Planning and Working

Capital Management
(part 1)
Learning Objectives
1. Appreciate the importance of planning.
2. Know and apply tools used in planning and forecasting.
3. Learn and apply the tools used in budgeting.
4. Understand the composition of working capital and the working capital
financing policies.
5. Appreciate the management of cash, accounts receivable, and inventories.
Planning
● Management planning is about setting the goals of the organization and
identifying ways to achieve them.
● This may be broken down into long-term plans and short-term plans.
● In the process of planning, resources have to be identified.
Steps in Planning
1. Set goals or objective.
2. Identify resources.
3. Identify goal-related tasks.
4. Establish responsibility centers for accountability and timeline.
5. Establish an evaluation system for monitoring and controlling.
6. Determine contingency plans.
Set goals or objectives
● The goals of the company can be divided into short-term, medium-term, and
long term goals.
● Long-term and medium term plans are usually established during strategic
planning where the vision and mission of a company are formulated and
revisited.
● Vision describes what top managers want their company to become.
● Mission describes how the company will achieve its vision and makes the
purpose and objectives of the company clear.
Identify Resources
● Resources include production capacity, human resources who will man the
operations and financial resources.
Identify goal related tasks
● Management must figure out how to achieve an objective.
● Fox example, if the target for this year is to increase sales by 15%, one task can
be to hire more sale agents if the management believes that the number of
sales agents it has is not enough to support this 15% increase in sales.
Establish responsibility center
● A responsibility center is a functional entity within a business that has its own
goals and objectives, dedicated staff, policies and procedures, and financial
reports.
● It can identify into budgeting team, production team, marketing team and etc.
● If tasks are already identified to achieve goals, the next important step to do is
to identify which department should be held accountable for this task.
Establish an evaluation system for monitoring and
controlling.
● The management must establish a mechanism which will allow plans to be
monitored.
● Can be done through quantified plans such as budgets and projected financial
statements.
Determine the contingency plans
● Budgets and projected financial statements are anchored on assumptions. If
these assumptions do not become realities, management must have
alternative plans to minimize the adverse effect on the company.
• Characteristics of an Effective Plan.

• In planning, the goal of maximizing shareholders’ wealth must always be put in

mind.

• The following criteria may be used for effective planning: -

Specific – target a specific area for improvement. -

Measurable – quantify or at least suggest an indicator of progress. -

Assignable – specify who will do it. -

Realistic – state what results can realistically be achieved, given available

resources.

- Time-related – specify when the result(s) can be achieved.

Budget Preparation
1. Sales Budget
2. Production Budget
3. Operating Budget
4. Cash Budget
Sales Budget

● The most important financial statement account in forecasting

since most of the expenses are correlated with sales.
External Internal

Gross Domestic Product growth rate Production capacity

Inflation Man power requirements

Interest Rate Management style of managers

Foreign Exchange Rate Reputation and network of the

controlling stockholders

Income Tax Rate Financial resources of the company

Development in the industry

Competition

Economic Class

Regulatory Environment

Political Crisis
Production Budget
● Is a schedule which 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.

Required Production in Units = Expected Sales + Target Ending Inventories-

Beginning Inventories
Operating Budget
● Refers to the variable and fixed costs needed to run the operations of the
company but are not directly attributable to the generation of sales.
● Examples: rent payments, wages and salaries of selling and administrative
personnel, Administrative costs, travel and representation expenses,
professional fees, interest payments, tax payments.
Cash Budget

● The cash budget forecasts the timing of the cash outflows and
matches them with cash inflows from sales and other receipts.
The cash budget is also a control tool to monitor the way the
company handles cash.
Steps in formulating Cash Budget
1. Form the sales forecast, identify how much would be collected in the cash
budget period. Sales may be made in cash or for credit. Cash sales are
translated to cash at the point of sale while credit sales are collected
depending on the credit period.
Continuing from previous example, assume selling price is PHP100/unit. Sales for
each month are expected to be collected as follows: ‣ Month of sales : 20% ‣ A
month after sales: 50% ‣ 2 months after sales: 30% - How much is total receipts
from sales?
2. Identify other receipts.

- Examples: ‣ interest received ‣ return on principal investments ‣ proceeds from

sale of non-operating assets ‣ issuance of capital stock ‣ proceeds from borrowings

Add these receipts to the collections from sales to get to total receipts.
3. From the Production Budget, identify how much of the purchases made will be
paid by the company on the cash budget period. Like sales, purchases may be
made in cash or on credit depending on the supplier’s credit terms. - Continuing
from previous example:

‣ Assume that cost per unit is PHP50.

‣ All purchases this month are paid the following month. How much is total cash
disbursements for purchases?
4. From the operations budget, identify which expenses will be paid in cash during
the cash budget period.

- The following expense items will be paid based on the following periods:

‣ Rent payments: Rent of PHP5,000 will be paid each month.

‣ Wages and salaries: Fixed salaries for the year are PHP96,000, or PHP8,000 per
month.

Wages are estimated as 10% of monthly sales.

‣ Tax payments: Taxes of PHP25,000 must be paid in April.

5. Identify all other cash payments to be made.

- Examples:

‣ Fixed-asset purchases in cash

‣ Cash dividend payments

‣ Principal Payments

‣ Repurchase of common stock

‣ Purchase of stock/bond investments

- It is important to recognize that depreciation and other noncash charges are NOT included in the cash
budget.

- The following items will be paid based on the following periods:

‣ Fixed-asset outlays: New machinery costing PHP130,000 will be purchased and paid for in April. ‣ Interest
payments: An interest payment of PHP10,000 is due in May. ‣ Cash dividend payments: Cash dividends of
PHP20,000 will be paid in January. ‣ Principal payments (loans): A PHP20,000 principal payment is due in
February.
6. Match the receipts and disbursements on the periods they become collectible
and payable, respectively

7. Set a minimum required cash balance. This balance is maintained in case

contingencies arise. Recall from the steps in planning that we should also plan for
contingencies.
8. If the net cash flow is above the minimum cash balance, the company is in
excess cash and may consider putting it in short term investments. If it is below, the
company should make a short term borrowing during that period. - Moreover, [A]
Company has a beginning cash balance of PHP80,000 and would like to maintain
an ending cash balance of PHP100,000 per month. Prepare [A] Company’s Cash
Budget for January to May. Prepare a cash budget.
Evaluating the Cash Budget:

‣ If the ending cash balance after payment of all required disbursements is less than
the required ending balance, the company needs to borrow additional cash from
short term borrowings to meet its required ending balance. Should the ending cash
balance exceed the company’s minimum cash requirement the next period, the
company may be able to repay the loan plus accrued interest.

‣ Should the Company have excess cash above its required maintaining cash
balance, the company may invest this cash on short term investments so that it will
have an opportunity to earn additional profits. If the company’s cash balance would
then fall below its minimum cash requirement, the company may withdraw the
investment to be able to meet the required cash balance.