Chapter 7

Funds Analysis, CashFlow Analysis, and Financial Planning
© Pearson Education Limited 2004 Fundamentals of Financial Management, 12/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI

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After studying Chapter 7, you should be able to:

 



Explain the difference between the flow of funds (sources and uses of funds) statement and the statement of cash flows -- and understand the benefits of using each. Define "funds" and identify sources and uses of funds. Create a sources and uses of funds statement, make adjustments, and analyze the final results. Describe the purpose and content of the statement of cash flows as well as implications that can be drawn from it. Prepare a cash budget from forecasts of sales, receipts, and disbursements -- and know why such a budget should be flexible. Develop forecasted balance sheets and income statements. Understand the importance of using probabilistic information in forecasting financial statements and evaluating a firm's condition.

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Funds Analysis, Cash-Flow Analysis, and Financial Planning
Flow

of Funds (Sources and Uses) Statement
Statement of Cash Flows Forecasting Financial Statements

Accounting Cash-Flow Range

of Cash-Flow Estimates

Forecasting
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Flow of Funds Statement
A summary of a firm’s changes in financial position from one period to another; it is also called a sources and uses of funds statement or a statement of changes in financial position. Has been replaced by the cash flow statement (1989) in U.S. audited annual reports.

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Why Examine the Flow of Funds Statement QUESTION?
Why should we bother to understand a Flow of Funds Statement that is no longer required to appear in U.S. audited annual reports?
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especially if it is prepared under the “indirect method. Is easy to prepare and often preferred by managers for analysis purposes over the more complex cash flow statement. Helps you to better understand the cash flow statement.Why Examine the Flow of Funds Statement The Flow of Funds Statement:   Includes important noncash transactions while the cash flow statement does not.”  7-6 .

Extends beyond just transactions involving cash.Flow of Funds Statement What are “funds”? All of the firm’s investments and claims against those investments. 7-7 .

Assets. and Liabilities (broadly defined). The pluses (minuses) indicate increases (decreases) in assets or liabilities. Sources.Sources and Uses Statement The letters labeling the boxes stand for Uses. 7-8 A L S U + + - .

BW’s Determination of Sources and Uses Assets 2007 2006 +/S/U Cash and C.140 930 (299) 631 50 223 2.E. Acct. LT Total Assets 7-9 $ $ $ $ 90 394 696 5 10 1.195 1030 (329) 701 50 223 2.169 $ $ $ $ 100 410 616 5 9 1. Inventories Prepaid Exp Accum Tax Prepay Current Assets Fixed Assets (@Cost) Less: Acc. Assets Investment. LT Other Assets. Depr. Rec. Net Fix.044 + + + S S U -U N/A N/A N/A U --- .

Depr. LT Other Assets.044 S S U -U N/A N/A N/A U --- . LT Total Assets 7-10 $ $ $ $ 90 394 696 5 10 1. Inventories Prepaid Exp Accum Tax Prepay Current Assets Fixed Assets (@Cost) Less: Acc. Assets Investment.E.140 930 (299) 631 70 50 223 2. Rec. Acct.BW’s Determination of Sources and Uses Assets 2007 2006 +/S/U Cash and C. Net Fix.169 $ $ $ $ 100 $10 410 16 616 80 5 9 1 1.195 1030 (329) 701 50 223 2.

Stock ($1 par) Add Pd in Capital Retained Earnings Total Equity 7-11 Total Liab/Equity $ $ 290 94 16 100 500 530 $ $ 295 94 16 100 505 453 200 729 157 1086 2.BW’s Determination of Sources and Uses Liabilities and Equity 2007 2006 +/S/U Notes Payable Acct. Payable Accrued Taxes Other Accrued Liab.169 + $ $ . Long-Term Debt Shareholders’ Equity Com.044 - + U ---N/A S --S N/A 200 729 210 $ 1.139 $ 2. Current Liab.

Payable Accrued Taxes Other Accrued Liab. Long-Term Debt Shareholders’ Equity Com.169 53 $ $ . Current Liab.044 $ 5 77 U ---N/A S --S N/A 200 729 210 $ 1.139 $ 2. Stock ($1 par) Add Pd in Capital Retained Earnings Total Equity 7-12 Total Liab/Equity $ $ 290 94 16 100 500 530 $ $ 295 94 16 100 505 453 200 729 157 1086 2.BW’s Determination of Sources and Uses Liabilities and Equity 2007 2006 +/S/U Notes Payable Acct.

Long-Term Debt Decrease.“Basic” Sources and Uses Statement SOURCES Increase. Cash + Cash Equivalents USES Increase. Accum Tax Prepay Decrease. Inventories Increase. Net Fixed Assets 7-13 $ 53 16 77 10 $156 $80 1 5 70 $156 . Notes Payable Increase. Accounts Receivable Increase. Retained Earnings Decrease.

Adjusting the “Basic” Sources and Uses Statement The following three slides are Basket Wonders’ Balance Sheet and Income Statement that was discussed in Chapter 6. This information will be needed to adjust the “basic” Sources and Uses Statement. 7-14 .

b. LT 223 Total Assets b $2. e. d. How the firm stands on a specific date. 31. Assets $ 701 Investment. Cash/likely convertible to cash within 1 year. Rec. What BW owned. deductions for wear and tear. Future expense items already paid. $ 90 Acct. Original amount paid.169 7-15 a.195 Fixed Assets (@Cost)f 1030 Less: Acc. Depr. Acc. Amounts owed by customers. 2007a Cash and C.c 394 Inventories 696 Prepaid Exp d 5 Accum Tax Prepay 10 Current Assetse $1. g. f.Basket Wonders’ Balance Sheet (Asset Side) Basket Wonders Balance Sheet (thousands) Dec. g (329) Net Fix. LT 50 Other Assets. c. .E.

etc. Debts payable > 1 year. Payablec 94 Accrued Taxes d 16 Other Accrued Liab.169 a. b. 2007 Notes Payable $ 290 Acct. Earnings reinvested. What BW owed and ownership position. g.b $2. salaries. Stock ($1 par) g 200 Add Pd in Capital g 729 Retained Earnings h 210 Total Equity $1. Original investment. e. f. Debts payable < 1 year. c. 31. Assets = Liabilities + Equity. h. Owed to suppliers for goods and services. e $ 500 Long-Term Debt f 530 Shareholders’ Equity Com. d 100 Current Liab. Unpaid wages. . d. Note.139 7-16 Total Liab/Equitya.Basket Wonders’ Balance Sheet (Liability Side) Basket Wonders Balance Sheet (thousands) Dec.

adv. d. officer’s salaries. etc. . Measures profitability over a time period. c..599 Gross Profit $ 612 SG&A Expenses c 402 EBITd $ 210 Interest Expensee 59 EBT f $ 151 Income Taxes 60 EATg $ 91 Cash Dividends 38 Increase in RE $ 53 7-17 a. Cost of borrowed funds. Received.Basket Wonders’ Income Statement Basket Wonders Statement of Earnings (in thousands) for Year Ending December 31. Operating income. Sales comm. from customers. b. 2007a Net Sales $ 2. or receivable.. f. g. Taxable income.211 Cost of Goods Sold b 1. Amount earned for shareholders. e.

. 7-18 . R. Source: Less Use: Net Profit Cash Dividends $91 38 $53 (Net) Source: Incr.E.Adjusting the “Basic” Sources and Uses Statement Recognize Profits and Dividends Change in retained earnings is composed of profits and dividends.

to F.Adjusting the “Basic” Sources and Uses Statement Recognize Depreciation and Gross Changes in Fixed Assets Change in net fixed assets is composed of depreciation and fixed assets. Incr.. Source: Less Use: (Net) Use: 7-19 Depreciation Add.A.A. Net F. $ 30 100 $ 70 .

Cash + Cash Equivalents $ 91 30 16 77 10 $224 7-20 . Accounts Receivable Increase. Long-Term Debt Decrease.Sources and Uses Statement (Sources Side) SOURCES Funds provided by operations Net Profit Depreciation Decrease.

Tax Prepay Decrease.Sources and Uses Statement (Uses Side) USES Dividends Additions to fixed assets Increase. Inventories Increase. Accum. Notes Payable $ 38 100 80 1 5 $224 7-21 .

. 7-22 Uses Primarily through an increase in inventories and expenditures on capital assets.Analyzing the Sources and Uses Statement Sources Primarily through net profit from operations and long-term debt increases.

and 7-23 financing activities.Statement of Cash Flows A summary of a firm’s payments during a period of time. investing activities. . This statement reports cash inflows and outflows based on the firm’s operating activities.

7-24 .Statement of Cash Flows Cash Flow from Operating Activities Shows impact of transactions not defined as investing or financing activities.  These cash flows are generally the cash effects of transactions that enter into the determination of net income.

Cash Flow From Operating Activities Cash Inflows From sales of goods or services From interest and dividend income Cash Outflows To pay suppliers for inventory To pay employees for services To pay lenders (interest) To pay government for taxes To pay other suppliers for other operating expenses 7-25 .

S.Cash Flow From Operating Activities It would seem more logical to classify interest and dividend income as an “investing” inflow. while interest paid certainly looks like a “financing” outflow. 7-26 .classified these items as “operating” flows. the U. Financial Accounting Standards Board -.by a slim 4 to 3 vote -. But.

Statement of Cash Flows Cash Flow from Investing Activities Shows impact of buying and selling fixed assets and debt or equity securities of other entities. Cash Flow from Financing Activities Shows impact of all cash transactions with shareholders and the borrowing and repaying transactions with lenders. 7-27 .

plant. equipment) From sale of debt or equity securities (other than common equity) of other entities Cash Outflows To acquire fixed assets (property.Cash Flow From Investing Activities Cash Inflows From sale of fixed assets (property. plant. equipment) To purchase debt or equity securities (other than common equity) of other entities 7-28 .

Cash Flow From Financing Activities Cash Inflows From borrowing From the sale of the firm’s own equity securities Cash Outflows To repay amounts borrowed To repurchase the firm’s own equity securities To pay shareholders dividends 7-29 .

Indirect Method -Statement of Cash Flows Cash Flow from Operating Activities Net Income Depreciation Decrease. accum. accounts receivable Increase. tax prepay $ 91 30 16 ( 80) ( 1) Net cash provided (used) by operating activities 7-30 $ 56 . inventories Increase.

Indirect Method -Statement of Cash Flows Cash Flow from Investing Activities Additions to Fixed Assets Net cash provided (used) by investing activities $(100) $(100) 7-31 .

Indirect Method -Statement of Cash Flows Cash Flow from Financing Activities Increase. long-term debt Dividends paid Net cash provided (used) by financing activities 7-32 $ ( 5) 77 ( 38) $ 34 . notes payable Increase.

2007 $ 90 Supplemental cash flow disclosures Interest paid $ Taxes paid 7-33 59 60 . 2006 100 Cash and cash equivalents.Indirect Method -Statement of Cash Flows Increase (decrease) in cash and cash equivalents $ ( 10) Cash and cash equivalents.

c 7-34 See Worksheet on next slide for calculation . b.227 (2.Direct Method -Statement of Cash Flows Cash Flow from Operating Activities Cash received from customersa Cash paid to suppliers and employeesb Interest paid Taxes paidc $2.051) ( 59) ( 61) $ 56 Net cash provided (used) by operating activities a.

971 80 $2.Worksheet for Preparing Operating Activities Section (a) +(-) (b) +(-) Sales Decrease (increase) in AR Cash received from customers COGS .Depreciation + SGA Increase (decrease) in inventory Cash paid to suppliers and employees $2.211 16 $2. tax prepay Taxes paid $ $ 60 1 61 .227 $1.051 (c) +(-) 7-35 Income taxes (federal / state) Incr (Decr) in accum.

Direct Method -Statement of Cash Flows Cash Flow from Investing Activities Additions to Fixed Assets Net cash provided (used) by investing activities $(100) $(100) 7-36 .

long-term debt Dividends paid Net cash provided (used) by financing activities 7-37 $ ( 5) 77 ( 38) $ 34 . notes payable Increase.Direct Method -Statement of Cash Flows Cash Flow from Financing Activities Decrease.

accum.Direct Method -Statement of Cash Flows Increase (decrease) in cash and cash equivalents Cash and cash equivalents. 2007 Supplemental cash flow disclosures $ ( 10) 100 $ 90 7-38 Net Income Depreciation Decrease. tax prepay Net cash provided (used) by operating activities $ 91 30 16 ( 80) ( 1) 56 $ . inventories Increase. 2006 Cash and cash equivalents. accounts receivable Increase.

The financial manager is better able to:    Determine the future cash needs of the firm Plan for the financing of these needs Exercise control over cash and liquidity of the firm 7-39 .Cash Flow Forecasting A Cash Budget is a forecast of a firm’s future cash flows arising from collections and disbursements. usually on a monthly basis.

Product line sales projections are consolidated into a single forecast.The Sales Forecast Internal Sales Forecast  Sales representatives project sales for the period in question (sales under their control or management).   7-40 . Sales projections are screened and consolidated for product lines.

  7-41 . Expected market share is projected for current and new product lines. Product line sales projections are consolidated into a single forecast.The Sales Forecast External Sales Forecast  Economists project overall economic and business trends that will affect the firm.

and no “bad debts.” Hint: The cash flow forecast will be used in forecasting the financial statements later in this chapter.BW’s Cash Flow Forecast Lisa Miller has finalized a cash flow forecast for the first six months of 2008. Lisa is expecting 90% of monthly sales will be credit sales with 80% of credit sales collected in 30 days. 7-42 . 20% in 60 days.

90% Cash Sales. 10% Total Sales. current 80% of last month’s credit sales 20% of 2-month-old credit sales Total sales receipts 7-43 $ 17 169 $ 15 123 39 $225 42 $180 . 100% NOV $193 21 $214 DEC $212 24 $236 JAN $154 17 $171 FEB $135 15 $150 CASH COLLECTIONS Cash sales.Collections and Other Cash Receipts (Thousands) SALES Credit Sales.

Collections and Other Cash Receipts (Thousands) SALES Credit Sales. 90% Cash Sales. 100% MAR $256 28 $284 APR $205 23 $228 MAY $160 18 $178 JUN $190 21 $211 CASH COLLECTIONS Cash sales. 10% Total Sales. current 80% of last month’s credit sales 20% of 2-month-old credit sales Total sales receipts 7-44 $ 28 108 $ 23 205 $ 18 164 $ 21 128 31 $167 27 $255 51 $233 41 $190 .

Schedule of Projected Cash Disbursements (Thousands) Purchases DEC $ 39 JAN $ 35 FEB $ 64 CASH DISBURSEMENTS FOR PURCHASES AND OPERATING EXPENSES 100% of last month’s purchases Wages paid Other expenses paid Total disbursements (purchases and operating expenses) 7-45 $ 39 90 34 $163 $ 35 94 34 $163 .

Schedule of Projected Cash Disbursements (Thousands) Purchases CASH DISBURSEMENTS FOR PURCHASES AND OPERATING EXPENSES MAR $ 53 APR $ 40 MAY $ 48 JUN $ 50 100% of last month’s purchases Wages paid Other expenses paid Total disbursements (purchases and operating expenses) 7-46 $ 64 111 34 $209 $ 53 107 34 $194 $ 40 92 34 $166 $ 48 92 34 $174 .

Schedule of Net Cash Disbursements (Thousands) JAN Total disbursements for $163 purchases and operating expenses Capital expenditures 70 Dividend payments 0 Income taxes 25 Total cash disbursements $258 FEB $163 MAR $209 40 0 0 $203 0 9 0 $218 7-47 .

Schedule of Net Cash Disbursements (Thousands) APR Total disbursements for $194 purchases and operating expenses Capital expenditures 0 Dividend payments 0 Income taxes 25 Total cash disbursements $219 MAY $166 JUN $174 0 0 0 $166 0 10 0 $184 7-48 .

Projected Net Cash Flows and Cash Balances Beginning cash balance Total cash receipts Total cash disbursements Net cash flow JAN $ 90 225 258 $( 33) FEB $ 57 MAR $ 34 180 167 203 218 $( 23) $( 51) Ending cash balance without additional financing $ 57 7-49 $ 34 $( 17) .

Projected Net Cash Flows and Cash Balances Beginning cash balance Total cash receipts Total cash disbursements Net cash flow APR $( 17) 255 219 $ 36 MAY $ 19 233 166 $ 67 JUN $ 86 190 184 $ 6 Ending cash balance without additional financing $ 19 7-50 $ 86 $ 92 .

capital expenditures.Range of Cash-Flow Estimates Examine factors that may influence cash receipts such as changes in the state of the economy that influence consumer buying decisions and pricing strategies. and dividend payments. 7-51 . Examine factors that may influence cash disbursements such as changes in the state of the economy that impact operations.

Management Uncertainty in Ending Cash Balances January Distribution PROBABILITY OF OCCURRENCE $42 $51 $60 $69 $78 7-52 ENDING CASH BALANCE (thousands) .

Management Uncertainty in Ending Cash Balances February Distribution PROBABILITY OF OCCURRENCE $4 $15 $26 $37 $48 7-53 ENDING CASH BALANCE (thousands) .

7-54 .Summary of the Range of Cash-Flow Estimates   Allows examination of the relevant factors which may generate uncertainty regarding future cash flows. Enables management to better plan for contingencies that will arise than using a single-point estimate of monthly cash flows.

Considerations (1) Forecasted Income Statement (2) Forecasted Balance Sheet 7-55 .Forecasting Financial Statements Expected future financial statements based on conditions that management expects to exist and actions it expects to take.

Forecasting BW’s Income Statement Lisa Miller is forecasting the income statement for 2008.222. COGS are estimated from the average of years 2005 through 2007. Selling.000. She estimates that sales for the 6 months ended June 30 will be $1.000 per month. while the income tax rate is assumed equal to 40%. 7-56 . general. and administrative costs are forecasted at $34. Cash dividends and interest expenses are expected to remain constant.

e.3% multiplied by net sales. b.Basket Wonders’ Forecasted Income Statement Basket Wonders Forecasted Statement of Earnings (in thousands) for Six Months Ending June 30.222 Cost of Goods Sold b 865 Gross Profit $ 357 SG&A Expenses c 204 EBIT $ 153 Interest Expensed 29 EBT $ 124 Income Taxes 50 EAT $ 74 Cash Dividendse 19 Increase in RE $ 55 7-57 a. c.5)($38. Did not change. d.7. and 72. 2008 Net Salesa $ 1. . $34. 71. From sales budget.3. Six (6) months of dividends = (.000. Average of 68.000 x 6 months.000) = $19. Assumed to be $29.000.

140 $110. Capital expenditure of Fixed Assets (@Cost) 1. 100% June. Inv Turnover = 2.b 222 Inventoriesc 692 b.a $ 92 a.021 d.5/yr.000 and Less: Acc. (386) depreciation of d Net Fix.Basket Wonders’ Balance Sheet (Asset Side) Forecasted Balance Sheet (thousands) June 30. Assets $ 742 $69. LT 223 ASSUMPTIONS Total Assets $2. Accum Tax Prepay 10 Current Assets $1.E. Investment. Depr. Prepaid Exp 5 c. 20% May. 2008 Cash and C. LT 50 Other Assets. Acct. From Cash Flow Forecast.036 7-58 .000. Rec.

etc. b. salaries. Increase in retained 265 earnings (See 7-57). Long-Term Debt Shareholders’ Equity Com. No net change in accruals. Previous balance less amount paid down. d Current Liab. $1. 729 e. Stock ($1 par) Add Pd in Capital Retained Earnings e Total Equity 7-59 Total Liab/Equity a. Decrease in unpaid 200 wages.194 ASSUMPTIONS $2. Payableb Accrued Taxes c Other Accrued Liab. c.036 $ 226 50 16 20 $ 312 530 . 2008 Notes Payablea Acct.Basket Wonders’ Balance Sheet (Liability Side) Forecasted Balance Sheet (thousands) June 30. d. 100% of June purchases.