Financial Planning

FINANCIAL MANAGEMENT (ACCO 20123)

Compiled by: Beth Alejandro PUP Sto Tomas, Batangas

References : Principles of Managerial Finance 14th Ed., >.Gitman, C.Zutter

Financial Management 2nd Ed. , L.Payongayong, R.Roque, O.Ayuyao
Learning Objectives

After this lesson, the learner is expected to:

• Describe the financial planning process and

recognize its importance in achieving business
objectives

• Prepare a cash plan, profit plan and pro-forma

financial statements
The Financial Planning Process
Financial Planning Process
- Planning that begins with long-term, or
strategic, financial plans that in turn guide the
formulation of short-term, or operating, plans
and budgets.

2 Key Aspects
Cash planning - preparation of cash budget
Profit planning – preparation of pro-forma
financial statements
Objectives of Budgeting

• It compels or forces managers to plan

• It provides information that can be used

to improve decision-making functions

• It helps to set a benchmark that can be

used for performance evaluation

• It improves communication and

coordination
Major Benefits of Budgeting

• Planning

• Evaluating performance

• Coordinating and control

• Motivation and positive behavior

Limitations of Budgeting

• Accuracy of estimates

• Adverse reactions from employees

• Amount of work used in developing a

good budget
The Financial Planning Process

Long-term (Strategic) Financial Plans –

Plans that lay out a company’s planned
financial actions and the anticipated
impact of those actions over periods
ranging from 2 to 10 years.

Short-term (Operating) Financial Plans -

Specify short-term financial actions and
the anticipated impact of those actions.
Long-term (Strategic) Financial Plans
• They lay out a company’s planned financial actions and the
anticipated effect of those actions over periods ranging from 2
to 10 years.

• They are part of an integrated strategy that, along with

production and marketing plans, guides the firm toward
strategic goals.

• They may include outlays for fixed assets, research and

development activities, marketing and product development
actions, capital structure, and major sources of financing,
termination of product lines or lines of business,
Short-term (Operating) Financial Plans
• Specify short-term financial actions and the
anticipated effect of those actions,

• Most often cover a 1- to 2-year period.

• Key inputs are sales forecast and various forms of

operating and financial data

• Key outputs include operating budgets, the cash budget,

and pro forma financial statements.
Short-term Financial Planning Process
Master Budget

Master budget – a network that is composed of

operating budgets and financial budgets

Operating budget – a detailed schedule for each

item in the operation of the business (sales,
production, purchases, operating expenses)

Financial budget – composed of the budgeted

balance sheet, cash budget, and in some
cases includes capital acquisition budget.
Operating Budget

Includes the following:

Sales budget or sales forecast – the starting point of all
operating budgets. It is a detailed schedule showing
the expected sales for the coming year in peso and in
units of products/services.
Production budget – Prepared for manufacturing firms
only. It shows the goods to be produced for the
period, the required beginning and ending inventory
of finished goods.
Purchases budget – prepared for manufacturing and
merchandising firms. It shows direct materials
purchases for manufacturing and goods for sale for
merchandising firm
Operating Budget

Includes the following:

Cost of Goods Sold budget – shows the total number of units
sold and its cost

Operating expenses budget – shows all the expenses for the

period, for each kind of expense including direct labor, and
manufacturing overhead.

Budgeted Income Statement – show how profitable

operations are in the period,
- prepared based on detailed operating budgets;
Financial Budget

Financial budget includes the following:

Budgeted balance sheet – shows the pro-forma

presentation of the financial condition of the
company. It is prepared beginning with the current
balance sheet and adjusted by the amounts from the
operating budgets.

Cash budget – shows the beginning cash balance and

adjusted by the total cash receipts and cash
disbursement during the period whether from
operating, investing or financing activities of the firm.
This will also reflect if the company needs borrowing
or can invest in case of excess cash.
Types of budgetary system

Master budget – is the budget that summarizes the activities of all

the units of the organization – sales, production, distribution,
finance. It quantifies targets for sales, cost-driver activity,
purchases, production, net income, cash position and other
objectives that management specify.
Static budget – a budget for a specific level of activity. It
compares the result to the original budgeted activity level.
Flexible budget – is based on different levels of activity. It is a
useful tool for comparing actual cost incurred to the cost
allowable for the actual level achieved.
Types of budgetary system

Zero-based budget – treats all activities in the organization to

start at zero level. It forces management to rethink each phase
of an organization’s operations before allocating resources.

Continuous budget (rolling budget) – a master budget that adds

a month in the future as the month that just ended is dropped. As
they add a new 12th month, managers may update the other 11
months as well. Then they can compare the actual monthly result
with both the original plan and the most recently revised plan.
Cash Planning: Cash Budgets

Cash budget (cash forecast) - A statement of

the firm’s planned inflows and outflows of
cash that is used to estimate its short-term
cash requirements.

- typically designed to cover 1 year,

divided into monthly time interval
Sales Forecast

Sales forecast - The prediction of the firm’s sales over

a given period, based on external and/or internal
data;
- used as the key input to the short-term
financial planning process.
- ordinarily prepared by the Marketing or Sales
Department
- prepared using a combination of external and
internal forecast data
Cash Budget General Format
Preparing the Cash Budget
Total Cash Receipts - All of a firm’s inflows of cash
during a given financial period
-includes cash sales, collection of accounts
receivable, other cash receipts
Total Cash Disbursements - All outlays of cash by the
firm during a given financial period.
- common disbursements :
Cash purchases Payments of accounts payable
Rent Salaries and wages
Tax payments Loan principal and interest payment
Cash Budget:
Cash receipts & disbursements

Examples/Exercises
Cash Receipts Examples/Exercises

Cullen Industries, a defense contractor, is developing a cash

budget for October, November, and December.
Cullen’s sales in August and September were $100,000 and
$200,000, respectively. Sales of $400,000, $300,000, and $200,000
have been forecast for October, November, and December,
respectively.
Historically, 20% of the firm’s sales have been for cash,
50% have generated accounts receivable collected after 1
month, and the remaining 30% have generated accounts
receivable collected after 2 months.
Bad-debt expenses (uncollectible accounts) have been
negligible.
In December, the firm will receive a $30,000 dividend from
stock in a subsidiary.
Cash Receipts Examples/Exercises

Cullen Industries

Projected Cash Receipts ($000)

Aug Sept Oct Nov Dec

Sales Forecast
Cash sales
Collection of AR
After 1 month
After 2 months
Other cash receipts
Total cash receipts $ - $ - $ - $ - $ -

Solution in excel sheet

Cash disbursements Example
Cullen Industries has gathered the following data needed for the preparation of a
cash disbursements schedule for October, November, and December.

Purchases The firm’s purchases represent 70% of sales. Of this amount, 10% ispaid
in cash, 70% is paid in the month immediately following the month of purchase, and
the remaining 20% is paid 2 months following the month of purchase.

Rent payments Rent of $5,000 will be paid each month.

Wages and salaries Fixed salaries for the year are $96,000, or $8,000 per
month. In addition, wages are estimated as 10% of monthly sales.
Tax payments Taxes of $25,000 must be paid in December.
Fixed-asset outlays New machinery costing $130,000 will be purchased and
paid for in November.
Interest payments An interest payment of $10,000 is due in December.
Cash dividend payments Cash dividends of $20,000 will be paid in October.
Principal payments (loans) A $20,000 principal payment is due in December.
Repurchases or retirements of stock No repurchase or retirement of stock is
expected between October and December.
Cash disbursements Example
Cullen Industries
Projected Cash Disbursements ($000)

Aug Sept Oct Nov Dec

Purchases (70% x sales)$ 70 $ 140 $ 280 $ 210 $ 140
Cash purchases (10%)
Payment of AP
After 1 month (70%)
After 2 months (20%)
Rent payments
Salaries and wages
Tax payments
Fixed-asset outlays
Interest payments
Cash dividend paymnt
Principal payments
Totl cash dibursements $ - $ - $ - $ - $ -
Preparing the Cash Budget

Cash Budget General Format

√
√
Preparing the Cash Budget
Net Cash Flow – the difference between the firm’s cash
receipts and its cash disbursements in each period

Ending cash – the sum of the firm’s beginning cash and its
net cash flow for the period.

Required Total Financing – amount of funds needed by the

firm if the ending cash for the period is less than the
desired minimum cash balance, typically represented
by notes payable

Excess Cash Balance - The (excess) amount available

for investment by the firm if the period’s ending cash is
greater than the desired minimum cash balance;
assumed to be invested in marketable securities.
Preparing the Cash Budget
We proceed to calculate Cullen Industires' cash budget
using the cash receipts and disbursements that we have
calculated. Cullen wishes to maintain as a reserve for
unexpected needs, a minimum cash balance of $25,000.
Cullen Industries
CASH BUDGET ($000)

Oct Nov Dec

Total cash receipts
Less: Total cash disbursements
Net Cash Flow
Add: Beginning cash
Ending cash
Less: Minimum cash balance
Required financing (Notes Payable)
Excess cash bal. (Marketable Securities)
Evaluating the Cash Budget
Cullen Industries
CASH BUDGET ($000)

Oct Nov Dec

Total cash receipts $ 210 $ 320 $ 340
Less: Total cash disbursements $ 213 $ 418 $ 305
Net Cash Flow $ -3 $ -98 $ 35
Add: Beginning cash $ 50 $ 47 $ -51
Ending cash $ 47 $ -51 $ -16
Less: Minimum cash balance $ 25 $ 25 $ 25
Required financing (Notes Payable) $ -76 $ -41
Excess cash bal. (Marketable Securities)
$ 22
• Cash surplus in Oct ➔
• Cash shortage in Nov ➔
• Cash shortage in Dec ➔
EXERCISES CASH PLAN
Exercises: Projected Cash Receipts
Exercise 1.
A firm reported actual sales of ₱65,000 in the month of
June and ₱70,000 in July. The sales forecasts indicate that
sales are expected to be $85,000, $92,000, and ₱95,750
for the months of August, September, and October,
respectively.
Sales are 60% cash and 40% credit, and credit sales are
collected evenly over the following 2 months. No other cash
receipts were received. What are the firm’s expected cash
receipts for the months of August, September, and
October?
Exercise: Projected Cash Disbursement
Exercise 2
Total Corp. approached you to compile a cash disbursement
projection for the months of March, April, and May.
Use the following information and the format we used in class
today as a guide to prepare this schedule.
Sales: January = ₱520,000; February = ₱540,000;
March = ₱550,000; April = ₱600,000; May = ₱660,000; June =
₱670,000
Purchases: Purchases are calculated as 70% of the following
month’s sales, 50% of purchases are made in cash, 30% of
purchases are settled one month after purchase, and the
remaining 20% of purchases are settled two months after
purchase.
Exercise: Projected Cash Disbursement
Exercise 2 (continuation)
Rent: The firm pays rent of ₱9,500 per month.
Wages and salaries: The fixed wage and salary costs are ₱7,500
per month plus a variable cost of 6.5% of the current month’s
sales.
Taxes: The tax to be paid in May amounts to₱57,500.
Fixed asset outlays: New equipment will be acquired during
March at a cost of ₱85,000.
Interest payments: An amount of ₱32,000 for interest is due in
March.
Cash dividends: Dividends of ₱15,000 will be paid in April.
Exercises: Cash Budget
Exercise 3
Liane Miranda, a financial analyst for Shazam Company, has
prepared the following sales and cash disbursement estimates
for the period February–June of the current year.
Month Sales Cash disbursements
February ₱500 ₱400
March 600 300
April 400 600
May 200 500
June 200 200
Exercises: Cash Budget

Exercise 3 (continuation)
Shazam notes that, historically, 30% of sales have been for
cash. Of credit sales, 70% are collected 1 month after the sale,
and the remaining 30% are collected 2 months after the sale.
The firm wishes to maintain a minimum ending balance in its
cash account of ₱25. Balances above this amount would be
invested in short-term government securities (marketable
securities), whereas any deficits would be
financed through short-term bank borrowing (notes payable).
The beginning cash balance at April 1 is ₱115.
Exercises: Cash Budget

Exercise 3 (continuation)

a. Prepare cash budgets for April, May, and June.

b. How much financing, if any, at a maximum would Shazam
Company require to meet its obligations during this 3-month
period?
.
Exercises: Cash Budget
Exercise 4
A company has the following expected pattern of collections on credit sales:
70% collected in the month of sale, 15% in the month after the month of sale,
and 14% in the second month after the month of sale. The remaining 1% is
never collected. At the end of May, it has the following accounts receivable
balances:
from April sales P21,000
from May sales P48,000
The expected sales for June is P150,000. What is the total sales for April?
a. P150,000
b. P72,414
c. P70,000
d. 140,000
Exercises: Cash Budget
Exercise 5
For the month of October, a company forecasts total cash
collections to be P1 million. Also for October, it estimates that its
beginning cash balance will be P50,000 and that it will borrow cash
in the amount of P70,000. If the company estimates an ending
cash balance of P30,000 for October, what must its projected cash
disbursements be?
a. P1,090,000
b. P1,120,000
c. P1,070,000
d. P1,020,000
Cash Flow Within the Month

• Cash budget only shows cash flows on a total

monthly basis
• A firm must look more closely at pattern of daily
cash receipts and cash disbursements
• Synchronization of cash flows in the cash budget
at month-end does not ensure that the firm
will be able to meet its daily cash
requirements
• The greater the variability of cash flows from day
to day, the greater the amount of attention
required.
Cash Budget Illustrative Problem
The Country Store is a retail outlet for a variety of hardware and
hardware and home wares. The owner of the store, Kay Gonzales, is
anxious to prepare a budget for the next quarter, which is typically quite
busy. She is most concerned with her cash position because she expects
that she will have to borrow to finance purchases in anticipation of sales.
She gathered all the data necessary to prepare simplified budget which is
presented herein.
In addition, equipment will be purchased in April for P19,750 cash,
and dividends of P4,000 will be paid in June. Borrowing occurs at the end
of a month when cash is needed. Repayments (if appropriate) occur at the
end of a month when cash is available. Interest also is paid in cash at the
end of the month at an annual rate of 12% on the amount of note payable
outstanding during that month. Additional data are available on the next
slide.
Illustrative Problem

Budgeted expenses (per month)

Salaries and wages ₱ 7,500
Freight out as a % of sales 6%
Advertising ₱ 6,000
Depreciation ₱ 2,000
Other expenses as a % of sales 4%
Minimum inventory policy as a % of next month's cost of sales 30%
Required minimum cash balance ₱ 8,000
Budgeted sales
March (actual) ₱ 60,000
April ₱ 70,000
May ₱ 85,000
June ₱ 90,000
July ₱ 50,000
Illustrative Problem
Sales mix, cash and credit:
Cash sales 20%
Credit sales (collected the following month) 80%
Gross profit rate 40%
Loan interst rate (inerest paid in cash monthly) 12%
Inventory paid for in:
Month of purchase 50%
Month after purchase 50%
Cash as of March 31, 2020 ₱ 9,000
Inventory as of March 31, 2020 ₱ 12,600
Accounts payable for March purchases ₱ 18,300

Required: Prepare the following (quarterly basis):

Sales budget
Cash collections
Purchases
Cash disbursements for purchases
Operating expenses and disbursements for expenses (separate interest)
Illustrative Problem Solution

SOLUTION:
APRIL MAY JUNE TOTAL
Schedule of sales budget
Credit sales 80% 56,000 68,000 72,000 196,000
Cash sales 20% 14,000 17,000 18,000 49,000
Total sales 70,000 85,000 90,000 245,000
Schedule of cash collections
Cash sales 14,000 17,000 18,000 49,000
Collections from prior month 48,000 56,000 68,000 172,000
Total collections 62,000 73,000 86,000 221,000
Schedule of purchases budget
Desired ending inventory (30% NM COGS) 15,300 16,200 9,000 9,000
Cost of goods sold (60%) 42,000 51,000 54,000 147,000
Total required inventory 57,300 67,200 63,000 187,500
Less beginning inventory 12,600 15,300 16,200 12,600
Total purchases 44,700 51,900 46,800 143,400
Illustrative Problem Solution

Schedule of cash disbursements

For purchases
For March amount from previous month ₱ 18,300 ₱ 18,300
For April (50%this month, 50% next month) 22,350 22,350 44,700
For May 25,950 25,950 51,900
For June 23,400 23,400
Total disbursement for purchases 40,650 48,300 49,350 ₱ 138,300

Schedule of Operating Expenses & Disbursements for expenses except interest expense
Cash expenses
Salaries and wages ₱ 7,500 ₱ 7,500 ₱ 7,500 ₱ 22,500
Freight out 4,200 5,100 5,400 14,700
Advertising 6,000 6,000 6,000 18,000
Other expenses 2,800 3,400 3,600 9,800
Total disbursements for expenses ₱ 20,500 ₱ 22,000 ₱ 22,500 ₱ 65,000
Illustrative Problem Solution
CASH BUDGET APRIL TO JUNE
APRIL MAY JUNE
Beginning cash balance ₱ 9,000 8,000 8,000
Total collections 62,000 73,000 86,000
Total cash available 71,000 81,000 94,000
Cash disbursements
Inventory purchases 40,650 48,300 49,350
Operating expenses 20,500 22,000 22,500
Equipment purchase 19750
Dividends 4,000
Interest 179 154
Total disbursements 80,900 70,479 76,004
Minimum cash balance required 8,000 8,000 8,000
Total cash needed 88,900 78,479 84,004
Cash excess (deficit) (17,900) 2,521 9,996
Financing
Borrowing 17,900 0 0
Repayments (2,521) (9,996)
Total from financing 17,900 (2,521) (9,996)
Ending cash balance 8,000 8,000 8,000
Profit Planning
Pro-forma Financial Statements

Pro-forma statements - Projected or forecast

income statements and balance sheets.

Two Inputs Required for Preparing Pro-forma FS:

1) Financial statements for the preceding year
2) Sales forecast for the coming year
Short-term Financial Planning Process
Preparing the Pro-forma Income Statements

Percent-of-sales method - A simple method for

developing the pro forma income statement
- it forecasts sales and then expresses the various
income statement items as percentages of
projected sales.
- when using this simplified approach, it is better to
break down costs and expenses into fixed
and variable components
Preparing the Pro-forma Balance Sheet
Simplified approaches to preparing pro-forma BS:
1. Estimating balance sheet accounts as a strict
percentage of sales
2. Judgmental approach – better and more popular
approach. The firm estimates the values of certain
balance sheet accounts and uses its external
financing as a balancing, or “plug” figure.
3. Simulate movement in selected BS accounts linked
to cash plan and profit plan (projected IS) such as
inventory, AR, AP, PPE, RE, etc.. Other BS accounts
can assume no movement.
ILLUSTRATION USING THE
COUNTRY STORE

INCOME STATEMENT
AND
BALANCE SHEET

<<<in excel>>>
Evaluation of Pro-forma Statements

The weaknesses lie in two assumptions:

(1) that the firm’s past financial condition is an
accurate indicator of its future
(2) that certain variables (such as cash, accounts
receivable, and inventories) can be forced to take on
certain “desired” values.
Evaluation of Pro-forma Statements

How to use pro-forma financial statements to make

important decisions?
1. Analyze the firm’s inflows and outflows of cash,
liquidity, activity, debt, profitability, and market value,
2. Take steps to adjust planned operations to achieve
short-term financial goals
Example: if projected profits on pro-forma IS is too low,
take cost-cutting actions or product-pricing adjustment
If AR on projected BS is too high, consider changes in
credit and collection policy
Pro-forma statements are of great importance in solidifying the firm’s
financial plans for the coming year.
EXERCISES PROFIT PLAN