ₱12,500 ₱7,500 ₱40,000
Purchase Budget
Sales Purchase
Budget d Budget
te
e
pl
om
C
Since all CAPEX are material in amount, some firms include justification of each CAPEX item
in the budget
Cash Budget
• Typically includes the following main elements:
• Cash receipts- cash inflow from cash sales, AR collections, etc.
• Cash disbursements- cash outlays for cash purchases, payment of AP,
payment of S&A expenses, etc.
• Net change in cash (or net cash flow)- difference between cash
receipts and cash disbursements in each period
• Ending cash balance-sum of beginning cash balance and net cash
flow
•Target (or minimum) cash balance- desired balance the firm plans to
maintain
Cash Budget
• Typically includes the following main elements:
• New financing needed (or required total financing)- Amount of
funds needed if the ending cash for the period is less than the target
cash balance; typically represented by notes payable.
• Excess cash balance- Amount available for investment if the period’s
ending cash is greater than the minimum cash balance; assumed to be
invested in marketable securities
•Uses: (a) monitor and control firm’s operations, and (2) predict amount
and timing of future cash requirements.
The General Format of the Cash Budget
Expanded Format of the Cash Budget
Preparing the Cash Budget
01 Cash Receipts
02 Cash Disbursements
04 New financing
or excess cash
Preparing the Cash Budget
1. Prepare the cash receipts budget (using sales budget)
1.1 Refer to collection pattern of credit sales
1.2 Take note of other cash receipts such as interest/dividend
income, bond/stock issuance, sale of fixed assets
2. Prepare the cash disbursements budget (using production/purchase
budget, OPEX budget and CAPEX budget)
2.1 Refer to payment period of credit purchases
2.2 Identify timing of payment for expenses (e.g. utilities payment
are lagged one month because this are usually due the following
month)
Preparing the Cash Budget
2. Prepare the cash disbursements budget
2.3 Take note of other cash payments like interest payment
debt repayment, stock repurchases
3. Compute net cash flow and ending balance
4. Compare ending balance with minimum cash balance to
determine if new financing is needed or there is excess cash
for short-term investment
Cash Receipts Budget
• All sales of ACYFMG are on account.
• The company’s collection pattern is:
75% collected in the month of sale,
25% collected in the month following the month of sale,
*to avoid distortion, add MS or deduct NP balance here if not liquidated or paid within first month
**the excess cash (or new financing needed) figures refer to how much will be invested (owed) at the end of the
month, they do NOT represent monthly changes in ST investments (borrowings)
Financial Activities from Cash Budget
For ACYFMG to maintain a 4,000 cash balance, it will need to:
• January: Invest P7,980 excess cash balance in marketable
securities
• February: Liquidate P7,980 of marketable securities and borrow
P1,365 of notes payable
• March: Borrow P15,120 notes payable
• Financial manager should arrange for a line of credit of at least
P16,485.
Evaluating Cash Budget
• Cash budgets indicate the extent to which cash shortages or
surpluses are expected in the periods covered.
• At the end of the 3 months, ACYFMG expects the following
balances in cash, marketable securities, and notes payable:
Account Jan 20xz Feb 20xz Mar 20xz
Cash 4,000 4,000 4,000
Marketable Securities 7,980 0 0
Notes payable 0 1,365 16,485
Cash Budget- with financing cost and investment
income
• ACYFMG has an agreement with its bank to issue/repay
notes payable on the last day of the month with a fixed
annual rate of 12%
• ACYFMG invest any excess cash in marketable securities
which earns an annual rate of 8%
• Assume that ACYFMG would liquidate marketable
securities first to meet deficits before borrowing with
notes payable
• ACYFMG use excess cash to first repay notes payable
before investing marketable securities
ACYFMG Cash Budget for Q1 of 20xz
Jan Feb Mar Q1
Total cash receipts 24,500 14,375 8,750 47,625
Total cash disbursements (16,770) (23,720) (23,870) (64,360)
Net cash flow 7,730 (9,345) (15,120) (16,735)
Interest (MS or NP)* (25) 53 (13) 15
Beginning cash 4,250 11,955 2,663 4,250
Ending cash 11,955 2,663 (12,470) (12,470)
Minimum cash balance (4,000) (4,000) (4,000) (4,000)
Excess cash (MS) ₱7,955
New financing needed (NP) -₱1,337 -₱16,470 -₱16,470
*Jan: 2500 x 12%/12 =25; Feb: 7,955 x 8%/12 = 53; Mar: 1,337 * 12%/12 = 13
Identify the financial activities of ACYFMG every end of month of Q1 based on the cash budget:
borrow, invest, repay, and/or liquidate how much? What’s the minimum credit line to be
maintained for the quarter?
Illustrative: Cash Budget
Alyssa, a financial analyst for Best Value Store, has prepared the following sales and cash
disbursement estimates for the period August through December of the current year.
Month Sales Cash Disbursements
August 40,000 35,000
September 50,000 40,000
October 50,000 65,000
November 60,000 50,000
December 70,000 55,000
Ninety percent of sales are for cash, the remaining 10 percent are collected one month
later. All disbursements are on a cash basis. The firm wishes to maintain a minimum cash
balance of P5,000. The beginning cash and marketable securities balance in September is
P5,000 and P1500, respectively. Prepare a cash budget for the months of September,
October, November, and December, noting any needed financing or excess cash available.
Sep Oct Nov Dec Illustrative:
Total cash receipts Cash Budget
August sales
September sales Financial activities
(borrow, invest, repay
October sales or liquidate and how
November sales much?)
Low risk
Probability density
High risk
0 EBIT
Factors affecting business risk
Product
obsolescence
Legal,
Sales and
regulatory
cost
and foreign
variability
risk exposure
Business Operating
Competition
risk Leverage
Financial risk
• Is the increase in stockholder’s risk, over and above the firm’s business
risk, resulting from the use of financial leverage
• Is the risk of being unable to cover financial costs
• More debt or preferred stock results to more financial risk
Analysis and impact of Leverage
• Leverage results from the use of fixed-cost assets or fixed cost funds
to magnify returns to the firm’s owners.
• Generally, increases in leverage result in increases in risk and
return, whereas decreases in leverage result in decreases in risk and
return.
Operating Leverage
• Is the extent to which fixed operating costs are used in the firm’s operations
• The higher the operating leverage, the higher the business risk
• Compare EBIT at 200 unit sales and 800 unit sales
Rev.= 80 Rev.= 85
P P
TC
TC
VC=50 VC=50
FC
FC =7K
=5K
QBE Sales QBE Sales
=167 =200
Financial Leverage
• Is the extent to which fixed-income securities are used in a
firm’s capital structure
• The higher the financial leverage, the higher the financial risk
P900 EBIT
-P600 EBIT
Total Leverage
• results from the combined effect of using both fixed
operating and fixed financial costs;
• Hence, DTL = DOL x DFL
Measuring degree of leverage
Degree of Operating Degree of Financial Degree of Total
Leverage (DOL) Leverage (DFL) Leverage (DTL)
Effect Use of Fixed Operating Use of Fixed Financial Use of Fixed costs (both
Costs to magnify effect of Costs (interest on debt operating and financial)
changes in Sales to EBIT and PS dividends) to magnify effect of
to magnify effect of changes in Sales to EPS
changes in EBIT to EPS
Formula
(measuring
sensitivity)
=DOL x DFL
Formula
(at base
level)
ACYFMG is evaluating two different operating structures which are
described below.
The firm has common shares outstanding of 1,000, and a tax rate of 25%.
Sales price per unit is at P1.
Operating @ 10,000 units sold @ 20,000 units sold
structure
#1 EBIT = P1,500 EBIT = P3,500
EPS= 0.375 EPS= 1.875
#2 EBIT = P1,500 EBIT = P4,500
EPS= 0.9375 EPS = 3.1875
Calculate DOL, DFL and DTL using 20,000 units as a base sales level with
preferred stock dividends as follows:
EBIT PS dividends EPS (with PS
div.)
Structure #1 P3,500 P280 1.595
Structure #2 P4,500 P420 2.7675
Contents
3.1 Overview of financial planning
3.2 Developing a long-term financial
plan
3.2.1 Spontaneous and discretionary
financing
3.2.2 Determining discretionary
financing needs
Percent of sales method
Judgmental method
3.2.3 Excess capacity adjustments
3.2.4 Growth rates
3.2.4.1 Internal growth rate
3.2.4.2 Sustainable growth rate
Contents
3.3 Developing a short-term financial plan
3.3.1 Kinds of budget
3.3.2 Cash budget
3.3.3 Master budget
3.3.3.1 Operating budgets
3.3.3.2 Financial budgets
3.4 Leverage
3.4.1 Business and financial risk
3.4.2 Types of leverage
3.4.2.1 Operating leverage
3.4.2.2 Financial leverage
3.4.2.3 Total leverage
End of 3.1-3.4
Questions?
A. Rolling Budget
B. Continuous Budget
C. Revolving Budget
D. All of the above
KC: Problems
27. Milestone Inc’s sales budget is shown below:
May June July August
55,000 80,000 67,000 42,000
All of Milestone’s sales are credit sales. The company collects 60% of its
sales in the next month and the remainder in the month after that.
a. Compute for Milestone’s cash collection in July
b. What is the balance Milestone’s receivables account at the end of July?
c. What is Milestone’s cash collection in August?
d. What is the balance Milestone’s receivables account at the end of
August?
e. Due to a change in economic conditions Milestone will only be able to
collect 40% of its July sales in August. As a result of this, cash receipts
in August will decline by____.
KC: Problems
28. Big Deal, Inc. wants to grow 30% next year. If it maintains its 40%
dividend payout ratio, liabilities to equity ratio of 1, and total asset
turnover of 2, what must its profit margin be to achieve this growth?
32. Last year Hamper-Chief Inc. fixed asset turnover was 2.5 and it had
P33.2 million of fixed assets that were used at only 80% of capacity.
What is the maximum sales growth rate the company could achieve
before it had to increase its fixed assets?