3.

FINANCIAL
PLANNING

Business Finance
Mr. Christopher B. Cauan
Learning Objectives ---------------------------------------------------
.
. .
. This chapter aims to achieve the following: .
. .
. Discuss the important role of financial planning and
.
. forecasting;
.
. Foresee the business’ investing and financing needs to .
. support its operations for next year or beyond; and .
. .
. Come up with short-term and long-term financial plans or .
. budget for the business .
. .
. .
. .
----------------------------------------------------------------------------------------

Business Finance
Mr. Christopher B. Cauan
3.1 Steps in the
Financial
Planning
Process
Business Finance
Mr. Christopher B. Cauan
Financial Planning process is often defined as the forecasting of a business’
future financing requirements.

Financial Planning process is articulated in a document called the financial

plan.

1. Long-term financial plan, also known as strategic

financial plan
Long-term financial financing requirements of a business three-to-
five years down the road.

2. Short-term financial plan, also known as operating

financial plan.
Involves forecasting the financing requirements of a business
within a year or less, and as is expected is more detailed than a
former.

Business Finance
Mr. Christopher B. Cauan
Developing the long-term plan following few simple steps:

a. Forecast your sales

understanding of the industry your business belongs to
knowing your target market segment from the industry
forecasting your market share in terms of sales from that segment

b. Compute the dividend payout ratio and the plowback ratio

If the business pays any cash dividend, then this dividend amount
should be divided by net income to get the dividend payout ratio.

The ratio tells us the proportion of net income paid out as

dividends.
If the business does not pay any dividend, then it is equal to zero.
The plowback ratio, also known as retention ratio is 100%.

Business Finance
Mr. Christopher B. Cauan
 The plowback ratio is the proportion of net income that does not
get paid out in cash dividends.

Example:

If a business has earnings of ₱5 million and pays out ₱3 million in

dividends, then the payout ratio is 60%. Therefore, the plowback
ratio is 40%.

c. Identify your spontaneously generated funds

“done naturally” , these funds come about as a result of normal

business operations.
to increase sales, is to increase inventory.
Everything “naturally” increases as a result of higher sales.

Business Finance
Mr. Christopher B. Cauan
d. Use the percent of sales approach to prepare the pro forma financial
statement

Dividing expenses, assets, and liabilities by the sales figure. This

sales figure can be based on the latest available financial
statement, the average figure the past few years, or a combination
of both.

pro forma is a Latin word meaning “as a matter of form” and it is

used to emphasized projected figures.

e. Calculate your External Financing Need (EFN)

EFN, also known as Additional Funds Needed (AFN) and

Discretionary Financing Needs (DFN), is required additional
financing to acquire needed assets.

Business Finance
Mr. Christopher B. Cauan
Example:

Sales are forecasted to grow 20% next year.

This translates to a 20% growth in assets.
Use the percent of sales approach to calculate the weighs needed
in preparing the pro forma income statement.

Income Statement Percent of Sales

Sales 9,268,315.00
Costs 5,097,573.25 55.00%
Taxable Income 4,170,741.75
Taxes (30%) 1,251,222.53
Net Income 2,919,519.23 31.50%
Dividends (0%) 0.00
Addition to 2,919,519.23
Earnings

Business Finance
Mr. Christopher B. Cauan
To prepare the pro forma income statement……….

Simply increase the sales by 20%.

Multiply the resulting figure by 55%to get the cost.
To get the addition to retained earnings, simply subtract dividends
paid from the net income.

Pro Forma Income Statement Percent of Sales

Sales (20%) 11,121,978.00
Costs 6,117,087.90 55.00%
Taxable Income 5,004,890.10
Taxes (30%) 1,501,467.03
Net Income 3,503,423.07 31.50%
Dividends (0%) 0.00
Addition to 3,503,423.07
Earnings

Business Finance
Mr. Christopher B. Cauan
3.2 The Budget
Preparation

Business Finance
Mr. Christopher B. Cauan
The primary tool in short-term financing plan is the cash budget, also
known as cash forecast.
It plots the business’ projected cash inflow and outflow and
its typically done monthly and is used to cover a year’s time.

Cash Budget
Jan Feb Mar
Cash Receipts (1)
Less: Cash Disbursements (2)
Net Cash Flow
Add: Beginning Cash
Ending Cash
Less: Minimum Cash Balance
Required Total Financing (3)
Excess Cash Balance (3)

Business Finance
Mr. Christopher B. Cauan
 Preparing the cash budget comes down to a few simple steps:

1. Forecast the business’ monthly sales. Again, this can be done using
historical figures.
2. Forecast the cash sales and the credit sales from the projected monthly
sales. Cash sales are more preferable to credit sales. If sales are made on
credit, then estimate when those receivables will be collected.
3. Take into account other cash receipts. Other cash receipts are sources of
cash other than sales such as interest payment received, among others.

4. Sum up the total cash receipts.

5. Forecast the business’ monthly purchases.
6. Forecast the cash purchases and the credit purchases from the projected
monthly purchase. If purchases are made on credit, then forecast when
those payables will be paid.

Business Finance
Mr. Christopher B. Cauan
7. Take into account other disbursements. Other cash disbursements
include wages and salaries, taxes, capital expenditures, rent, and interest
payments.
8. Sum up the total cash disbursements.
9. Subtract the total cash disbursements from the total cash receipts to get
the net cash flow.
10. Add the beginning cash balance to the net cash flow to get the ending
cash balance. The ending cash balance of the previous month is the
beginning cash balance of the following month.
11. Subtract the minimum cash balance from the ending cash balance. The
minimum cash balance, also known as target cash balance, is the
minimum cash balance the business needs to have on hand, to conduct
its day to day operations.
=
Minimum cash balance > Ending cash balance Financing is required
=
Minimum cash balance < Ending cash balance Business has excess cash

Business Finance
Mr. Christopher B. Cauan
 Sales in January and February were 150,000 and 220,000, respectively.
Sales of 380,000, 340,000 and 295,000 have been forecasted for March, April
and May, respectively.
We are trying to develop a cash budget for March to May.
Based on historical data, 15% of the business sales are in cash form, 55% have
generated accounts receivables collected for one month, and the remaining
30% have generated accounts receivables collected after two months.
Sales Forecast Jan Feb Mar Apr May
150,000 220,000 380,000 340,000 295,000
Cash sales (15%) 22,500 33,000 57,000 51,000 44,250
Account Receivable
Collections
(55% of sales) Lagged 1 mo. 82,500 121,000 209,000 187,000
(30% of sales) Lagged 2 mos. 45,000 66,000 114,000
Other cash receipts 150,000 150,000 150,000 150,000 150,000
Total Cash receipts 172,500 265,500 373,000 476,000 495,250
Business Finance
Mr. Christopher B. Cauan
 Let us now prepare the cash disbursement for the same period using steps 5 to
8 articulated above.
Consider the case below.
Purchases represent 80% of sales.
Of this amount, 5% is paid in cash, 80% and 15% are paid after one month
and two months, respectively.
After the purchase, the business also pays a rent of 15,000 every month.
Wages are 5% of monthly sales or fixed salary cost for the year is 144,000 or
12,000 per month.
Taxes of 40,000 will be paid in April.
Capital expenditure in the form of new machinery costing 200,000 will be
purchased and paid in full in March.
Interest payment of 110,000 is due every month.
Principal payment of 150,000 is also due in May.

Business Finance
Mr. Christopher B. Cauan
 Jan Feb Mar Apr May
Purchases (80% 0f sales) 120,000 176,000 304,000 272,000 235,000
Cash purchases (5% of purchases) 6,000 8,800 15,200 13,600 11,800
Accounts payable
payment
(80% of purchases) Lagged 1 mo. 96,000 140,800 243,200 217,600
(15% of purchases) Lagged 2 18,000 26,400 45,600
mos.
Rent payments 15,000 15,000 15,000 15,000 15,000
Wages and salaries 19,500 23,000 31,000 29,000 26,750
Tax payments 40,000
Fixed asset outlay 200,000
Interest payments 110,000 110,000 110,000 110,000 110,000
Principal 150,000
payments
Total cash 150,500 252,800 530,000 447,200 576,750
disbursements
 And now, we are ready to prepare the cash budget following the steps 9-11.

Consider the information below.

At the end of February, the cash balance was 70,000. It wants to have a
target cash balance of 90,000.

Jan Feb Mar Apr May

Cash Receipts 172,500 265,500 373,000 476,000 495,250
Less: Cash Disbursements 150,500 252,800 530,000 477,200 576,750
Net Cash Flow 22,000 12,700 -157,000 -1,200 -81,500
Add: Beginning Cash 70,000 -87,000 -88,200
Ending Cash 70,000 -87,000 -88,200 -169,700
Less: Minimum Cash Balance 90,000 90,000 90,000
Required Total Financing -177,000 -178,200 -259,700
Excess Cash Balance

Business Finance
Mr. Christopher B. Cauan
3.3 Tools in
Managing Cash,
Receivables, and
Inventory

Business Finance
Mr. Christopher B. Cauan
Net Working Capital (NWC) is computed by subtracting the business’
current liabilities from its current assets.

Zero NWC = One CR

Just like the current ratio, NWC measures the liquidity of a business and
higher NWC means more liquid the business is.

Business purchases raw materials to manufacture the products

they sell.
More often then not, these material purchases are acquired on
credit.
Once those products are sold, they are either paid in full
immediately or are paid at a later date or a combination of two.

Business Finance
Mr. Christopher B. Cauan
 Ideally, you would want to receive the full payment for the sales
right away and use the money to pay your raw materials.
However, reality is that there is a mismatch in the timing of the
cash receipts – the cash inflows – and the cash payment for the
raw materials.
Therefore, we need to know how long, on average, it takes for the
business to pay its suppliers and to collect on its sales.

Operating cycle – is the time from raw material purchase to the cash
receipt.
Operating cycle is composed of two periods.

Inventory period, known as Age of Inventory

Accounts Receivable period, known as Age of Receivables

Business Finance
Mr. Christopher B. Cauan
 Inventory period, known as Age of Inventory
Refers to the time it takes for the business to sell its finished
product from the time it purchased the raw materials.

Accounts Receivable period, known as Age of Receivables

The time it takes for the business to collect on the sale of the
finished product.

Operating cycle = Inventory Period + Accounts Receivable

A shorter cycle is much preferred.
Cash Conversion Cycle, also known as Cash Cycle, is the time it takes for the
business to collect on its accounts receivable after it has paid for its raw
materials.
Cash Cycle = Operating cycle - Accounts Payable Period
Accounts Payable Period is defined as the time it takes for the business to pay
for its raw materials from the time they are acquired.
A shorter cycle is much preferred.
Business Finance
Mr. Christopher B. Cauan
Let us now compute the Operating Cycle and Cash Conversion Cycle of
Good Food Snack House for 2104.

Cost of Goods Sold

Accounts Payable Turnover =
(Beginning Balance + Ending
Accounts Payable)/2

6,228,552
=
(467,376 + 560, 851) / 2

6,228,552
= 514, 114

= 12 times

Business Finance
Mr. Christopher B. Cauan
 365
Accounts Payable Period =
Accounts Payable Turnover
365
=
12
= 30 days

Cash Cycle = Operating Cycle – Accounts Payable Period

= 132 - 30 days
= 102 days

The computation yields 102 days which means there is a 102 –day gap between
the time the business pays for its raw materials and the time it collects the
payment on its sales.

Result: Either borrow money or hold liquid reserves in the form of cash.

Business Finance
Mr. Christopher B. Cauan
5Cs of Credit that helps you carefully select your customers

1. Character. This refers to the customer’s track of record of settling its

obligations on time. More often than not, customers without a track record
should not be given credit.

2. Capacity. This refers to the capacity of the customer to repay you. This is
typically done through financial statement analysis.

3. Capital. This refers to the customer’s level of capital in relations to its debt.

4. Collateral. This refers to the value of the assets that the customer has and
plans to use to secure the credit.

5. Conditions. This refers to the general global and home country

macroeconomic conditions and the industry-specific conditions.

Business Finance
Mr. Christopher B. Cauan
 End
of
Chapter 3
Business Finance
Mr. Christopher B. Cauan