Copyright © 2010 Pearson Prentice Hall. All rights reserved. Chapter 12 Forecasting and Short-Term Financial Planning.

Copyright © 2010 Pearson Prentice Hall. All rights reserved.

Chapter 12

Forecasting and Short-Term Financial Planning

Copyright © 2010 Pearson Prentice Hall. All rights reserved.12-2

• Is the future uncertain?• Yes. Can we plan for it? Also Yes.• One of the main tasks of a finance manager

is to forecast for the coming period. The forecast is the foundation of a company’s short term financial action plan.


12.1 Sources and Uses of Cash

• Long term decisions are called capital budgeting and are viewed as decisions that have long term effects and cannot be easily changed. However, short term decisions have short term effects and can be changed or modified at low costs.

• One of the main tools of forecasts is cash budgets. Cash is considered to be the life-blood of a business. Cash management main goal is to have sufficient cash. Cash shortages can be problematic while cash excesses can lead to poor returns.

• Since most businesses do not function on a purely cash basis, it

is critical for them to forecast their needs for cash in advance. • The cash budget is the analytical tool that estimates the

future timing of cash inflow and cash outflow and projects potential shortfalls(deficits) and surpluses.


Identifying all possible sources and uses of cash is essential for preparing a useful cash budget. This list can serve as a guide when preparing a cash budget.

12.1 Sources and Uses of Cash (continued)

FIGURE 12.1 Cash inflows and cash outflows for a company.


Despite setting up a cash reserve, the firm is projected to have cash shortfalls in 3 months and surpluses in 2 after all cash receipts and disbursements have been forecasted for the first half of 2010.

12.1 Sources and Uses of Cash (continued)

TABLE 12.1 Bridge Water Pumps and Filters, Cash Budget for First Six Months of 2010 ($ in thousands)


Example:

• For March, Heavenly Hotel will have cash receipts of $365,000 and cash disbursements/payments of $ 370,000.If its beginning balance of cash is $4,000 and its reserves are $3,000,what will be the shortfall in cash for the month?.

• Net cash flows=365,000-370,000=-$5,000. Ending cash balance = -5,000+4,000=-1,000.

Short fall=-1000-3000=-$4,000.


12.2 Cash Budgeting and the Sales Forecast

•We starts the process of cash budget by the predictions of the cash inflows from future sales(sales forecasts).•Sales revenue base variable driving almost all other items in the cash budget, Must forecast sales as accurately as possible. •There is usually a time lag between when a sale is made and when the cash receipts come in Must keep track of collections time-line.•Need internal data (information that is proprietary or unique to the firm) as well as external data (publicly available information) as sources for objective sales forecasts.


12.2 (A) Cash Inflow from Sales

• Firms typically sell products and services partially for cash and partially on credit.

• An analysis of a firm’s collection policy can help project cash inflow from sales.

• It is quite common for firms to collect some of their receivables in the 2 months following the sale, i.e., November 2008’s credit sales will be partially collected in December 2008 and January 2009.


12.2 (A) Cash Inflow from Sales (continued)

Managers often figure in a small percentage of the forecasted sales as bad debts when preparing a cash budget.

TABLE 12.2 Bridge Water Pumps and Filters Cash Flow from Sales: January, February, and March 2009 Cash Flow Estimates


Example• The sales for October, November, and

December are $10,000,$12,000 and $18,000 respectively. For any particular months of sales, the following percentages are received over time in cash:20% in cash from that same month of sales,50% in cash from the previous month’s sales, and 30% in cash from the sales from the two months ago. What amount of cash will be received during December?

• =0.2*December sales +0.5*November sales+0.3*October sales

=0.2*18,000+0.5*12,000+0.3*10,000= $12,600


12.2 (B) Other Cash Receipts

• Besides sales, which are the main contributor to a firm’s cash inflow, need to forecast the timing and magnitude of other occasional sources of cash such as– asset sales, – funds raised through issuance and sale of

securities, and – income earned on investments (dividends,

interest, etc.)


12.3 Cash Outflow from Production

• The magnitude and timing of the various cash disbursements of a firm depend mainly on forecasted sales. – Payments for raw materials, labor costs, overheads such

as utilities and rent, shipping costs, etc. • Like sales, there is often a time lag between when the firm

receives and records the benefit, and when it actually makes the payment for it.

• The cash budget can be used as a handy planning document to keep track of the projected disbursements.

• Depreciation is merely a tax write-off, not a cash Depreciation is merely a tax write-off, not a cash disbursement, so should not be included in a cash budgetdisbursement, so should not be included in a cash budget.


12.4 The Cash Forecast: Short-Term Deficits and Short-term Surpluses

The main objective of developing a cash budget Firm has sufficient cash available from its revenues and other receipts to cover its periodic cash disbursements/payments such as:

1. Accounts payables for materials and supplies2. Salaries, wages, taxes, and other operating expenses 3. Capital expenditures for plant, equipment, and machinery 4. Dividends, interest, and flotation cost payments related to the

raising and servicing of capital

Over a short planning cycle, the total periodic cash inflow rarely matches the total periodic outflow, This results in forecasted cash deficits and cash surpluses in certain periods.Therefore, cash budget can help us to determine whether we need short term borrowing or not (i.e. when we have deficit).


12.4 The Cash Forecast: Short-Term Deficits and Short-term Surpluses (continued)

TABLE 12.3 Monthly Cash Budget for Bridge Water Pumps and Filters


12.4 (A) Funding Cash Deficits

Cash shortfalls can be handled in 4 ways:1. Cash from savings2. Unsecured loans (letters of credit)3. Secured loans (using accounts receivable or

inventories)4. Other sources (commercial paper, trade

credit, or banker’s acceptance).


12.4 (B) Investing Cash Surpluses

When a company has excess funds, it has 4 options:

1. Put the surplus in a savings account or invest it in marketable securities.

2. Repay lenders and owners (retire debt early or pay extra dividends).

3. Replace aging assets.4. Invest in the company, accepting positive net

present value projects


• Example : A company's cash sales for May are $300,000, its accounts receivable payments for May are $200,000, its beginning cash for May is $50,000, and there are no other cash inflows for May.

Its accounts payable for May are $250,000, its wages and salaries for May are $100,000, its interest payments for May are $50,000, and there are no other outflows for May.

What is the company's ending cash balance for May?


• Answer: The total incoming cash flow for May = cash sales for May + accounts receivable payments for May = $300,000 + $200,000 = $500,000.

• The total outgoing cash flow for May = accounts payable for May + wages and salaries for May+ interest payment for May = $250,000 + $100,000 + $50,000 = $400,000.

• Thus, its net cash flows for May are total incoming cash flow for May - total outgoing cash flow for May = $500,000 - $400,000 = $100,000.

• Ending cash balance for May = beginning cash for May + net cash flow for May = $100,000 + $50,000 = $150,000.

Copyright © 2010 Pearson Prentice Hall. All rights reserved. Chapter 12 Forecasting and Short-Term Financial Planning.

Documents

cash receipts

cash inflows

cash budgeting

cash balance

cash excesses

cash outflows

sufficient cash

cash shortfalls