Chapter 2: Financial Planning, Budget, and FS Projection

FINANCIAL PLANNING
 Provides sense of freedom
 Attain your personal financial goals
 Increased sense of awareness
 Protect your family from financial uncertainties
 Maintains budgets and planning your tax expenses
 Helps in monitoring your spending and expenses
 Provide opportunities to obtain and protect your financial resources

Illustrative Financial Planning Process

Step 1: Calculate set-up costs

- by comparing your set-up costs or your operating costs to your start-up equity investment,
you can work out how much money, if any, you’ll need to borrow to start your business or
proceed with another operating year, set-up costs or start up for another operating period will
include:

1. Accounting fees
2. Registration and licenses/or renewal
3. Equipment and fit out
4. Initial working capital

Step 2: Profit and loss forecast

- this is the projection phase of sales and expenses for at least a year of operating business. In
order to generate it, the following are done by managers:
1. Contrast future income from sales with the expense of the products produced and fixed
business costs.
2. Compute for possible margins and check the pricing model of the company.

Step 3: Cash-flow forecast

- the projection of cash flow is the most important part of planning the finances of the
company. All managers must have knowledge of these:

1. Start up firms or another period of operation often have certain cash requirements to be
capable of extending services to customers.
2. There might be delays on payment of the customers.
3. Firms that did not plan of their finances and did not project cash flows would be
vulnerable to external and internal factors that might cause gaps in the cash flow.

Step 4: Projection of balance sheet

- a company assessment after one year of business operations. You should construct it by
using the following as your model:

1. The expected transactions in your setup costs

Step 5: Break even analysis

- once you’ve forecast your fixed costs, you can calculate how much revenue you need to
break even. If you’ve decided on your pricing, it’s easy to calculate revenue based on sales.
Commonly used approaches to predict what those sales will be included are the ones given
below:
1. Set a benchmark for a service sector based on the average number of hours worked per
week; Reference estimates on 60-70 per cent usage, instead of saying that half of the time is
spent on charges.
2. For other companies - identify the range and market reach of business, then use a
conservative calculation of the probable market share to calculation future sales.
3. Prepare multiple projections based on best possible outcome, worst possible outcomes and
average outcome.
4. Record your hypotheses and the assumptions underlying them, then check and refine them
according to your current experience of business operations and successful methods.

BUDGET
Budgeting is a method whereby you established a plan on how your money will be spent.
The spending program is called a budget. Developing this spending plan gives you the
freedom to decide in advance whether you will have sufficient or adequate money to do the
things you want and need to do.
If you don’t have adequate money to do whatever you’d like to do, then you could use
this strategic planning to prioritize your spending and focus your money on the most
valuable aspects for you.

IMPORTANCE OF BUDGETING
Now that you understand that budgeting helps you to build spending plan with your
income, it means you’ll still have enough money to purchase and do the things you need and
the things that matter to you. Whether you are actually in debt, implementing a budget or
spending plan can either keep you out of debt or help you find your way out of debt.

BUDGET PREPARATION
1. Sales budget
2. Production budget
SALES BUDGET
The most important account in the financial statement in making a forecast is sales since
most of the expenses are correlated with sales. Cost of sales ratio, as well as the variable
operating expenses are based on the sales figure.
Looking at the accounts in the balance sheet, mostly are also correlated with sales. The
amount of cash that a company maintains, its accounts receivables and inventories, property
plant and equipment, and trade payables are affected by sales.
Given the importance of the sales forecast, the financial manager must be able to support
this figure with reasonable assumptions. The following external and internal factors should
be considered in forecasting sales.

EXTERNAL INTERNAL
 Foreign Exchange Rate  Production capacity
 Income Tax Rates  Manpower requirements
 Inflation  Management style of managers
 Developments in the industry  Reputation and network of the controlling
 Competition stockholders
 Interest Rate  Financial resources of the company
 Economic Crisis
 Regulatory Environment
 Political Crisis
 Gross Domestic Product (GDP) growth
rate

There are implications if sales budget is not correct. If understated, there can be lost
opportunities in the form of foregone sales. If it is too optimistic, the management may
decide to unnecessarily increase capacity or hire more employees and end up with more
inventories.

The sales budget indicates the number of units a firm expects to sell. The number or
units is multiplied by the selling price. The determining factor of all the other budgets
included in the master budget is the sales budget.
XYZ Company
Sales Budget (in millions)
For the Year Ending December 31,2020
Quarter Total
1 2 3 4
Expected 600 500 800 800 2700
Sales in units
Unit selling P 70 P 70 P 70 P 70 P 70
price
Total Sales P 42,000 P 35,000 P 56,000 P 56,000 P 189,000

PRODUCTION BUDGET
Provides information regarding the number of units that should be produced over a given
accounting period based on expected sales and targeted level of ending inventories.

It is computed as follows:
Required Production in Units = Expected Sales + Target Ending

Note: Ending inventory of current period is beginning inventory of next period.

XYZ Company forecast sales in units from first quarter to fourth quarter as follows:

XYZ Company
Sales Budget (in millions)
For the Year Ending December 31,2020
Quarter Total
1 2 3 4
Expected 600 500 800 800 2700
Sales in units
Assumptions:
1. XYZ Company would like to maintain 150 units in its ending inventory at the end of each
month.
2. Beginning inventory at the start of January amounts to 100 units.

Question: How many units should XYZ Company produce in order to fulfill the expected
sales of the company?

Answer:

XYZ Company
Sales Budget (in millions)
For the Year Ending December 31,2020
Quarter Total
1 2 3 4
Expected 600 500 800 800 2700
Sales in units
Target level 150 150 150 150 150
of ending
inventories
Total 750 650 950 950 2850
Less: 100 150 150 150 100
Beginning
inventory
Required 650 500 800 800 2750
Production