Chapter 11 – Forecasting and Chapter 11 – Forecasting and Short-Term Financial PlanningShort-Term Financial Planning

Learning ObjectivesLearning Objectives Understand how sales forecasts are used to Understand how sales forecasts are used to

predict cash inflow predict cash inflow Understand how production costs are used to Understand how production costs are used to

predict cash outflowpredict cash outflow Prepare pro forma statementsPrepare pro forma statements Calculate a company’s cash conversion cycleCalculate a company’s cash conversion cycle Explain ways to cover cash shortfallExplain ways to cover cash shortfall Explain options for investing cash excessExplain options for investing cash excess

Cash BudgetsCash Budgets

Periodic analysis of cash flow to analyze Periodic analysis of cash flow to analyze shortfall or excessshortfall or excess See Figure 11.1, page 320See Figure 11.1, page 320 All is well at end of period but shortfall during period All is well at end of period but shortfall during period

must be funded (March is cash short)must be funded (March is cash short)

Sources and UsesSources and Uses Sources: (1) cash sales, (2) payments received, (3) Sources: (1) cash sales, (2) payments received, (3)

sale of assets, or (4) borrowingsale of assets, or (4) borrowing Uses: (1) cash purchases, (2) payments made, (3) Uses: (1) cash purchases, (2) payments made, (3)

wages, (3) rent, (4) utilities, (5) interest, (6) dividends, wages, (3) rent, (4) utilities, (5) interest, (6) dividends, (7), retirement of debt, and (8) stock repurchases(7), retirement of debt, and (8) stock repurchases

Sales ForecastingSales Forecasting

Two issuesTwo issues When do sales occur?When do sales occur? When does the firm receive money from sales?When does the firm receive money from sales?

Predicting SalesPredicting Sales External DataExternal Data Internal DataInternal Data

Predicting Cash timing from salesPredicting Cash timing from sales Table 11.1, timing of sales receiptsTable 11.1, timing of sales receipts January receipts come from three different sales January receipts come from three different sales

monthsmonths

Production CostsProduction Costs

Cash disbursements closely tied to sales Cash disbursements closely tied to sales forecasts for firms selling productsforecasts for firms selling products Products produced in anticipation of saleProducts produced in anticipation of sale Stored as inventory until saleStored as inventory until sale Cash outflow occurs before, during, and after Cash outflow occurs before, during, and after

productionproduction Before: Purchas of suppliesBefore: Purchas of supplies During: Pay laborDuring: Pay labor After: Inventory and shipping costsAfter: Inventory and shipping costs

Individual months production cash outflow Individual months production cash outflow associated with several months of productionassociated with several months of production

Pro Forma StatementsPro Forma Statements

Pro Forma Statements Pro Forma Statements Relationship of various accounts to Sales or Relationship of various accounts to Sales or

AssetsAssets Income Statement – Percent of Total SalesIncome Statement – Percent of Total Sales Balance Sheet – Percent of Total AssetsBalance Sheet – Percent of Total Assets

Predicting net income with Pro FormaPredicting net income with Pro Forma Take predicted sales and using percent of Take predicted sales and using percent of

sales, fill in accounts on income statementsales, fill in accounts on income statement If relationships remain constant, pro forma If relationships remain constant, pro forma

income statement predicts net income for the income statement predicts net income for the periodperiod

Cash Conversion CycleCash Conversion Cycle

Cash is an inventory itemCash is an inventory item Need to know how much you will need to complete Need to know how much you will need to complete

daily transactionsdaily transactions Anticipate daily cash inflow Anticipate daily cash inflow Plan for any short fall between outflow and inflowPlan for any short fall between outflow and inflow

Cash Conversion Cycle (CCC)Cash Conversion Cycle (CCC) looks at the timing of cash flow or how long it takes looks at the timing of cash flow or how long it takes

the business to generate cash flow from a salethe business to generate cash flow from a sale Three cycles, (1) production, (2) collection, and (3) Three cycles, (1) production, (2) collection, and (3)

payment used to find CCCpayment used to find CCC

Short-term Cash Flow PlanningShort-term Cash Flow Planning

CCC components (Figure 13.3, page 331)CCC components (Figure 13.3, page 331) Production cycle – from when product is Production cycle – from when product is

started until customer “buys” the productstarted until customer “buys” the product Collection cycle – from time customer “buys” Collection cycle – from time customer “buys”

the product until customer makes paymentthe product until customer makes payment Payment cycle – from the time company Payment cycle – from the time company

receives materials for production until the receives materials for production until the company makes payment to suppliercompany makes payment to supplier

CCC = Production + Collection - PaymentCCC = Production + Collection - Payment

Short-term Cash Flow PlanningShort-term Cash Flow Planning

Estimating production cycleEstimating production cycle Find average inventoryFind average inventory Determine inventory turnover using COGSDetermine inventory turnover using COGS Calculate production cycleCalculate production cycle Example page 332…7.6 DaysExample page 332…7.6 Days

Estimate collection cycleEstimate collection cycle Find average accounts receivableFind average accounts receivable Determine A/R turnover using credit salesDetermine A/R turnover using credit sales Calculate collection cycleCalculate collection cycle Example page 333…13.8 daysExample page 333…13.8 days

Short-term Cash Flow PlanningShort-term Cash Flow Planning

Estimate payment cycleEstimate payment cycle Find average accounts payableFind average accounts payable Determine accounts payable turnoverDetermine accounts payable turnover Calculate payment cycleCalculate payment cycle Example page 334…7.0 daysExample page 334…7.0 days

CCC = 7.6 + 13.8 – 7.0 = 14.4 daysCCC = 7.6 + 13.8 – 7.0 = 14.4 days Must carry (finance) operations 15 daysMust carry (finance) operations 15 days To reduce CCC, speed up production or To reduce CCC, speed up production or

collection, or slow down payments…collection, or slow down payments…

Constructing Cash BudgetsConstructing Cash Budgets

Putting Together the timing of cash inflow and Putting Together the timing of cash inflow and cash outflowcash outflow

Cash Inflow…mainly sales and borrowingCash Inflow…mainly sales and borrowing Cash Outflow…Cash Outflow…

Accounts payableAccounts payable Wages, Taxes, and other operating expensesWages, Taxes, and other operating expenses Capital expendituresCapital expenditures Long-term financing expenses (interest and Long-term financing expenses (interest and

dividends)dividends) Example Table 11.5Example Table 11.5

Monthly ups and downs of cashMonthly ups and downs of cash Now to manage these ups (excess) and downs Now to manage these ups (excess) and downs

(shortfalls)(shortfalls)

Deficits and ExcessDeficits and Excess

Funding DeficitsFunding Deficits SavingsSavings Unsecured Loans – Letters of CreditUnsecured Loans – Letters of Credit

Prearranged borrowingPrearranged borrowing Like a credit cardLike a credit card

Secured LoansSecured Loans Other SourcesOther Sources

Commercial Paper (Business IOU)Commercial Paper (Business IOU) Trade Credit (Borrow from your suppliers)Trade Credit (Borrow from your suppliers) Banker’s Acceptance (Post dated check)Banker’s Acceptance (Post dated check)

Deficits and ExcessDeficits and Excess

Investing ExcessInvesting Excess Savings Account or Marketable SecuritiesSavings Account or Marketable Securities

Short term investingShort term investing Repayment to LendersRepayment to Lenders

Pay down debtPay down debt Extra Dividend to OwnersExtra Dividend to Owners

Replace AssetsReplace Assets More maintenance activitiesMore maintenance activities

Invest in positive NPV projects – long term Invest in positive NPV projects – long term investinginvesting

Managing Accounts ReceivableManaging Accounts Receivable

Aging receivablesAging receivables Identifies chronic late payersIdentifies chronic late payers Assigns late fees to proper accountsAssigns late fees to proper accounts Follow-up with late paying customersFollow-up with late paying customers

Example 13.2Example 13.2 Follow-up invoice with late feesFollow-up invoice with late fees Late fees billed by individual invoicesLate fees billed by individual invoices

Credit Terms, Float Credit Terms, Float & Cash Management& Cash Management

Granting of credit to customersGranting of credit to customers Policy on qualifying customers for creditPolicy on qualifying customers for credit Policy on payment planPolicy on payment plan Policy on follow-up for late paymentsPolicy on follow-up for late payments

Qualifying for creditQualifying for credit Credit screeningCredit screening

Increasing cost as more information requiredIncreasing cost as more information required Increasing cost usually match the increase in the size of the Increasing cost usually match the increase in the size of the

creditcredit

Example 13.3 – Inflatable boatsExample 13.3 – Inflatable boats

Credit Terms, Float Credit Terms, Float & Cash Management& Cash Management

Payment PolicyPayment Policy Methods to speed up receivablesMethods to speed up receivables

Discount for speedy paymentDiscount for speedy payment Lock boxes for faster processing of paymentsLock boxes for faster processing of payments Wire transfersWire transfers

Your Payment Policy (Accounts Payable)Your Payment Policy (Accounts Payable) Methods to slow down payablesMethods to slow down payables

Check payment Check payment Playing the float with remote disbursementsPlaying the float with remote disbursements

Inventory ManagementInventory Management

Keeping track of inventoryKeeping track of inventory ABC MethodABC Method

A goods are critical goods, or high priced goodsA goods are critical goods, or high priced goods B goods are moderately priced or essential goodsB goods are moderately priced or essential goods C goods are low priced or non-essential goodsC goods are low priced or non-essential goods

Most effort is spent on A goodsMost effort is spent on A goods Little effort is spent on C goodsLittle effort is spent on C goods

Economic Order Quantity – how much Economic Order Quantity – how much inventory to keep on handinventory to keep on hand

HomeworkHomework

Problem 2 – Predicting SalesProblem 2 – Predicting Sales Problem 6 – Sales ReceiptsProblem 6 – Sales Receipts Problem 10 – Pro Forma StatementProblem 10 – Pro Forma Statement Problem 12 – Pro Forma StatementProblem 12 – Pro Forma Statement Problem 14 -- CCCProblem 14 -- CCC

Problems – Second SetProblems – Second Set

Problem 13 – Credit ScreeningProblem 13 – Credit Screening Problem 15 – Credit TermsProblem 15 – Credit Terms Problem 17 – Economic Order QuantityProblem 17 – Economic Order Quantity