FINANCIAL MANAGEMENT Forecasting and short term financial planning

FINANCIAL MANAGEMENT Forecasting and short term financial planning

Introduction • Is the future uncertain ? Yes! • Can we plan for it? Yes! • Forecasting the coming period = draw a financial picture of the firm for the next week, quarter, year; • Major task in FM, starting point for the firm’s shortterm financial action plan; • Tools used in forecasting: – Cash forecasts (cash budgets); – Pro forma financial statements (cash budget projections);

Introduction • Financial forecasts usually begin with sales estimates. • Deviations from the plan are likely; • How do the managers solve cash shortages? • What to do in the case in which the company experiences excess in cash? Is it a good thing? • How to forecast the timing of cash flow into and out of the company in the first place?

Introduction • Short-term vs. long-term financial decisions: – Length of effect; – Cost; – Degree of information gathering prior to the decision;

Sources and uses of cash • Goal of cash management: – Hold sufficient cash on hand (but not to much) to meet business obligations in a timely and appropriate manner. • Cash budget is an analytical tool that: – estimates the future timing of cash inflows and cash outflows and projects potential shortfalls and surpluses. • Usually begins with cash receipts (sales forecasting); • Remember the difference between: – Sales revenue and the receipt of cash from sales; – Cost of goods sold and the timing of the cash outflow for the production goods.

Cash budget: a basic example

Examples of cash inflows • Cash sales from products and services; • Accounts receivables (mainly credit sales); • Cash sales of equipment or other assets; • Funding sources (bank loans, bond sales, stock sales).

Examples of cash outflows • • • Cash purchases (supplies, inventories, raw materials); Accounts payable (to suppliers); Wages/salaries; Rent, lease, or mortgage payments; Utility payments (i. e. , overhead); Shipping costs; Interest payments; Dividend payments; Paying off debt (loans and bonds); Repurchase of stock.

Cash budgeting and the sales forecast • The timing of the sale and the cash inflow from the sale often happen at different times; – A. When will the sales occur? (Marketing, financial depts. ) – B. When will the firm receive the money for the sales? (Financial dept. , cash vs. credit sales)

Sales forecast • Next ? • (1) average of the two previous growth rates: 22% => sales in 2007 of 50, 654, 000 $; • (2) only the prior year’s growth rate: 18% => sales in 2007 of 48, 413, 000 $; • (3) average dollar increase in sales: 6, 800, 000 $ => sales in 2007 of 47, 828, 000 $.

Sales forecast • The actual sales revenues amount in 2007: • We need more sophisticated model than just historical data to project sales for a reliable number; • We need: Internal data + External data; • Analysis of the Bridge Water Pumps and Filters example, pg. 355 -357;

Cash outflows from production • Sales forecasts are used for scheduling production; • Cash expenditures are thus closely tied to sales; • Cash outflows timing: – Raw materials: before the production; – Wages/salaries: in the same period with production; – Overheads: some time after the beginning of production; – Shipping costs: after the sale of the production. • ! The recording of the cost of goods sold occurs at the time of the sale but the cash flow may take place over an extended time period. [Analysis of Example 12. 1]

The cash forecast: deficits and surpluses • Goal: hold sufficient cash to pay bills without carrying excess cash (i. e. , lost earning power for the firm); • Main categories of cash outflows: – A. Accounts payable for materials and supplies; – B. Salaries, labor wages, taxes, and other operating expenses; – C. Capital expenditures; – D. Long-term financing expenses (interest, dividends, issuing cost of debt and equity). • Usually, the first two categories apply to the daily operating decisions of the firm.

The cash forecast • This monthly cash flow estimate allows to anticipate periods with deficits and surpluses. • Need to borrow in March/April but in June the desired level of cash reserves will be available (15, 000 $).

Funding cash deficits • Solutions for cash shortfalls: – Cash from savings (i. e. , the simplest way to cover deficits) – Unsecured loans (lines of credit) – Secured loans (with accounts receivable or inventories); – Other sources (commercial paper, trade credit) • Line of credit: prearranged loan with no specific assets backing the loan in case of default; – Clean-up period: keep a zero balance for a certain period; – The interest rate floats (market rates, e. g. , ROBOR 3 M). • Commercial paper: financial asset sold to investors like bonds or stocks but with shorter maturity (< 90 days, max. 270).

Funding cash deficits/Investing cash surpluses • Delaying the suppliers is an option but it also has the drawback of “tainting” an immaculate client behavior. • Options for cash excess: – Savings account, marketable securities; – Repay lenders and owners (retire debt early or pay extra dividends); – Replace aging assets; – Invest in the company, accepting +NPV projects.

Planning with pro forma financial statements