Tutorial

Chapter III

Cash Flow and

Financial Planning

Cash Flow andFinancial Planning - Goals

• Tax depreciation procedures

• The firm’s statement of cash flows

• Financial planning process (short-term and long-term)

• Cash-planning process (cash budget)

• The pro forma income statement

• The pro forma balance sheet

Depreciation

= systematic charging of a portion of costs of Fixed Assets against revenues over time.

- The amount is determined by using Modified Accelerated Cost Recovery System (MACRS)- Depreciable value- Depreciable life

Statement of CF

- Summarizes the firm‘s CF over a given period of time

CF is divided into - operating flows

- investment flows

- financing flows

Inflows – Decrease in A, Increase in Liab., EAT, Depreciation, Sale of stock

Outflows – Inc. in A, Dec. in Liab., Net loss, Dividends paid, Repurchase of stock

Formulas

CF from operations = EAT + Depreciation

Operating CF = EBIT*(1-T) + Depreciation = NOPAT + Depreciation

FCF = OCF – NFAI – NCAI

NFAI = Change in net fixed A + Depreciation

NCAI = Change in current A – Change in (accounts payable + accruals)

Financial planning process

Long-term financial plans – cover a 2 to 10 years period, Strategic decisions

Short-term financial plans – cover 1 to 2 years period, Operating financing

Cash Budget = a statement of a firm‘s planned inflows and outflows of cash. As a basis is used the sales forecast provided by the marketing department.

Financial planning process

Profit planning – Pro-Forma Statements

Pro-Forma Statements = projected income statements and balance sheets, two inputs are needed - the sales forecast and the financial statements for the preceding year.

Preparing Pro-Forma Income Statement – percent-of-sales method

Preparing Pro-Forma Balance Sheet – judgmental approach

Exercise 3 - 3

• Determine OCF

• Sales of $2,500,000

• Cost of goods sold $ 1,800,000

• Operating expenses $300,000

• Depreciation expenses $200,000

• Tax rate 35%

Exercise 3 – 3 Solution

• OCF = [EBIT * (1-t)] + Depreciation

• EBIT = $2,500,000 - $1,800,000 - $300,000 = $400,000

• OCF = [$400,000 * (1 - 0.35)] + $200,000 = $460,000

Exercise 3 - 4

• Calculate FCF

• Increase in fixed assets $300,000

• Depreciation $200,000

• Increase in current assets $150,000

• Increase in accounts payable $75,000

• OCF was $700,000

Exercise 3 – 4 Solution

• FCF = OCF - NFAI - NCAI

• NFAI = change in fixed assets + depreciation

• NFAI = $300,000 + $200,000 = $500,000

• NCAI = change in current assets - change in (acc. payable + accruals)

• NCAI = $150,000 - $75,000 = $75,000

• OCF = $700,000

• FCF = $700,000 - $500,000 - $75,000 = $125,000

Exercise 3 - 5

• Estimate net profits before taxes

• Sales forecast of $650,000

• Fixed costs of $250,000

• Variable costs 35% of Sales

• Operating expenses include fixed costs of $28,000 and variable costs 7,5% of sales

• Interest expenses are $20,000

Exercise 3 – 5 Solution

Problem 3 - 2

• Accounting cash flow

• Earnings after taxes $50,000

• Depreciation $28,000

• Amortization $2,000

• What was the firms accounting cash flow from operations?

Problem 3 – 2 Solution

• Earnings after taxes $50,000

• Plus: Depreciation $28,000

• Plus: Amortization $ 2,000

• Cash Flow from operations $80,000

Note: Deprec. and Amor. are non-cash charges. Depreciation is charged against tangible assets, amortization is charged against intangible assets.

Problem 3 - 4

• Depreciation and accounting Cash Flow

• Asset original cost of $180,000 has a 5-year

• MACRS recovery period, now in 3rd year (19%)

• Accruals $15,000

• Current assets $120,000

• Interest expense $15,000

• Sales revenue $400,000

• Inventory $70,000

• Total cost before deprec., int. and tax $290,000

• Tax rate on ordinary income 40%

Problem 3 – 4 Solution

Problem 3 - 5

Problem 3 – 5 Solution

Problem 3 - 7

• Cash receipts

• Sales of $65,000 in April, $60,000 in May

• Sales of $70,000 in June, $100,000 in July and in August

• Half of sales are for cash and the other half is collected evenly over next 2 months

• What are firms expected cash receipts for June, July and August?

• Use Excel sheet (Problem 3-7.xlsx)

Problem 3 – 7 Solution

Problem 3 - 8

• Cash disbursement schedule for April, May and June

• Sales from February: $500,000 $500,000 $560,000 $610,000 $650,000 $650,000

• Purchases: 60% of next month’s sales, 10% in cash, 50% after 1 month, 40% after 2 month

• Rent: $8,000 per month

• Wages and Salaries: Fixed $6,000/month + 7% of sales

• Taxes: $54,500 due in June

• Fixed asset outlays: New equipment in April for $75,000

• Interest payments: A payment of $30,000 is due in June

• Cash dividends: $12,500 will be paid in April

• Principal payments and retirements: None

• Use Excel sheet (Problem 3-8.xlsx)

Problem 3 – 8 Solution

Problem 3 - 14

• Pro forma income statement

• Use the percent of sales method to prepare a pro forma income statement

• Use fixed and variable cost data to develop a pro forma income statement

• Use Excel sheet (Problem 3-14.xlsx)

Problem 3 – 14 Solution a)

Problem 3 – 14 Solution b)

•Using fixed and variable costs higher profit is projected

• Percent of sales method is more conservative, but fixed and variable costs method is more accurate

Problem 3 - 17

• Pro forma balance sheet

• Analyze expected performance and financing needs for 2008 - 2yrs ahead

• Prepare pro forma balance sheet dated Dec. 31. 2008

• Discuss the financing changes suggested by the statement prepared

• Use Excel sheet (Problem 3-17.xlsx)

Problem 3 – 17 Solution

Company must arrange for additional financing of at least $775,000over the next two years based on the given constraints and projections