CH 4 - 8e WRL PPT REVISED

Chapter Four – Financial Planning
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Business Plan
A business plan is a model of what

management expects a business to become in
the future
– Expressed in words and financial projections
Financial statements are pro forma
– What financial statements will be if planning
assumptions are true
Good business plans are comprehensive
or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
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Component Parts of a
Business Plan
Typical outline
– Contents
– Executive summary
– Mission and strategy statement
Basic charter and establishes long-term direction
– Market analysis
Why the business will succeed against its competitors
– Operations (of the business)
How the firm creates and distributes its product/service
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Component Parts of a
Business Plan
Typical outline - continued

– Management and staffing
Firm’s projected personnel needs
– Financial projections
Projects the firm’s financial statements into the
future
– Contingencies
What the firm will do if things don’t go as
planned
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The Purpose of Planning and Plan
Information
Major audience of business plan include

– Firm’s own management
Planning process helps pull management team
together
Provides a road map for running the business
Provides a statement of goals
Helps predict financing needs
– Outside investors
Tells equity investors what returns can be
expected
Tells debt investors how firm will repay loans
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Using a Plan to Guide Business
Performance Figure 4.1
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Credibility and Supporting Detail
A good business plan shows

enough supporting detail to
indicate it is the product of
careful thinking
May display summarized financial
projections with enough detail to explain
the projections
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Four Kinds of Business Plan
Kinds of planning
1. Strategic Planning
2. Operational Planning
3. Budgeting
4. Forecasting
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Strategic Planning
– Addresses broad, long-term issues,
contains summarized, approximate
financial projections
Five-year horizon is common
Concepts expressed mainly in words, not
numbers
Firm analyzes itself, the industry and the
competitive situation
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Operational Planning
– Translates business ideas (day-to-day
operations) into concrete, short-term
projections
– Specifies how much the firm will sell, to
whom, and at what prices
– An equal mix of words and numbers
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Budgeting
– Short-term updates of the annual plan
Usually Covers a calendar quarter
Used in industries in which business
conditions change rapidly
– Mostly financial detail with a few words
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Forecasting
– Very short-term projections of profit and
cash flow
Where will the business’s financial
momentum carry it in the next few weeks
– Consists almost entirely of numbers
– Cash forecasts are projections of
short-term cash needs
Most large firms do monthly cash forecasts
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The Business Planning Spectrum
The Business Planning Spectrum

– The planning spectrum has broad, long-
term planning on one end and
numerical short-term forecasting on the
other end
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Business Planning Spectrum
Figure 4.2
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Business Planning Spectrum
Relating Planning Processes of Small

and Large Businesses
– Small businesses tend to develop a
single business plan containing both
strategic and operating elements
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Relating Business Planning in Large
and Small Firms Figure 4.3
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Financial Plan as a Component
of a Business Plan
Financial plan is the financial portion
of the business plan
– It is a set of pro forma financial
statements projected over the time
period covered by the business plan
– Financial statements are a piece of the
projection, not the center of the
projection
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Planning for New and Existing
Businesses
Hard to forecast a new operation

– No history on which to base projections
The Typical Planning Task

– Most financial planning involves forecasting
changes in ongoing businesses based on
planning assumptions
– Projected statements reflect assumptions such
as:
Unit sales will increase by 10%
Overall labor costs will rise by 4%, etc.
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The Planning Task
What we have and what we need to project
Figure 4.4
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The General Approach, Assumptions,
and the Debt/Interest Problem
What We Have and What We Need to

Project
– Only need to project an income statement and
balance sheet
Planning Assumptions
– An expected physical or economic condition
that dictates the size of one or more financial
statement items
Can be planned management actions (cost control)
or items outside management’s control (interest
rates, consumer demand)
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Example 4.1
Q: This year Crumb Baking Corp. sold 1 million coffee cakes per month to
grocery distributors at $1 each for a total of $12 million. The firm had
year-end receivables equal to two months of sales, or $2 million.
Crumb’s operating assumptions with respect to sales and receivables for
next year are:
Example
1. Price will be decreased by 10% in order to sell more product.

2. As a result of the price decrease, unit sales volume will increase to
15 million coffee cakes.
3. Collection efforts will be increased so that only one month of sales
will be in receivables at year end.
Forecast next year’s revenue and ending receivables balance on the

basis of these assumptions. Assume sales are evenly distributed over
the year.
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Example 4.1
A: There are three inter-related planning assumptions: (1) a

management action regarding pricing; (2) the expected customer
response to the price change; and (3) and change in collection
efforts.
Example
The first two assumptions establish the revenue forecast. Next

year, the firm expects to sell 15 million coffee cakes at $0.90 each,
revenue = 15,000,000 x $.90 = $13,500,000.
The third assumption regarding receivables requires the use of the
total revenue forecast. Receivables are expected to decrease from
two months of revenue to only one month; thus receivables are
expected to be
$13,500,000  12 = $1,125,000.
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The Procedural Approach
– Financial plans are built line-by-line beginning

with revenues
Income statement items are projected, stopping just
before interest expense line
Then balance sheet items are projected except long-
term debt and equity
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Debt/Interest Planning Problem
– The next items needed are interest expense and
debt
– Planned debt is required to forecast interest,
but interest is required to forecast debt
– Every financial plan runs into this dilemma
Can be resolved using a numerical approach
beginning with a guess at the solution
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The Debt/Interest Planning Problem
Figure 4.5
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An Iterative Numerical Approach
Solves the debt/interest problem

– Interest: Guess a value of interest expense
– EAT: Complete the income statement
– Ending equity: Calculate as beginning equity plus EAT (less
dividends plus new stock to be sold if either of these exist)
– Ending debt: Calculate as total L&E (= total assets) less current
liabilities less ending equity
– Interest: Average beginning and ending debt then calculate
interest expense on that value
– Test the results: Compare calculated interest to the original
guess
If significantly different - repeat the process replacing the
original interest expense guess with the interest expense just
calculated
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If the May not be scanned,
calculated valuecopied
of orinterest
duplicated,is
or posted
close toto
a publicly
the accessible stop
guess, website, in whole
or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-
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Example 4.2
Q: The following partial financial forecast has been done for Graybarr
Inc. Complete the financial plan, assuming that Graybarr pays
interest at 10% and has a flat income tax rate of 40% including
federal and state taxes. Also assume no dividends are to be paid
and no new stock is to be sold.
Financial Plan for Graybarr Inc. ($000)
Example
Income Statements Balance Sheets

Next Year
Next Year Beginning Ending
Revenue $ 10,000 ASSETS
Cost/Expense $ 9,000 Total Assets $ 1,000 $ 3,000
EBIT $ 1,000 LIABILITIES
Interest ? Current Liabilities $ 300 $ 700
EBT ? Debt $ 100 ?
Tax ? Equity $ 600 ?
EAT ? Total L&E $ 1,000 $ 3,000
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Example 4.2
A: The huge increase in assets will cause the company’s debt to

increase at a dramatic rate. The first iteration is represented below,
with the steps enumerated.
Financial Plan for Graybarr Inc. ($000)
Income Statements Balance Sheets
Next Year 3:
Next Year Beginning Ending Calculate
Example
Revenue $ 10,000 ASSETS Ending

Cost/Expense $ 9,000 Total Assets $ 1,000 $ 3,000 equity as
EBIT $ 1,000 LIABILITIES beginning
Interest $ 200 Current Liabilities $ 300 $ 700 equity plus
EBT $ 800 Debt $ 100 $ 1,220 EAT less
Tax $ 320 Equity $ 600 $ 1,080 dividends.
EAT $ 480 Total L&E $ 1,000 $ 3,000
1: Guess at the firm’s 4: Calculate Ending
2: Compute
interest expense. Most debt as total L&E
EAT.
firms use last year’s value less ending equity
as a guess. less ending current
liabilities.
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Example
4.2
A: Now we check to see if the the interest implied by our calculated

debt (average debt x interest rate) [which is (($100,000 +
$1,220,000)  2)  10% = $66,000] is significantly different from the
initial guess. Our original guess of $200,000 is much higher than
the calculated interest of $66,000. Thus, a second iteration is
performed.
Financial Plan for Graybarr Inc. ($000) Given these
Example
Income Statements Balance Sheets results the

Next Year average debt
Next Year Beginning Ending is $620,000
Revenue $ 10,000 ASSETS and interest is
Cost/Expense $ 9,000 Total Assets $ 1,000 $ 3,000 $62,000. The
EBIT $ 1,000 LIABILITIES second
Interest $ 66 Current Liabilities $ 300 $ 700 iteration and
EBT $ 934 Debt $ 100 $ 1,140 the calculated
Tax $ 374 Equity $ 600 $ 1,160 result differ
EAT $ 560 Total L&E $ 1,000 $ 3,000 by only
$4,000.
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In Class Problem
Interest/Debt Planning
$000
Begin End
Assets $1,750 $2,630
Current Liabs 550 730
Debt 300 ?
Equity 900 ?
Total Liab @ Equity $1,750 ?
EBIT $500
Interest (12%) ? Start by guessing interest based
EBT ? on beginning debt
Tax (42%) ?
Net Income ?
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In Class Problem
Interest/Debt Planning
$000
Begin End
Assets $1,750 $2,630
Current Liabs 550 730
Debt 300 731 746

Equity 900 1,169 1,154
Total Liab @ Equity $1,750 $2,630
EBIT $500
Interest (12%) 36 62
EBT 464 438
Tax (42%) 195 184
Net Income $269 254
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Plans with Simple Assumptions
The Quick Estimate Based on Sales Growth
– The percentage of sales method assumes all

financial statement line items vary directly with
sales revenue
This is an unrealistic assumption
Management virtually always has more insight
– The modified percentage of sales method
assumes most but not all line items vary with
sales
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Q: The Underhill Manufacturing Company expects nextExample
year’s4.3
revenues to increase by 15% over this year’s. The firm has some
excess factory capacity, so no new fixed assets beyond normal
replacements will be needed to support the growth. This year’s
income statement and ending balance sheet are estimated as
follows:
Underhill Manufacturing Company this year ($000)

Income Statement Balance Sheet
Example
COGS $ 7,470 Cash $ 348

Gross Margin $ 6,110 Accounts receivable $ 1,698
Expense $ 3,395 Inventory $ 1,494
EBIT $ 2,715 Current assets $ 3,540
Interest $ 150 Net fixed assets $ 2,460
EBT $ 2,565 Total Assets $ 6,000
Tax $ 1,077 LIABILITIES
EAT $ 1,488 Accounts payable $ 125
Accruals $ 45
Current Liabilities $ 170
Debt $ 1,330
Equity $ 4,500
Total L&E $ 6,000
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Example 4.3
Assume the firm pays state and federal income taxes at a combined
flat rate of 42%, borrows at 12% interest, and expects to pay no
dividends. Project next year’s income statement and balance sheet
by using the modified percentage of sales method.
A: We’ll increase everything except net fixed assets by 15%.

Underhill Manufacturing Company This Year ($000)
Example
Income Statement Balance Sheet All highlighted

COGS $ 8,591 Cash $ 400
items were
Gross Margin $ 7,027 Accounts receivable $ 1,953 increased by
EBIT $ 3,122 Current assets $ 4,071
15%.
Interest - Net fixed assets $ 2,460
EBT - Total Assets $ 6,531
At this point we are at the
Tax - LIABILITIES
EAT - Accounts payable $ 144
debt/interest impasse. We’ll
Accruals $ 52 guess at interest (using last
Current Liabilities $ 196 year’s interest of $150,000
Debt - as a starting point) and
Equity - work through the
Total L&E $ 6,531 procedure.
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Example 4.3

Income Statement Balance Sheet
Next Year This Year Next Year
Revenue $ 15,617 ASSETS Net Income was
COGS $ 8,591 Cash $ 348 $ 400 computed using an
Gross Margin $ 7,027 Accounts receivable $ 1,698 $ 1,953 Interest of $150,000.
Expense $ 3,904 Inventory $ 1,494 $ 1,718 The resulting Net
EBIT $ 3,122 Current assets $ 3,540 $ 4,071 Income was added to
Example
Interest $ 150 Net fixed assets $ 2,460 $ 2,460 Equity and the Debt
EBT $ 2,972 Total Assets $ 6,000 $ 6,531 figure was a plug,
Tax $ 1,248 LIABILITIES calculated by
EAT $ 1,724 Accounts payable $ 125 $ 144
subtracting Equity
Accruals $ 45 $ 52
and Current
Current Liabilities $ 170 $ 196
Debt $ 1,330 $ 112
Liabilities from Total
Equity $ 4,500 $ 6,224 L&E.
Total L&E $ 6,000 $ 6,531
Taking the average debt at 12% yields a calculated interest of

$86,000 which is considerably less than the $150,000 assumed.
Two additional iterations yield the following result.
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Example 4.3
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Forecasting Cash Needs

– A key reason for financial projections
is to forecast the firm’s external
financing needs
– When a plan shows increasing debt,
additional external financing will be
needed
Can be obtained by issuing new stock or
borrowing
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The Percentage of Sales Method—
A Formula Approach
Assuming net fixed assets as well as other

assets and liabilities vary with sales, the
percentage of sales method can be
condensed into a single formula
– Purpose – to estimate external financing
requirements approximately and quickly
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A Formula Approach
If the firm’s growth rate in sales is g, it can be

shown (see text) that external funds required (EFR)
in the planned (next) year will be
EFR = g(assetsthis year)
- (g  current liabilitiesthis year)
- [(1 – d) ROS][(1+g)salesthis year]
Where d=dividend payout ratio
EFR = Growth in assets

– growth in current liabilities
– planned year’s retained
earnings
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A Formula Approach Example 4.4
Q: Forecast the external financing requirements of the Underhill

Manufacturing Company assuming net fixed assets and EAT grow
at the same rate as sales. However, also assume the firm plans to
pay a dividend equal to 25% of earnings next year.
Income Statement Balance Sheet The items needed
Revenue $ 13,580 ASSETS to apply the EFR
Example
COGS $ 7,470 Cash $ 348

equation are
Gross Margin $ 6,110 Accounts receivable $ 1,698
highlighted. We
EBIT $ 2,715 Current assets $ 3,540 also need the ROS
Interest $ 150 Net fixed assets $ 2,460 figure of 11% (EAT 
EBT $ 2,565 Total Assets $ 6,000 sales, or $1,488 
Tax $ 1,077 LIABILITIES $13,580) and the
EAT $ 1,488 Accounts payable $ 125
Accruals $ 45
expected dividend
Current Liabilities $ 170 payout ratio of 25%.
Debt $ 1,330 Revenues are
Equity $ 4,500 expected to
Total L&E $ 6,000 increase by 15%.
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A Formula Approach Example 4.4
EFR = g(assetsthis year)

- (g  current liabilitiesthis year)
- [(1-d)ROS][(1+g)salesthis year]
EFR = .15($6,000) - .15($170)
Example
- [(1-.25)(.11)(1.15)($13,580)]
EFR = - $413.9
A negative result implies the firm will generate cash
Note that the EFR technique is of limited value
because it forces the unrealistic assumption that all
financial statement items vary exactly with sales
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The Sustainable Growth Rate
A theoretical measure of a firm’s strength

A firm can grow at its sustainable growth rate without
selling new stock if its financial ratios remain constant
Business operations create new equity equal to the
amount of current retained earnings, or
(1 – d)EAT
Implies sustainable growth rate in equity, gs
gs = EAT(1 – d) / equity
Since ROE = EAT / equity
gs = ROE(1 – d)
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Assumes the debt/equity ratio is constant

– Equity growth occurs via retained earnings
– New debt will need to be raised to keep the
debt/equity ratio constant
Gives an indication of the determinants of
a firm’s inherent growth capability
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Incorporating equations from the DuPont
equations into the gs equation we obtain
EAT sales assets
gs  1  d   
sales assets equity
gs = (1-d)ROS x Total Asset Turnover

x Equity Multiplier
Firm’s ability to grow depends on 4 abilities:
 Ability to earn profits on sales (ROS)
 Use of assets to generate sales (T/A Turnover)
 Use of borrowed money - leverage (equity mult)
 Percentage of earnings retained (1 – d)
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Plans With More Complicated
Assumptions
The percentage of sales method

– Appropriate for quick estimates
– Rarely used in formal plans due to lack of detail
Real plans generally incorporate complex
assumptions about important financial items
– Specific accounts can be forecast separately
– E.g. Fixed Assets accounts for Underhill
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A Capital Plan for Underhill
Example 4.5
Q: Beginning fixed asset accounts.

Gross $5,600,000
Accumulated depreciation (3,140,000)
Net $ 2,460,000
Depreciation on old assets $ 450,000

Example
Capital plan:
New Assets $1.2 million.
Depreciation: 5 years, Straight line,
Half year convention
Forecast Underhill’s fixed asset accounts for next

year.
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Example 4.5
A: Depreciation will come from old assets and new

additions.
Old depreciation $450,000
New depreciation
($1,200,000 / 5) x .5 = $120,000
Example
Total depreciation next year:
Old assets $450,000

New assets 120,000
Total $570,000
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Example 4.5
Develop ending Fixed Assets Accounts as Follows:
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In Class Example: Fox Inc.
Beginning fixed asset accounts.

Gross $3,200,000
Accumulated depreciation (1,250,000)
Net $ 1,950,000
Depreciation on old assets $ 660,000
Capital plan:
New Assets $1.0 million.
Depreciation: 5 years, Straight line,
No Half year convention
Forecast Fox’s fixed asset accounts for next year.
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Depreciation Forecast
Old depreciation $660,000
New depreciation
($1,000,000 / 5) = $200,000
Total depreciation next year:
Old assets $660,000

New assets 200,000
Total $860,000
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($000)
Begin Add End

Gross 3,200 1,000 4,200
Acum Depr (1,250) (860) (2,110)
Net 1,950 140 2,090
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More Complicated Plans
Indirect Planning Assumptions
Financial planning assumptions can be made:
– directly about the financial items
– indirectly about a derivative of the item
Indirect planning assumptions are usually

based on financial ratios
– Receivables are usually managed through the
Average Collection Period (ACP)
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Forecasting Accounts Receivable
Example 4.6
Q: Mylar’s ACP is 60 days and management wants to forecast

an improvement to 40 days. What is the ending A/R
balance if revenue is forecast at $7.9 million?
A: A/R
Example
ACP = x 360
Sales
A/R
40 days = x 360 An average balance
would generally be used.
$7,900,000 See footnote in text.
A/R = $877,777
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In Class Problem
Indirect Planning Assumptions
Schwartz Inc’s ACP is 49 days and management wants to
forecast an improvement to 39 days. What is the ending A/R
balance if revenue is forecast at $58,700,000?
A/R
ACP = ---------- x 360
Sales
A/R
39 days = --------------- x 360
$58,700,000
A/R = $6,359,167
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Comprehensive Problem
Macadam Company
Example 4.7
Q: The Macadam Company is planning for next year, and expects

the following results this year.
Example
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Macadam Company
Example 4.7
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Macadam Company
Example 4.7
The following facts are available:

– Payables are from inventory purchases
and COGS is 60% material.
– Depreciation from existing assets will be
$510,000.
– Nine days wages will be accrued at year
end on a payroll of $6.1M.
– The total effective tax rate is 40%.
– 10% interest will be paid on all borrowing.
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Macadam Company
Example 4.7
Planning Assumptions – Income Statement

– 20% growth in revenue
– Marketing expense will be 19% of sales
– The cost ratio will be 53%
– Engineering expenses will grow by 4%
– Finance and admin expenses will grow by
10%
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Macadam Company
Example 4.7
Planning Assumptions – Balance Sheet

○ Cash balance will be reduced by 20%
○ ACP will be 65 days (currently 90)
○ Inventory turnover will be 5.0 (now 3.0)
○ $5M in new assets, 10 year straight line
depreciation, half year convention
○ Pay invoices in 45 days (now 55)
○ No dividends and no new stock sales
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Macadam Company
Example 4.7
Calculate income statement items

– Revenue $14,200 x 1.20 = $17,040
– COGS $17,040 x .53 = $
9,031
– Mktg expense $17,040 x .19 = $ 3,238
– Engr expense $1,065 x 1.04 = $ 1,108
– Fin/admin expense $1,349 x 1.10 = $
1,484
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Macadam Company
Example 4.7
Calculate Balance Sheet items

○ Cash $1,560 x (1 - .20) = $1,248
○ Receivables:
AR
65  X360
$17,040
A/R = $3,077
COGS $9,031
Inventory: Inv Turn = ——— = ——— = 5.0
Inventory Inventory
Inventory = $1,806
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Macadam Company
Example 4.7
Calculate Balance Sheet item - Fixed Assets
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Macadam Company
Example 4.7
Calculate Balance Sheet items

○ Accounts Payable
○ Accruals
1 .8
accruals  $6,100 x  $211
52
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Comprehensive Problem - Macadam Co.
Example 4.7
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Comprehensive Problem - Macadam Co.
Example 4.7
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Planning at the
Department Level
Operating plan projections are more detailed

than the single numbers appearing on the
income statement
– Departmental detail supports the expense entries
on planned income statements
Manufacturing Departments
– Spending is incorporated into product’s cost
through cost accounting procedures
Cost ratio assumptions summarizes a great deal of
detail in manufacturing
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Supporting Detail for Annual Planning
at the Department Level Figure 4.6
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The Cash Budget
Forecasting cash is an important

part of financial planning
The cash budget is a detailed projection
of receipts and disbursements of cash
– Receipts come from cash sales, collecting
receivables, borrowing, and selling stock
– Disbursements include paying for
purchases, wages, taxes and other
expenses
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Receivables and Payables—Forecasting
with Time Lags
Forecasting receivables
collection is difficult since you
never know when
customers will pay their bills
– Some pay by the due date, some are late, a
few never pay
– However, a pattern of receipts is usually
known
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Receivables and Payables—
Forecasting with Time Lags Example
Q: A firm has the following historical collections pattern:

Months after sale 1 2 3
% collected 60% 30% 8%
Credit sales from January through March are expected to be:

Jan Feb Mar
Credit sales $500 $600 $700
Example
Determine the company’s expected cash collections from receivables.

A: Jan Feb Mar Apr May Jun
Credit sales $500 $600 $700
Collections from sales made in
Jan $300 $150 $40
Feb $360 $180 $48
Mar $420 $210 $56
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not be scanned, copied or duplicated, $300
or posted$510 $640 accessible
to a publicly $258 website,
$56 in whole
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Debt and Interest
Forecasting short-term debt and interest is difficult if

current cash needs are funded directly by borrowing
– The current month’s interest payment is based on the
preceding month’s loan balance
– That balance depends on whether the month’s cash flow is
positive or negative
Other Items
– Forecasting most other items is relatively straightforward
Payroll dates and interest payments on bonds are known in
advance
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The Cash Budget
Example 4.8
Q: The Pulmeri Company’s revenues tend to go through a quarterly

cycle. It’s now mid-March and management expects the first
quarter’s pattern to be repeated in the second quarter. The six-
month period is as follows ($000).
Jan Feb Mar Apr May Jun
Revenue $5,000 $8,000 $9,000 $5,000 $8,000 $9,000
Example
Historically, Pulmeri collects its receivables according to the

following pattern.
Months after sale 1 2 3
% collected 65% 25% 10%
No prompt payment discount is offered, and there are virtually no
bad debts. The firm purchases and receives inventory one month in
advance of sales. Materials cost about half of sales revenue.
Invoices for inventory purchases are paid 45 days after receipt of
material.
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The Cash Budget
Example 4.8
Payroll runs a constant $2.5M per month, and other expenses

such as rent, utilities, and supplies are a fairly steady $1.5M per
Example
month. A $0.5M tax payment is scheduled for mid-April.

Pulmeri has a short-term loan outstanding that is expected to
stand at $5M at the end of March. Monthly interest is 1% of the
previous month end balance.
Prepare Pulmeri’s cash budget for the second quarter.
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The Cash Budget
Example 4.8
A: First lay out revenue and lag in collections according to the
historical pattern.

Revenue $5,000 $8,000 $9,000 $5,000 $8,000 $9,000
Collections from
Example
sales in:
Jan $3,250 $1,250 $500
Feb $5,200 $2,000 $800
Mar $5,850 $2,250 $900
Apr $3,250 $1,250
May $5,200
© 2017 CengageSecond
Learning®.quarter
May not be scanned, copied or duplicated, or posted to$8,350 $6,300website,
a publicly accessible $7,350
in whole
or in part, exceptcollections
for use as permitted in a license distributed with a certain product or service or otherwise
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The Cash Budget
Example 4.8
A: Next, lag inventory purchases (half of sales dollars) back one

month from the date of sale and then lag the payment two
months forward in two equal parts.
Purchases $4,500 $2,500 $4,000 $4,500
Example
Payment
Feb $2,250 $2,250
Mar $1,250 $1,250
Apr $2,000 $2,000
May $2,250
Payment for $3,500 $3,250 $4,250
materials
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The Cash Budget
Example 4.8
A: Finally, summarize these results along with payroll and other

disbursement and work through the interest charges.
Pulmeri Company
Cash Budget
Second Quarter 20X1
($000)
Example

Revenue $5,000 $8,000 $9,000 $5,000 $8,000 $9,000
Collections $8,350 $6,300 $7,350
Disbursements
Materials purchases $3,500 $3,250 $4,250
Payroll $2,500 $2,500 $2,500
General expenses $1,500 $1,500 $1,500
Tax
or in part, except for usepayment $500or otherwise
as permitted in a license distributed with a certain product or service 76 on a password-
The Cash Budget
Example 4.8
Pulmeri Company
Cash Budget
Second Quarter 20X1
($000)
Example
Disbursements $8,000 $7,250 $8,250

before interest
Cash flows before $350 $(950) $(900)
interest
Interest $(50) $(47) $(57)
Net cash flow $300 $(997) $(957)
Cumulative cash $(5,000) $(4,700) $(5,697) $(6,654)
flow (loan)
77 on a password-
Management Issues in
Financial Planning
The Financial Plan as a Set of Goals

– The financial plan can be a tool to manage the
company and motivate performance
– Problems arise when top management puts in
stretch goals
A target for which the organization strives, but is unlikely
to fully achieve
Want employees to stretch toward max performance
But people will give up if the goal seems impossible
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Risk in Financial Planning
in General
Stretch planning and aggressive

optimism can lead to
unrealistic plans with little
chance of coming true
Top-down plans forced on the organization by

management are often unrealistically optimistic
– The risk in financial planning is that the plan
overstates achievable performance
79 on a password-
in General
Underforecasting—The Other Extreme

– Sets a goal that is easy to meet, ensures success
Doesn’t motivate best possible performance
– Bottom-up plans are consolidated from lower
management’s inputs and tend to understate what
the firm can do
The Ideal Process
– A combination of the top-down and bottom-up
approaches to planning
– End result is a realistic, achievable compromise
80 on a password-
in General
Scenario Analysis—What Ifing

– Many companies produce several plans
reflecting different scenarios — “what if”
– Gives planners a feel for the impact of
assumptions not coming true - BUT
Communication
– A business unit is expected to have confidence in
its plan, so
– A single plan tends to be published along with its
attendant risks
81 on a password-
Financial Planning and Computers
Today, virtually all business planning is done

with the aid of computers
Computers make planning quicker,
but don’t improve the judgments
that are the heart of good planning
Repetitive Calculations and Changing
Assumptions
– Before computers, recomputing was time-
consuming and labor-intensive
– Now we can test any number of assumption sets
82 on a password-

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Chapter Four – Financial Planning

A business plan is a model of what

Typical outline - continued

Major audience of business plan include

A good business plan shows

The Business Planning Spectrum

Relating Planning Processes of Small

Hard to forecast a new operation

The Typical Planning Task

What We Have and What We Need to

1. Price will be decreased by 10% in order to sell more product.

Forecast next year’s revenue and ending receivables balance on the

A: There are three inter-related planning assumptions: (1) a

The first two assumptions establish the revenue forecast. Next

– Financial plans are built line-by-line beginning

Solves the debt/interest problem

Income Statements Balance Sheets

A: The huge increase in assets will cause the company’s debt to

Revenue $ 10,000 ASSETS Ending

A: Now we check to see if the the interest implied by our calculated

Income Statements Balance Sheets results the

Current Liabs 550 730

Debt 300 731 746

The Quick Estimate Based on Sales Growth

– The percentage of sales method assumes all

Underhill Manufacturing Company this year ($000)

COGS $ 7,470 Cash $ 348

A: We’ll increase everything except net fixed assets by 15%.

Income Statement Balance Sheet All highlighted

Underhill Manufacturing Company This Year ($000)

Taking the average debt at 12% yields a calculated interest of

Forecasting Cash Needs

Assuming net fixed assets as well as other

If the firm’s growth rate in sales is g, it can be

EFR = Growth in assets

Q: Forecast the external financing requirements of the Underhill

COGS $ 7,470 Cash $ 348

EFR = g(assetsthis year)

A theoretical measure of a firm’s strength

Assumes the debt/equity ratio is constant

gs = (1-d)ROS x Total Asset Turnover

The percentage of sales method

Q: Beginning fixed asset accounts.

Depreciation on old assets $ 450,000

Forecast Underhill’s fixed asset accounts for next

A: Depreciation will come from old assets and new

Old depreciation $450,000

Total depreciation next year:

Old assets $450,000

Develop ending Fixed Assets Accounts as Follows:

Beginning fixed asset accounts.

Depreciation on old assets $ 660,000

Forecast Fox’s fixed asset accounts for next year.

Total depreciation next year:

Old assets $660,000

Begin Add End

Indirect planning assumptions are usually

Q: Mylar’s ACP is 60 days and management wants to forecast

Q: The Macadam Company is planning for next year, and expects