Chapter
29
FINANCIAL PLANNING
Brealey, Myers, and Allen
Principles of Corporate Finance
11th Edition
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
FIGURE 29.1 FIRM’S CUMULATIVE CAPITAL
REQUIREMENT
• Line A: Permanent cash surplus
• Line B: Short-term lender for part of year, borrower for
remainder
• Line C: Permanent short-term borrower
29-2
FIGURE 29.2 CASH AS PERCENT OF ASSETS, U.S.
NONFINANCIAL FIRMS
29-3
TABLE 29.1 INCOME STATEMENT, DYNAMIC
MATTRESS, 2012 ($ MILLIONS)
29-4
TABLE 29.2 YEAR-END BALANCE SHEETS,
DYNAMIC MATTRESS ($ MILLIONS)
29-5
TABLE 29.3 STATEMENT OF CASH FLOWS,
DYNAMIC MATTRESS , 2012 ($ MILLIONS)
29-6
29-2 TRACING CHANGES IN CASH
• Example
• Sources of cash flows for Dynamic Mattress
• Earned $60m net income (operating activity)
• Set aside $20m as depreciation
• Depreciation is not cash outlay, must be added
back in order to obtain cash flow (operating
activity)
• Released $5m in inventory (operating activity)
• Increased accounts payable, borrowed $25m
from suppliers (operating activity)
• Issued $30m long-term debt (financing activity)
29-7
29-2 TRACING CHANGES IN CASH
• Example, continued
• Uses of cash flows for Dynamic Mattress
• Expanded accounts receivable by $25 million
(operating activity)
• Invested $30 million (investing activity)
• Paid $30 million dividend (financing activity)
• Purchased $25 million marketable securities
(financing activity)
• Repaid $25 million short-term bank debt
(financing activity)
29-8
29-2 TRACING CHANGES IN CASH
• Simple Cycle of Operations
29-9
29-2 TRACING CHANGES IN CASH
• Cash Cycle
inventory at start of year
Average days in inventory =
annual cost of goods sold/365
Average collection period =
receivable s at start of year
annual sales/365
payables at start of year
Average payment period =
annual cost of goods sold/365
29-10
29-3 CASH BUDGETING
• Steps to Prepare Cash Budget
• Forecast sources of cash
• Forecast uses of cash
• Calculate whether firm is facing cash
shortage or surplus
29-11
29-3 CASH BUDGETING
• Example
• Dynamic Mattress forecasted sources of cash
• Accounts receivable ending balance =
accounts receivable beginning balance +
sales - collections
29-12
TABLE 29.4 COLLECTIONS ON ACCOUNTS
RECEIVABLE ($ MILLIONS)
29-13
29-3 CASH BUDGETING
• Example
• Forecasted uses of cash for Dynamic Mattress
• Payment of accounts receivable
• Labor, administration, and other expenses
• Capital expenditures
• Taxes, interest, and dividend payments
29-14
TABLE 29.5 CASH BUDGET FOR 2013, DYNAMIC
MATTRESS COMPANY ($ MILLIONS)
29-15
TABLE 29.6A DYNAMIC MATTRESS FINANCING
PLAN ($ MILLIONS)
29-16
TABLE 29.6B DYNAMIC MATTRESS FINANCING
PLAN ($ MILLIONS)
29-17
29-5 LONG-TERM FINANCIAL PLANNING
• Planning Horizon
• Time horizon for financial plan
• Departments often asked to submit three
alternatives
• Optimistic
• Expected
• Pessimistic
• Financial plans ensure plans stay consistent
with capital budgets
29-18
29-5 LONG-TERM FINANCIAL PLANNING
• Why Build Financial Plans?
• Contingency planning
• Considering options
• Forcing consistency
29-19
29-5 LONG-TERM FINANCIAL PLANNING
Inputs
Planning Model
Outputs
• Inputs
• Current financial statements, forecasts of key
variables
• Planning Model
• Equations specifying key relationships
• Outputs
• Projected financial statements (pro forma),
financial ratios, sources and uses of funds
29-20
29.7 CONDENSED YEAR-END BALANCE SHEET,
DYNAMIC MATTRESS ($ MILLIONS)
a When
only net working capital appears on firm’s
balance sheet, this figure is referred to as total
capitalization
29-21
TABLE 29.8 ACTUAL (2012) AND FORECASTED
OPERATING CASH FLOWS, DYNAMIC MATTRESS
29-22
TABLE 29.9 ACTUAL (2012) AND FORECASTED
REQUIRED EXTERNAL CAPITAL
29-23
TABLE 29.10 ACTUAL (2012) AND PRO FORMA
BALANCE SHEETS, DYNAMIC MATTRESS
29-24
29-5 LONG-TERM FINANCIAL PLANNING
• Pro Formas
• Projected or forecasted financial statements
• Percentage of Sales Model
• Sales forecasts are driving variable, most other
variables proportional to sales
• Balancing Item
• Variable that adjusts to maintain consistency of
financial plan, also called plug
29-25
29-5 LONG-TERM FINANCIAL PLANNING
• Planners Beware
• Many models ignore realities such as
depreciation, taxes, etc.
• Percent of sales methods not realistic because
fixed costs exist
• Most models generate accounting numbers, not
financial cash flows
• Adjustments must be made to consider these
and other factors
29-26
29-6 GROWTH AND EXTERNAL FINANCING
• Sustainable Growth Rate
• Steady rate at which firm can grow without
changing leverage
retained earnings
Internal growth rate =
net assets
retained earnings net income
equity
=


net income
equity
net assets
Sustainabl e growth rate = plowback ratio  return on equity
29-27