Module 8- finance Skills for Mangers D076

Cash Budgets

a plan for controlling cash inflows and outflows business to balance income with expenditures

What are the key uses of the cash budget?

indicating future financing needs, providing a basis for corrective action, and providing the data for performance evaluation

Six principles of effective budgeting:

know yourself

understand the key areas of savings, income, and expenses

develop savings, income, and expense strategies

keep records

use a method that meets your needs and objectives

eliminate consumer debt and minimize long-term debt

When evaluating a company’s performance what can variances on a company’s cash budget indicate?

variances show that certain managers or divisions are not meeting targets

How far into the future do cash budgets usually forecast?

between one month and one year

What are three principles of budgeting that are important to know before beginning the budgeting process?

keep records, develop savings, income, and expense strategies, and use a method that meets your needs and objectives

What are the three main uses of cash budgets?

cash budgets are used to forecast future financial need, aid in performance evaluation, and show when corrective action is needed

Steps to creating a cash budget:

determine cash receipts

estimate cash disbursements

create the cash budget

What is the cash position for a period?

beginning cash + net cash flow (cash receipts - cash disbursements)

Steps to creating a budget for your personal finances:

understand your goal

track your savings, income, and expenses

develop a cash budget (plan)

implement your plan

compare the cash budget to your actual spending and make necessary changes

50/30/20

50% goes to needs

30% goes to wants

20% goes to savings

What three things should be included in a cash budget for a business?

cash receipts, cash disbursements, and borrowing

What is the difference between tracking and monitoring cash flows?

monitoring involves using your tracking record to evaluate cash flows against your target, identify patters and changes in cash flows, and gauge when correction is needed

Profit forecasting

the projection of future earnings after all projected costs are subtracted from projected sales

Balance sheet forecasting

using sales growth and the profit forecast to construct a pro forma balance sheet to understand the future implications of the sources and uses of finances

What is a pro forma balance sheet used for?

to understand how sources and sues of finances change in a company. helps management understand the future implications of the company’s financing strategies

What does forecasting answer?

given expectations for future growth (in sales, asset base, ect) how much additional financing will you need?

Discretionary financing needed (DFN) / external financing needs (EFN) / additional funds needed (AFN)

the additional financing needed given a firm’s expectations for future growth

What is budgeting used to establish?

where management ideally wants to take the company

it quantifies the expected performance that a company wants to achieve in a future period

What is forecasting concerned with?

whether the company is heading in the right direction

estimates the number of sales that will be achieved in the future to understand the future financial needs of the company

Characteristics of budgeting:

a detailed representation of the future results, financial position, and cash flows that management wants to achieve during a certain period of time

it is compared to actual results to understand why and how the company’s performance differed from the expected results

management team can take actions to adjust the budget based on the company’s actual performance

Characteristics of financial forecasting:

broad representation of the impact of today’s business decisions on the future performance of the company and how they will affect the company’s financial position

can be used to immediate actions, such as changing the company’s credit standards, inventory holdings, production levels, dividends policies ect

there is no variance analysis to compare with actual performance

Spontaneous accounts

accounts that vary naturally with sales

Discretionary accounts

accounts that do not vary automatically with sales but are left to the discretion of management

percentage of sales method for forecasting:

1) sales forecast and 2) historical relationships between sales and other variables to create pro forma statements (‘what ifs’)

Pro Forma Statement

a financial statement that projects an estimate for future periods "as if” sales grew as predicted

Steps to the percentage of sales method:

project sales revenues and expenses

forecast change in spontaneous balance sheet accounts

deal with discretionary accounts

estimate fixed asset account

calculate retained earnings (RE)

determine total financing need (projected total assets)

calculate DFN

When will discretionary accounts increase to supply needed financing?

after the DFN has been identified

What are 2 accounts that do not fit into spontaneous or discretionary acounts?

fixed assets and retained earnings account

Why is retained earnings account seperate?

depreciation expenses

interest expenses

dividends

Net margin

the percentage of sales remaining after all costs have been deducted from a company’s total sales. also known as net profit margin; indicates the profit earned by the firm

Payout Ratio

the percent of net income distributed to the shareholders (dividend policy)

What are the only 2 things that can happen to net income?

it can be paid out as dividends

it can be retained within the firm as retained earnings

retention ratio / plowback ratio

the percentage of net income retained in the firm

How to project retained earnings:

Projected RE= Old RE +

(Projected sales net margin * plowback ratio)

plowback ratio= 1 - payout ratio

payout ratio= dividends / net income

how to calculate the difference between the firm’s total financing need (total projected assets) and financing currently in place:

DFN

Which action decreases the discretionary financing needed (DFN)?

increasing the plowback ratio

Sustainable growth rate (SGR)

the growth rate that allows a firm to maintain its present financial ratios without issuing new equity

Steady state growth

the level of growth where four key financial ratios—profitability, asset, utilization, leverage, and payout—are constant and where the firm does not need to issue any new equity to fund the growth

How to reduce DFN:

slow sales growth

examine capacity constraints

lower dividend payouts

increase net margin

lumpy assets

increase of fixed assets as the firm approaches its full capacity and is paid for in a lump sum

Sales capacity formula

sales capacity= actual sales / % of capacity

What is discretionary financing needed (DFN)?

the additional financing needed given a firm’s expected future growth

Company abc would like to continue to grow, but in order to maintain control of all decisions and ownership, it wants to avoid issuing new stock. which calculation will show the company’s leadership the fastest that abc can grow?

sustainable growth rate (defined as the rate at which a firm can grow without issuing new equity)