Finance Skills for Management: Unit 5

Items in a Cash Budget

1) Cash Receipts - cash sales and not credit sales - credit sales are only recorded when consumer pays bill 2) Cash Disbursements - items you buy to supply, rent, taxes, interest, and other selling, general, and administrative expenses month-to-month 3) Borrowing - borrow money if not sufficient cash for the month or not

Creating a Cash Budget

1) Determine cash receipts 2) Estimate cash disbursements 3) Create the cash budgets (beginning cash + net cash flow (receipts - disbursements)

Tracking Cash Flows

1) Envelop Method - best for those who use cash to pay rather than debit or credit card. 2) Spreadsheet Method - Excel or another spreadsheet application. Keep daily journal of expenses by category and date spent. 3) Computer Resources - online apps such as mint.com, goodbudget, walley, etc. Budget services for modest fee.

Key Principles for Effective Budgeting

1) Know Yourself 2) Understand the Key Areas of Savings, Income, and Expenses 3) Develop Savings, income and expense strategies. 4) Keep records 5) Use a Method that meets your needs and objectives. 6) Eliminate Consumer Debt and Minimize Long-Term Debt - consumer debt is a trap. Economically expensive and halts your growth and savings.

Key Forecasts

1) Profit Forecasting - projection of future earnings after all the projected costs are subtracted from the projected sales. 2) Balance Sheet Forecasting - Using sales growth and the profit forecast to construct a pro forma balance sheet to understand the future implications of the sources and uses of finances.

Percent of Sales Method seven steps:

1) Project sales revenues and expenses 2) Forecast change in spontaneous balance sheet accounts 3) Deal with discretionary accounts 4) Estimate fixed asset account 5) Calculate retained earnings 6) Determine total financing need (projected total assets) 7) Calculate DFN

Ways to Reduce DFN: Insights from the SGR

1) Slow Sales Growth usually by increasing prices which will lower sales. Higher prices will increase net margin, leading to higher net income and more cash retained within the firm. Lower sales will decrease forecasted assest in pro forma balance sheet, thus reducing the future financial need. 2) 'Examine Capacity Constraints - biggest driving of DFC - instead of fixed asset expansion can company add another production shift, outsource, etc? 3) Lower Dividend Payout - increases retention ratio - negative stockholder reaction 4) Increase Net Margin = aside from raising cost, also by cutting costs - increasing economies of scale or managing expenses such as advertising

Application to Persoanl Finance

1) Understand your goals 2) Track your savings, income, and expense (fixed and variable) 3) Develop a cash budget(plan) 4) Implement your plan 5) Compare the cash budget to your actual spending and make necessary changes.

Three Major Uses of Cash Budgeting

1)Future Financing Needs - indicate the amount and timing of future financing needs. Charting future expected cash inflows and outflows, firm can see when its borrowing needs will be highest during the year. 2) Corrective Action - budgets provide a basis for taking corrective action when budgeted and actual figures do not match. ( allows you to negotiate good terms with the bank, increases bank's trust in you as a responsible, forward-looking business owner) 3) Performance Evaluation- variances from budget may indicate managers or division are not meeting targets.

Limitations of Sustainable Growth Rate

1. consumer trends and economic conditions may affect growth 2) poor forecasting and business planning

Step 5: Calculate Retained Earnings (RE)

3 reasons RE requires special attention: 1) Depreciation expense - if firm invests in new fixed assets, depreciation expense will change on income statement. Will affect net income and thus RE. 2) Interest Expense - if firm take on more debt or pays off some debt, interest expense must be adjusted, will affect net income & RE 3) Dividends - RE affected by firm's dividend policy. Assume: both net margin and dividend policy (payout ratio) are constant when forecasting changes in RE Net margin = net income / sales Net income: can only be paid out as dividends or kept as retained earning The payout ratio tells you the percent of net income distributed to the shareholders, and the retention ration/plowback ratio (% net income retained in firm) is proportion of earning retained after dividends paid out. Projected RE = Old RE + (Projected Sales X Net Margin X Plowback Ratio) Plowback Ratio = 1 - Payout Ratio Payout Ratio = Dividends / Net Income

Step 6: Determine Total Financing Need

According to balance sheet equation (Assets = Liabilities + Owners Equity) all assets on firm's balance sheet have to financed through either liabilities or equity.

Sales Capacity

Actual Sales / % of capacity

Discretionary Accounts

Another name for non-spontaneous accounts. Do not increase automatically but are left to the discretion of management.

lumpy assets

Assets that cannot be acquired in small increments, but instead must be obtained in large, discrete amounts. (factories, equipment, etc)

Financial Forecasting versus Budgeting

Both establish a plan for the future. Budgeting is concerned with where mgmt. wants to take the company, forecasting is concerned with whether the company is heading in the right direction. Often used together.

Budgeting and Financial Forecasting

Budgeting - manage and forecast future cash needs and receipts. - short-term cash management Financial Forecasting - allows firm to project future asset needs and understand how wide a gap there is to fill between the asset side and the financing side of the balance sheet. long-term investment and financing needs

Step 4: Estimate Fixed Asset Account

Change in fixed assets in response to a change in slaes depends upon the firm's current production capacity utilization. If at capacity, assets must grow to reach the percent increase. May have to grow at larger rate that the rate of growth, ex having to purchase another factory or big piece of machinery.

Lesson 32: Introduction to Financial Forecasting

Describe Financial forecasting process.

Lesson 34: The Percent of Sales Method: Determining Financing Needs from a Sales Forcast

Describe how additional financing requirements are determined from a sales forecast. Most common forecasting process. In general uses (1) a sales forecast (2) historical relationships between sales and other variable to create pro forma statements (pro forma meas as if) (3) Last step is to calculate the firm's DFN

Lesson 28: Introduction to Budgeting

Describe the budgeting process.

Lesson 33: Goals of Financial Planning

Describe the link between asset requirements and sales growth.

Lesson 36: Using Forecasting to Determine Fixed Asset Requirements

Describe the use of forecasting to prepare appropriate future asset levels, given projected sales growth.

Step 7: Calculate DFN

Difference betw/ firms total financing need (total projected assets( and financing currently in place constitutes the DFN DFN = Projected Total Assets - Projected Total Liabilities - Projected Owner's Equity A negative DFN means firm has adequate financing, a positive DFN means they do not and must get additional financing. .

Step 2: Forecast Change in Spontaneous Balance Sheet Accounts

Estimate changes in balance sheet accounts given the predicted change in sales. Which accounts in the balance sheet change with grown in sales? AR, inventory level, raw material, AP - examples from current asset and current liability section of balance sheet - all these are spontaneous accounts

Lesson 31: Tracking, Monitoring, and Revising a Budget

Explain the importance of tracking, monitoring, and revision, with respect to the budgeting process.

Module 9: Financial Forecasting: Lessons 32-36

Given a basic financial forecast, the student explains how the forecast is used to predict and plan for future financial need.

Forecasting Financing Needs

Given expectations for future growth (in sales, in asset base, etc.) how much additional financing will you need? Additional financing is called: discretionary financing needed (DFN) / external financing needed (EFN) or additional funds needed (AFN) Primary objective of the forecasting process. Requires # of assumptions: incl. future sales levels, relationship between sales and assets, and the firm's profitability. watch for GIGO syndrome = garbage in, garbage out

Lesson 29: Steps to Create a Cash Budget

ID steps in Creating a Budget

Step 1: Project Sales Revenues and Expenses

Information typically provided to you by the marketing or sales department due to these are the ones in best position to measure the pulse of the market and closes to customers. Process includes making a list of goods to be sold and services to be provided. Based on list and on data from current sales and market studies, marketing or sales dept. estimate number of goods and services to be sold. Sales are forecasted under different scenarios w/ some aggressive and some conservative assumptions.

Steady State Growth

Level of growth where the following four financial ratios are constant and firm does not need to issue new equity: 1. Profitability 2. Asset Utilization 3. Leverage 4. Payout SGR = ROE X (1-b) b= dividend payout ratio (dividends/net income) Also retention ratio or plowback ratio SGR can be influenced by adjusting any of the basic components of these rations: profitability (net margin), asset efficiency (total asset turnover), leverage (measured by leverage ration / amount of assets to equity) and dividend payout ratio.

Understand Important Linkages

Linkages between revenues, expenses, and investments in fixed assets for growth and financing of such assets. A solid financial model will allow you to see how changes in cost structures or sales grown will impact your future cash glows, financing needs and cash budgeting.

Monitoring Cash Flows

Monitoring is using tracking data against target to ID patterns and changes in cash flow, understand circumstances you may need to correct.

Step 3: Deal with Discretionary Accounts

Only change with management action. - Notes payable, long-term financing accounts, common stock/equity all discretionary accounts. Leave them constant in project for now.

Cash Budgeting

Planning for future receipts and disbursements of cash. Usually prepared for a shorter time period. Between one month to one year.

Revising the Budge

Process that allows you to make changes to the budget to meet your financial goals. Tracking and monitoring are musts before revisions.

Lesson 30: Items Included in Budget Construction

Recognize the items included in budget construction.

Why Financial Forecasting?

Relates to investment and financing decisions. Powerful tool for individuals and corporations. In conjunction with ratio analysis, answers a large portion of financial questions posed to non-finance business professionals and constitutes an entire discipline among finance professions. Helps decision makers understand how actions taken today can impact the firm's future performance.

Module 8: Budgeting: Lesson 28-31

Student describes steps in the general budgeting process for individuals and organization

Sustainable Growth Rate

T.he maximum growth rate a firm can achieve without external equity financing while maintaining a constant debt-equity ratio.

Spontaneous Accounts

vary automatically with sales ie-most current assets, AP, AR, cash, inventory, accruals (wages, taxes)