Financial Planning Corporate Finance

McGraw-Hill/Irwin
 29-2

Balance Sheet
Example - Dynamic Mattress Company

2009 2008 2009 2008

Current assets: Current liabilities:
Cash 25 20 Bank loans 0 25
Marketable securities 25 0 Accounts payable 135 110
Accounts receivable 150 125 Total current liabilities 135 135
Inventory 125 130 Long-term debt 90 60
Total current assets 325 275 Net worth (equity and retained 350 320
Fixed assets: earnings)
Total liabilities and net worth 575 515
Gross investment 350 320
Less depreciation 100 80
Net fixed assets 250 240
Total assets 575 515
 29-3

Income Statement
Example - Dynamic Mattress Company
1. Sales 2,200
2. Cost of goods sold 1,644
3. Other expenses 411
4. Depreciation 20
5. EBIT (1-2-3-4) 125
6. Interest 5
7 Pretax income (5-6) 120
8. Tax at 50% 60
9. Net income (7-8) 60

Dividend 30
Earnings retained in the business 30
 29-4

Changes in Cash Flows

Example -
Dynamic
Cash flows from operating activities:
Mattress
Company Net income 60
Depreciation 20
Decrease (increase) in accounts receivable -25
Decrease (increase) in inventories 5
Increase (decrease) in accounts payable 25
Net cash flow from operating activities 85

Cash flows from investing activities:

Investment in fixed assets -30

Cash flows from financing activities:

Dividends -30
Sale (purchase) of marketable securities -25
Increase (decrease) in long-term debt 30
Increase (decrease) in short-term debt -25
Net cash flow from financing activities -50

Increase (decrease) in cash balance 5

 29-5

Changes in Cash Flows

Example - Dynamic Mattress Company

 Dynamic sources of cash flows

1. It earned $60 million of net income (operating activity).
2. It set aside $20 million as depreciation. Remember that depreciation is
not a cash outlay. Thus, it must be added back in order to obtain
Dynamic’s cash flow (operating activity).
3. It reduced inventory, releasing $5 million (operating activity).
4. It increased its accounts payable, in effect borrowing an additional $25
million from its suppliers (operating activity).
5. It issued $30 million of long-term debt (financing activity).
 29-6

Changes in Cash Flows

Example - Dynamic Mattress Company

 Dynamic uses of cash flows

1. It allowed accounts receivable to expand by $25 million (operating activity). In
effect, it lent this additional amount to its customers.
2. It invested $30 million (investing activity). This shows up as the increase in gross
fixed assets in Table 29.2.
3. It paid a $30 million dividend (financing activity). (Note: The $30 million
increase in Dynamic’s equity in Table 29.2 is due to retained earnings: $60
million of equity income, less the $30 million dividend.)
4. It purchased $25 million of marketable securities (financing activity).
5. It repaid $25 million of short-term bank debt (financing activity)).
 29-7

Working Capital

Simple Cycle of operations

Cash

Receivables Raw materials

Finished goods
 29-8

The Cash Cycle

inventory at start of year

Avg Days in Inventory =
annual COGS/365

receivables at strat of year

Avg collection period =
annual sales/365

payables at strat of year

Avg payment period =
annual COGS/365
 29-9

Cash Budgeting
 Steps to preparing a cash budget
Step 1 - Forecast sources of cash.
Step 2 - Forecast uses of cash.
Step 3 - Calculate whether the firm is facing a cash
shortage or surplus.
 29-10

Cash Budgeting
Example - Dynamic Mattress Company

Dynamic forecasted sources of cash

AR ending balance = AR beginning balance + sales -

collections
 29-11

Cash Budgeting
Example - Dynamic Mattress Company
Dynamic collections on AR
Second Fourth
First Quarter Third Quarter
Quarter Quarter
1. Receivables at start of period 150 199 181.6 253.6
2. Sales 560 502 742 836
3. Collections:
Sales in current period (70%) 392 351.4 519.4 585.2
Sales in last period (30%) 119* 168 150.6 222.6
Total collections 511 519.4 670 807.8
4. Receivables at end of period 1 + 2 - 3 199 181.6 253.6 281.8
* We assume that sales in the last quarter of the previous year were $397 million.
 29-12

Cash Budgeting
Example - Dynamic Mattress Company

Dynamic forecasted uses of cash

 Payment of accounts payable
 Labor, administration, and other expenses
 Capital expenditures
 Taxes, interest, and dividend payments
 29-13

Cash Budgeting
First Second Third Fourth

Example Sources of cash:

Quarter Quarter Quarter Quarter

Collections on accounts receivable 511 519.4 670 807.8

Dynamic Other
Total sources 511
0 0
519.4
77
747 807.8
0

cash budget Uses of cash:

Payments on accounts payable 250 250 267 261
Increase in inventory 150 150 170 180
Labor and other expenses 136 136 136 136
Capital expenditures 70 10 8 14.5
Taxes, interest, and dividends 46 46 46 46

Total uses 652 592 627 637.5

Sources minus uses -141 -72.6 120 170.3

Calculation of short-term borrowing requirement:

Cash at start of period 25 -116 -188.6 -68.6
Change in cash balance -141 -72.6 120 170.3
Cash at end of period -116 -188.6 -68.6 101.7
Minimum operating balance 25 25 25 25
Cumulative financing required 141 213.6 93.6 -76.7