Financial Planning Tools and

Concepts
LESSON 3
 WHAT IS PLANNING?
 Planning is an important aspect of the firm’s
operations because it provides road maps for
guiding, coordinating, and controlling the firm’s
actions to achieve its objectives.
 Planning is very much related to another
management function, controlling.
 Steps in Planning
1. Set goals or objectives
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.
Budget Preparation

 Sales Budget
 Production Budget
 Operating Budget
 Cash Budget
 Sales budget
 Most important financial statement
account in forecasting because almost
all other accounts in the financial
statements are affected by sales.
 The following external and internal factors should be
considered in forecasting sales:
External Internal
• Gross Domestic Product (GDP) growth rate • production capacity resources of the company

• Inflation • man power requirements

• Interest Rate • management style of managers

• Foreign Exchange Rate • reputation and network of the controlling

stockholders
• Income Tax Rates • financial
• Developments in the industry
• Competition
• Economic Crisis
• Regulatory Environment
• Political Crisis
 Production Budget
 A 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.

Required production in units = Expected Sales + Target

Ending Inventories - Beginning Inventories
Expected Sales
Add: Target Ending Inventories
Less: Beginning Inventories
Required Production in Units
 [A] Company forecasts sales in units for
January to May as follows:
January February March April May

Units 2000 2200 2500 2800 3000

- Moreover, [A] Company would like to maintain 100

units in its ending inventory at the end of each month.
- Beginning inventory at the start of January amounts
to 50 units.
 How many units should [A] Company produce in order to fulfill the
expected sales of the company?

MONTH

January February March April May Total

Projected Sales (Units) 2,000 2,200 2,500 2,800 3,000 12,500

Target level of ending

inventories 100 100 100 100 100 100
Total 2,100 2,300 2,600 2,900 3,100 12,600

Less: beginning
inventories 50 100 100 100 100 50

Required Production 2,050 2,200 2,500 2,800 3,000 12,550

 Operation budget
 This shows the company’s anticipation of incurrence of
selling, administrative and other expenses.
 Rent payments, Wages and Salaries of selling and
administrative personnel, Administrative Costs, Travel and
representation expenses, Professional fees, Interest
Payments, Tax Payments
Cash budget
 This identifies where the company derives its cash
inflows as well as how the cash is used throughout
a particular period.
 The following are the steps in formulating a cash
budget:
A. 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. Credit periods may range from 10 days
to more than a month depending on the strategy of the company.
 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%
 MONTH

January February March April May Total

Units 2,000 2,200 2,500 2,800 3,000 12,500

Sales in Peso 200,000 220,000 250,000 280,000 300,000 1,250,000

Collection from current

month sales 40,000 44,000 50,000 56,000 60,000 250,000

Collection from previous

month sales 100,000 110,000 125,000 140,000 475,000

Collection from two

months prior sales     60,000 66,000 75,000 201,000
Total Collections from
Sales (Cash Receipts) 40,000 144,000 220,000 247,000 275,000 926,000
 B. 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.

C. 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?

 MONTH

January February March April May Total

Required Production 2,050 2,200 2,500 2,800 3,000 12,550

Cost in Peso 102,500 110,000 125,000 140,000 150,000 627,500

Payment from current

month sales 102,500 110,000 125,000 140,000 477,500

Total Payment for

Purchases 0 102,500 110,000 125,000 140,000 477,500
 D. 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.
 E. 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.
 MONTH
January February March April May Total

Total Payment for Purchases 102,500 110,000 125,000 140,000 477,500

Rent Payment 5,000 5,000 5,000 5,000 5,000 25,000
Wages 20,000 22,000 25,000 28,000 30,000 125,000
Salaries 8,000 8,000 8,000 8,000 8,000 40,000
Tax Payment 25,000 25,000
Fixed Asset Outlay 130,000 130,000
Interest Payment 10,000 10,000
Cash Dividend 20,000 20,000
Principal Payment   20,000      20,000

Total Cash Disbursement 53,000 157,500 148,000 321,000 183,000 872,500

 F. Match the receipts and disbursements on the periods they
become collectible and payable, respectively.
 G. Set a minimum required cash balance. This balance is
maintained in case contingencies arise.
 H. 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.
 MONTH
January February March April May Total
Cash Receipts 40,000 144,000 220,000 247,000 275,000 926,000
Less: Cash Disbursement 53,000 157,500 148,000 321,000 193,000 872,500
Net Cash Flow -13,000 -13,500 72,000 -74,000 82,000 53,500
Add: Beginning Cash 80,000 67,000 53,500 125,500 51,500 80,000
Ending Cash Balance 67,000 53,500 125,500 51,500 133,500 133,500
Less: Minimum Cash Balance 100,000 100,000 100,000 100,000 100,000 100,000

Cumulative excess cash balance

(Cumulative required financing)
-33,000 -46,500 25,500 -48,500 33,500 33,500
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. If 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.
‣ If 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.