Week 3

Financial Planning Tools and Concept

 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
(Gitman & Zutter, 2012).
 Management planning is about setting the goals of the organization and identifying
ways on how to achieve them (Borja& Cayanan, 2015).
 There are two phases of financial planning. Financial planning starts with long term
plans which would then translate to short term plans

Long-term financial plans

- These are a set of goals that lay out the overall direction of the company.
- A long-term financial plan is an integrated strategy that takes into account various
departments such as sales, production, marketing, and operations for the purpose of guiding
these departments towards strategic goals.
- Those long-term plans consider proposed outlays for fixed assets, research and development
activities, marketing and product development actions, capital structure, and major sources of
financing.
- Also included would be termination of existing projects, product lines, or lines of business;
repayment or retirement of outstanding debts; and any planned acquisitions(Gitman & Zutter,
2012).

Short-term financial plans

- Specify short-term financial actions and the anticipated impact of those actions. Part of short
term financial plans include setting the sales forecast and other forms of operating and
financial data. This would then translate into operating budgets, the cash budget, and pro
forma financial statements (Gitman & Zutter, 2012).

For corporations, long term and short term objectives are usually identified. These can be seen
in the company’s vision and mission statements. The vision statement states where the
company wants to be while the mission statement states the plans on how to achieve the
vision.

• In planning, contingencies must be considered as well.

• Budgets and projected financial statements are anchored on assumptions. If these
assumptions do not become realities, management must have alternative plans to minimize
the adverse effects on the company (Borja & Cayanan, 2015).
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Formula and format for the preparation of budgets and projected financial statements
Characteristics of an Effective Plan.
• In planning, the goal of maximizing shareholders’ wealth must always be put in mind.
• The following criteria may be used for effective planning:
- Specific – target a specific area for improvement.
- Measurable – quantify or at least suggest an indicator of progress.
- Assignable – specify who will do it.
- Realistic – state what results can realistically be achieved, given available resources.
- Time-related – specify when the result(s) can be achieved.
* "This is the S.M.A.R.T. way to write management's goals and objectives"

A plan is useless if it is not quantified. A quantified plan is represented through budgets and
projected or pro-forma financial statements.

These budgets and pro-forma financial statements are useful for controlling. They serve as the
bases for monitoring actual performance

Meeting the plans is good. However, failing to meet the plans is not equivalent to failure if the
reasons for not meeting such plans can be justified especially when the reasons are fortuitous
in nature and are beyond the control of management.

External and internal factors influencing sale, among others:

 Macroeconomic Variables (external)
 Macroeconomic variables such as the GDP rate, inflation rate, and interest rates,
among others play an important role in forecasting sales because it tells us how much
the consumers are willing to spend. A low GDP rate coupled by a high inflation rate
means that consumers are spending less on their purchases of goods and services. This
means that we should not forecast high sales of the periods of low GDP.
 Developments in the Industry (external)
Products and services which have more developments in its industry would likely
have a higher sales forecast than a product or service in slow moving industry.
Consumer trends are always changing, thus the industry should be competitive to be
able to appeal to more customers and stay in the market.
 Competition (external)
Suppose you are selling bread and you know that each person in your community
eats an average of one loaf of bread a day. The population of your community is 500
people. If you are the only person selling bread in your town, then your sales forecast is
500 units of bread. However, you also have to take account your competition. What if
there are 4 other sellers of bread? You will need to have to divide the sales between the
5 of you. Does this mean your new forecast should be 100 units of bread? Not
necessary. You should also know the preference of your consumers. If more of them
would prefer to buy more bread from you, then you should increase your sales forecast.
 Production Capacity and man power (internal)
Suppose that you have already evaluated the macroeconomic factors and
identified that there is a very strong market for your product and consumers are very
likely to buy from you. You forecasted that you will be able to sell 1,000 units of your
product. However, you only have 20 employees who are able to produce 20 units each.
Your capacity cannot cover your expected demand hence, you are limited by it. To be
able to increase capacity, you should be able to expand your management

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The concepts and tools in working capital management.

Working capital is the lifeblood of any business. It determines the ability of the company to
manage its cash flow to always have enough to meet its debt obligations. Managing the
components of working capital is an essential skill of any business owner or manager. There
are a number of different tools than can be used to manage working capital.
Definition
Working capital is defined as the total current assets, cash, receivables and inventory of a
company, minus its current liabilities, which are all debts due in less than 12 months. It is a
measure of the liquidity of a company. A manager's goal is to always be increasing working
capital, which can be easily tracked on a daily or monthly basis. A business that is making a
profit and has a positive cash flow should always be increasing its working capital position.
Cash flow schedule
Every company should have a weekly cash flow schedule plotted on a spreadsheet that shows
when money is coming in, going out and how much will be left. When a business sells its
products on terms to a customer, the funds from the sale may not be collected for 30, 45 or
even 60 days. Current liabilities, on the other hand, will typically have to be paid on shorter
terms. This difference in timing illustrates the importance of having a large working capital
position.
Accounts Receivable
The turnover of accounts receivable is an important indicator of a company's ability to sell
products and collect its funds. Accounts receivable turnover can be calculated as total sales
divided by the amount of accounts receivable. For example, if a company had annual sales of
$1.2 million and had average accounts receivable of $100,000 then its turnover ratio would be
12 times. If the company were selling on 30-day terms then this would be a perfect ratio.
Unfortunately, the real world does not always work this way. If the accounts receivable
balance were $150,000, then the turnover ratio would drop to eight, which indicates a
collection period of 45 days, 360 days divided by eight.
Inventory
Inventory turnover is another metric that affects working capital. This metric is calculated by
dividing the total cost of goods sold by the inventory balance. A company needs to have an
inventory balance that is sufficient to meet demand but not so much that it has stale inventory
that is not selling.
Working capital turnover
Working capital turnover is calculated by dividing total sales by the amount of working capital.
A ratio that is very high indicates that the working capital is working too hard and the company
will have difficulty meeting its short-term debt obligations. A ratio that is very low is a sign that
the company has excess working capital and the funds should be pulled out to invest in other
assets that would be more productive. The optimum working capital turnover ratio for any
business is a trial-and-error process to determine the best level of working capital.

Working Capital Assets and their importance in the operations of the company.
• Working capital is the company’s investment in current assets such as cash, accounts
receivable, and inventories.
• Net Working capital is the difference between current assets and current liabilities

• The operating cycle is the sum of days of inventory and days of receivables.
• Days of Inventory (DoI)or inventory conversion period or average age of inventories, is the
average number of days to sell its inventory.
- A DoI of 20 days means that on the average it takes 20 days to sell its inventory.
- Since the Statement of Financial Position tells the financial condition of a company at the
end of the period, we take Average Inventory for the year in our calculation.

Or, this formula can be used without computing for inventory turnover:
• Cash Conversion Cycle, also called the net operating cycle, is computed as the operating
cycle less days of payable.

- The Cash Conversion Cycle is the length of time it takes for the initial cash outflows for goods
and services purchased (materials, labor, etc.) to be realized as cash inflows from sales (cash
sales and in the collection of receivables).

• Permanent Working Capital is the minimum level of current assets required by a firm to
carry-on its business operations given its production capacity or relevant sales range.

• Temporary working capital is the excess of working capital over the permanent working
capital given its production capacity or relevant sales range.

During the year, sales are not the same every month. This is why companies have slack
season and peak season. If a company has annual sales of PHP50 million, chances are these
sales are not generated uniformly throughout the year. Given this situation, the net working
capital requirements during the slack season is lower than those during the peak season. The
net working capital needed to support an operation during the slack season represents the
permanent working capital requirements while the additional net working capital needed
during the peak season represents the temporary working capital requirements.
Business Finance
Week 3