Chapter 13. Financial Planning.

Financial planning involves analyzing the financial flows of a company; forecasting the consequences of various investment, financing, and dividend decisions; and weighing the effects of various alternatives.

The idea is to determine where the firm has been, where it is now, and where it is going -not only the most likely course of events, but deviations from the most likely outcome.

METHODS OF ANALYSIS.
One of the valuable aids we find is a funds-flow statement, with which a financial manager or creditor may evaluate how a firm uses funds and may determine how this uses are financed.

In the analysis of future funds flows, we have the cash budget statement (determines the short-term cash needs of the firm) and the pro forma statement (enables the financial manager to analyze the effect of various policy decisions on the future financial condition and performance of the firm).

The final method of analysis involves sustainable growth modeling. Here we determine whether the sales growth objectives of the company are consistent with its operating efficiency and with its financial ratios.


SOURCE AND USE OF FUNDS.
The flow of funds in a firm may be visualized as a continuous process. For every use of funds, there must be an offsetting source, so that the reservoir of cash fluctuates over time with the production schedule, sales, collection of receivables, capital expenditure and financing.

The funds statement is a method by which we study the net funds flow between two points in time.

Funds Statement on a Cash Basis.
Source and use statements tell us the major uses of funds and how those uses have been financed over time.

Basically, one prepares a funds statement on a cash basis by:
(1) Classifying net balance sheet changes that occur between two points in time.

(2) Classifying, from the income statement and the shareholders' equity statement, the factors that increase cash and the factors that decrease cash.

(3) Consolidating this information in a source and use of funds statement form.

Sources of funds that increase cash are:
1. A net decrease in any asset other than cash or fixed assets.
2. A gross decrease in fixed assets.
3. A net increase in any liability.
4. Proceeds from the sale of preferred or common stock.
5. Funds provided by operations.

Uses of funds include:
1. A net increase in any asset other than cash or fixed assets.
2. A gross increase in fixed assets.
3. A net decrease in any liability.
4. A retirement or purchase of stock.
5. Cash dividends.

Categorizing the Changes. Once all sources and uses are computed, they may be arranged in statement form. When we substract the total uses of funds from the total sources, the difference should equal the actual change in cash between the two statement dates. Frequently, discrepancies will be due to equity adjustments, and the analyst should be alert to this possibility.

Accounting Statement of Cash Flows.
This statement employs positive and negative number for the increases and decreases in cash, respectively. Also, changes are categorized into operating activities, investing activities, and financing activities. A third difference is that it records gross investment in not only property, plant, and equipment (fixed assets) but also dispositions. Finally, repurchase of stock is considered a separate item.

Implications.
The analysis of funds statements gives us a rich insight into the financial operations of a firm -an insight that will be specially valuable when analyzing past and future expansion plans of the firm and the impact of these plans on liquidity. You can detect imbalances in the uses of funds and undertake appropriate actions.


CASH BUDGETING.
A cash budget is arrived at through a projection of future cash receipts and cash disbursements of the firm over various intervals of time. It reveals the timing and amount of expected cash inflows and outflows over the period studied. Cash budgets are indispensible as a planning tool when you manage a seasonal business for cash.

Preparation of the Cash Budget: Receipts.
The key to the accuracy of most cash budgets is the forecast of sales. This forecast can be based on an internal analysis (asking sales representatives to project sales), an external one (looking at trends in the economy and industry), or both (which would be more accurate).

Sales to Cash Receipts. The next job is to determine the cash receipts from these sales. For cash sales, cash is received at the time of sale; for credit sales, receipts do not come until later.

The firm should be ready to change its assumptions with respect to collections when there is an underlying shift in the payment habits of its customers.

Other receipts. In addition to the collection of sales from a product or service, cash receipts may arise from the sale of assets, from sale of stock, from a debt issue, from a tax refund, and from free income. For the most part, things of this sort are planned in advance and are predictable for purposes of cash budgeting.

Receivable Collection Period.
Different lags in the collections of sales result when the average collections period assumption is changed.

Forecasting Disbursements.
Given the sales forecast, management may choose to gear production closely to seasonal sales, to produce at a relatively constant rate over time, or to have a mixed production strategy. Once a production schedule has been stablished, estimates can be made of the needs in materials, labor, and additional fixed assets. As with receivables, there is a lag between the time a purchase is made and the time of actual cash payment.

Net Cash Flow and Cash Balance.
Once we are satisfied that we have taken into account all foreseeable cash inflows and outflows, we combine the cash receipts and cash disbursements schedules to obtain the net cash inflow or outflow for each month. The net cash flow may then be added to beginning cash in January and the projected cash position computed month by month for the period under review.

Deviations from Expected Cash Flows.
We stress again that a cash budget represents merely an estimate of future cash flows. Depending on the care devoted to preparing the budget and the volatility of cash flows resulting from the nature of the business, actual cash flows will deviate more or less widely from those that were expected.

In the face of uncertainty, we must provide information about the range of possible outcomes, and therefore working on additional cash budgets that consider different sets of assumptions (one for a maximum probable decline of business and another for a maximum probable increase in business).


PRO FORMA STATEMENTS.
Pro forma statements project forward the balance sheet and income statement.

Pro Forma Income Statement.
The pro forma income statement is a projection of income for a period of time in the future. As before, the key to accuracy is the sales forecast.

The pro forma income statement need not be based on a cash budget. Instead, one can make direct estimates of all the items. By first estimating a sales level, one can multiply.hystorical ratios of cost of goods sold and various expense items by the level in order to derive the statement.

Pro Forma Balance Sheet.
Pro formas can be based on the cash budget or on turnover ratios and percents of sales.

Estimates Based on Turnover. If a cash budget is not available, the receivable balance may be estimated on the basis of a turnover ratio. This ratio should be based on past experience. To obtain the estimated level of receivables, projected sales are simply divided by the turnover ratio.

Fixed Asset Estimate. Future net fixed assets are estimated by adding planned expenditures to existing net fixed assets and subtracting from this sum depreciation for the period, plus any sale of fixed assets at book value. Because capital expenditures are planned in advance, fixed assets generally are fairly easy to forecast.

Liability Estimates. We estimate accounts payable by adding total projected purchases for January through June, less total projected cash payments for purchases for the period, to the December 31 balance.

Equity, Cash, and Borrowing Estimates. Shareholder's equity at June 30 would be that at December 31 plus profits after taxes for the period, less the amount of cash dividends to be paid. In general, cash and notes payable serve as balancing factors in the preparation of the pro forma balance sheets, whereby assets and liabilities plus shareholders' equity are brought into balance.

Putting It Together. Once we have estimated all the components, they are combined into a balance sheet format.

Use of Ratios and Implications.
Financial ratios may be computed for analysis of the statements; these ratios and the raw figures may be compared with those for present and past balance sheets. Continual revision of these forecast keeps the firm alert to changing conditions in its environment and in its internal operations.


SUSTAINABLE GROWTH MODELING.
The management of growth requires careful balancing of the sales objectives of the firm with its operating efficiency and financial resources.

In the way of definition, the sustainable growth rate (SGR) is the maximum percent increase in sales that is possible, given a set of target financial and operating ratios.

If actual growth exceeds the SGR, something must give, and frequently it is the debt ratio. By modeling the process of growth, we are able to make intelligent trade-offs.

Steady-State Model.
To illustrate the calculation of a sustainable growth rate, we begin with a steady-state model where the future is exactly like the past with respect to balance sheet and performance ratios. Assumed also is that the firm engages in no external equity financing; the equity account builds only through earnings retention.

Variables employed.
A/S = total assets-to-sales ratio
NP/S = net profit margin (net profits divided by sales)
b = retention rate of earnings (1-b is the dividend payout ratio)
D/Eq. = debt-to-equity ratio
S₀ = most recent annual sales (beginning sales)
∆S = absolute change in sales from the most recent annual sales.

Sustainable Growth Rate. The idea is that an increase in assets (a use of funds) must equal the increase in liabillities and shareholders' equity (a source of funds). See formula in page 404.

Illustration. See the example in page 405.

Modeling under Changing Assumptions.
Most situations do not conform to steady-state modeling, so year-by-year modeling is in order.

In effect, the sales of the previous year and equity at the previous year serve as foundations on which to build year-by-year modeling. Also, we express dividends in terms of the absolute amount that a company wishes to pay, as opposed to a payout ratio. Finally, we allow for the sale of common stock in a given year, though this can be specified as zero. See formula in page 406.

Our Earlier Illustration. See example in page 406.

Varying Our Assumptions. See example in page 406.

Solving for Asset Turnover.
With any five of six variables, together with beginning equity and beginning sales, it is possible to solve for the sixth:
 Solving for the Asset Turnover. Assets-to-sales is a sensitive driver of the sustainable growth rate for capital-intensive businesses. See formula in page 407.
 Solving for the Debt Ratio. See formula in page 408.
 Solving for the Net Profit Margin. See formula in page 408.
 Solving for the Dividend. See formula in page 408.
 Solving for New Equity. See formula in page 409.

Implications.
By simulation, then, one is able to gain insight into the sensitivity of certain variables in the overall growth pictures.

To grow in a stable, balanced way, the equity base must grow proportionally with sales. When this is not the case, one or more financial ratios must change in order for the divergence in the two growth rates to be accommodated.

By putting things into a sustainable growth model, we are able to check the consistency of various growth plans.

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EJERCICIOS - Serie 1 - Capítulo 13