Chapter 29

FINANCIAL PLANNING

Brealey, Myers, and Allen

Principles of Corporate Finance
11th Edition
McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
FINANCIAL PLANNING
• Short-Term Planning: to make sure the
company does not run out of cash (cash
budget).
• Long-Term Financial Planning: to
develop a coherent long-term strategy.

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SHORT TERM FINANCIAL PLANNING
• Short-term financial decisions differ in two
ways from long-term decisions such as the
purchase of plant and equipment or the
choice of capital structure.
• First, they generally involve short-lived
assets and liabilities, and, second, they are
usually easily reversed

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SHORT TERM FINANCING NEEDS
• Short-term financing needs are tied to the
firm’s long-term decisions.
• Money needs to be invested in plant,
machinery, inventories, accounts
receivable, and all the other assets it takes
to run a business.
• These assets can be financed by either
long-term or short-term sources of capital.

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FIGURE 29.1 FIRM’S CUMULATIVE CAPITAL
REQUIREMENT

• Line A: Permanent cash surplus

• Line B: Short-term lender for part of year, borrower for remainder

• Line C: Permanent short-term borrower

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CASH FLOW STATEMENTS
• Cash flow statements classify cash flows
into those from operating activities,
investing activities, and financing activities.

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TABLE 29.1 INCOME STATEMENT, DYNAMIC MATTRESS,
2012 ($ MILLIONS)

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TABLE 29.2 YEAR-END BALANCE SHEETS, DYNAMIC
MATTRESS ($ MILLIONS)

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TABLE 29.3 STATEMENT OF CASH FLOWS, DYNAMIC
MATTRESS , 2012 ($ MILLIONS)

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29-2 TRACING CHANGES IN CASH
• Example
• Sources of cash flows for Dynamic Mattress
• Earned $60m net income (operating activity)
• Set aside $20m as depreciation
• Depreciation is not cash outlay, must be added
back in order to obtain cash flow (operating
activity)
• Released $5m in inventory (operating activity)
• Increased accounts payable, borrowed $25m
from suppliers (operating activity)
• Issued $30m long-term debt (financing activity)
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29-2 TRACING CHANGES IN CASH
• Example, continued
• Uses of cash flows for Dynamic Mattress
• Expanded accounts receivable by $25 million
(operating activity)
• Invested $30 million (investing activity)
• Paid $30 million dividend (financing activity)
• Purchased $25 million marketable securities
(financing activity)
• Repaid $25 million short-term bank debt
(financing activity)
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29-2 TRACING CHANGES IN CASH
• Simple Cycle of Operations

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29-2 TRACING CHANGES IN CASH
• Cash Cycle

inventory at start of year

Average days in inventory =
annual cost of goods sold/365

receivables at start of year

Average collection period =
annual sales/365

payables at start of year

Average payment period =
annual cost of goods sold/365

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29-3 CASH BUDGETING
• Steps to Prepare Cash Budget
• Forecast sources of cash
• Forecast uses of cash
• Calculate whether firm is facing cash
shortage or surplus

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29-3 CASH BUDGETING
• Example
• Dynamic Mattress forecasted sources of cash

• Accounts receivable ending balance =

accounts receivable beginning balance +
sales - collections

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TABLE 29.4 COLLECTIONS ON ACCOUNTS
RECEIVABLE ($ MILLIONS)

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29-3 CASH BUDGETING
• Example
• Forecasted uses of cash for Dynamic Mattress
• Payment of accounts payable
• Labor, administration, and other expenses
• Capital expenditures
• Taxes, interest, and dividend payments

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TABLE 29.5 CASH BUDGET FOR 2013, DYNAMIC
MATTRESS COMPANY ($ MILLIONS)

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SOURCES OF FUNDING
• Taking new loans
• Stretching Payables
• Disposal of short-term securities

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29-5 LONG-TERM FINANCIAL PLANNING
• Planning Horizon
• Time horizon for financial plan
• Departments often asked to submit three
alternatives
• Optimistic
• Expected
• Pessimistic
• Financial plans ensure plans stay consistent
with capital budgets
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29-5 LONG-TERM FINANCIAL PLANNING
• Why Build Financial Plans?
• Contingency planning
• Considering options
• Forcing consistency

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29-5 LONG-TERM FINANCIAL PLANNING
Inputs Planning Model Outputs

• Inputs
• Current financial statements, forecasts of key
variables
• Planning Model
• Equations specifying key relationships

• Outputs
• Projected financial statements (pro forma),
financial ratios, sources and uses of funds
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29.7 CONDENSED YEAR-END BALANCE SHEET, DYNAMIC
MATTRESS ($ MILLIONS)

a
When only net working capital appears on firm’s
balance sheet, this figure is referred to as total
capitalization
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TABLE 29.8 ACTUAL (2012) AND FORECASTED OPERATING
CASH FLOWS, DYNAMIC MATTRESS

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TABLE 29.9 ACTUAL (2012) AND FORECASTED
REQUIRED EXTERNAL CAPITAL

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TABLE 29.10 ACTUAL (2012) AND PRO FORMA BALANCE
SHEETS, DYNAMIC MATTRESS

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29-5 LONG-TERM FINANCIAL PLANNING
• Pro Formas
• Projected or forecasted financial statements

• Percentage of Sales Model

• Sales forecasts are driving variable, most other
variables proportional to sales
• Balancing Item
• Variable that adjusts to maintain consistency of
financial plan, also called plug

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29-5 LONG-TERM FINANCIAL PLANNING
• Planners Beware
• Many models ignore realities such as
depreciation, taxes, etc.
• Percent of sales methods not realistic because
fixed costs exist
• Most models generate accounting numbers, not
financial cash flows
• Adjustments must be made to consider these
and other factors

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29-6 GROWTH AND EXTERNAL FINANCING
• Sustainable Growth Rate
• Steady rate at which firm can grow without
changing leverage

retained earnings
Internal growth rate =
net assets
retained earnings net income equity
=  
net income equity net assets

Sustainable growth rate = plowback ratio  return on equity

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