Chapter 4: Long Term and Short-Term Financial
Planning
❖ Financial Planning Process - begins with long-term or
strategic, financial plans that in turn guide the
formulation of short-term, or operating, plans and
budgets
➢ 2 aspects:
➢ Cash planning - preparation of cash budget -
ensure that excess cash is put to work or have
outside financing lined up
➢ Profit Planning - preparation of pro-forma
statements (Balance Sheet and Income
Statement)
❖ Evidences needed for financial planning:
➢ VMGO - vision, mission, goals, and objectives
❖ Long-term (Strategic) Financial Plans - lay out a
company’s financial actions and the anticipated impact
of those actions over the periods ranging from 2-10
years
➢ Specify magnitude and timing of major
investments
➢ Two main objectives:
➢ Describe how a firm will build value for
shareholders by creating new products and
services
➢ Determine whether they will need additional
external capital (sell stock or borrow money),
whether firm will generate sufficient cash to
retire debt, pay dividends, or repurchases shares
❖ Activities:
➢ Proposed FA investments
➢ investments in other firms
❖ Short-term (Operating) Financial Plans - short-term
financial actions and the anticipated impact of those
actions
➢ Often covers 1-2 year period
➢ Begins with sales forecast - production plan -
determine estimates of resources to prepare the
pro-forma Income statement and cash budget -
develop balance sheet
❖ Measuring the Firm’s Cash Flow
● Estimating cash flow - central to the valuation
process
❖ Depreciation - portion of the goods of fixed assets
charged against annual revenues over time
➢ Allocation of historical cost over time
❖ Modified Accelerated Recovery System (MACRS) - used
to determine the depreciation of assets for tax purposes
➢ Tax Cuts and Jobs Act of 2017 - Immediately
deduct 100% of the cost of many (but not all)
types of new assets
❖ Depreciable value of an asset - amount to be
depreciated
➢ Under MACRS - full cost including outlays for
installation
❖ Depreciable life - time period over which an asset is
depreciated
➢ The shorter the depreciable life = larger
depreciation deductions = larger tax savings
❖ MACRS recovery period - appropriate depreciable life
of a particular asset as determined by MACRS
➢ There are six: 3, 5, 7, 10, 15, and 20 years
❖ Developing the statement of Cash Flows:
➢ Cash Flow from Operating Activities - directly
related to sales and production of the firm’s
products and services
■ If presented using direct
method, at the end - present
the indirect method
➢ Cash flow from investment activities - purchase
and sales of both fixed assets and equity
➢ Cash Flow from Financing Activities - debt and
equity financing transactions
■ Incurrence and repayment of debt
■ Cash inflows - shares of stock
■ Cash outflows - repurchase of stock /
payment of cash dividends
❖ Bottomline = net increase/decrease in cash +
beginning = ending cash balance
Classifying inflows and outflows of cash
(indirect method: adjustments to net income)
 ❖ Net current asset investment - investment by the firm
Inflows Outflows
in its current (operating) assets
Decrease in any asset Increase in any asset
NCAI = Change in current assets - Change in (accounts
Increase in any liability Decrease in any liability
payable + accruals)
Net profit after taxes Net loss after taxes
❖ Cash Planning:
Depreciation and other Dividends paid ➢ Cash Budget/ Cash Forecast - statement of the
non cash charges firm's planned inflows and outflows of cash that
Sales of stock Repurchase/ retirement managers use to estimate its short-term cash
of stock requirement
● Covers 1 year, divided into smaller time intervals
❖ Noncash charge - expense deducted on the income ● The more seasonal and uncertain the cash flows
statement but does not involve the actual outlay of = greater the number of intervals
cash
➢ Depreciation, amortization, and depletion ❖ Sales Forecast - prediction of the firm’s sales over a
given period
❖ Operating Cash Flow (OCF) - cash flow a firm generates ● Based on external/internal data
from its normal operations ● Key input to short-term financial planning process
= Net operating profits after taxes (NOPAT) + ● Most difficult aspect of forecasting: obtaining good
depreciation data

❖ Net operating profits after taxes (NOPAT) - earning
before interest and after taxes
= EBIT x (1-T); T= corporate tax rate
OCF = NOPAT + Depreciation
OCF = [EBIT x (1-T)] + Depreciation
❖ Free Cash flow (FCF) - amount of cash flow available to
investors (creditors and owners) after the firm has met
all operating needs and paid for investments in net
fixed assets and net current assets
➢ Gross of dividends
FCF = OCF - Net fixed asset investment (NFAI) - Net
current asset investment (NCAI)
❖ Net fixed asset investment - investment made by the
firm in fixed assets
➢ Expansions
NFAI = Change in net fixed assets + Depreciation
❖ External forecast - based on relationships observed
between the firm’s sales and certain key external
economic indicators
➢ Top-down approach
❖ Internal Forecast - based on buildup, or consensus, of
sales forecasts through the firm’s own sales channels
➢ Bottom-up approach
❖ Total Cash Receipts - all of a firm’s inflows of cash
during a given financial period
❖ Total Cash Disbursements - all outlays of cash by the
firm during a given financial period
★ DEPRECIATION & OTHER NONCASH CHARGES
ARE NOT INCLUDED IN THE CASH BUDGET
❖ Net Cash Flow - mathematical difference between the
firm’s cash receipts and its cash disbursements in each
period
❖ Ending Cash - sum of firm’s beginning cash and its net
cash flow for the period

❖ Required total financing - amount of funds needed by
the firm if the ending cash for the period is less than
the desired minimum cash balance
➢ Typically represented by accounts payable
❖ Excess cash balance - (excess) amount available for
investment by the firm if the period’s ending cash is
greater than the desired minimum cash balance
➢ Assumed to be invested in marketable
securities
❖ Evaluation of Pro Forma Statements
❖ Evaluating the Cash Budget
➢ Helps managers secure borrowing arrangement if
the firm needs cash
➢ Compare projections to firm’s actual performance
➢ Identify problems in which actual cash inflows and
outflows vary from the budget
❖ Coping with uncertainty in the cash budget
➢ Incorporate most careful and accurate forecasts as
possible
➢ Two ways to cope with uncertainty:
■ Scenario analysis - prepare several cash
budgets based on:
● Pessimistic
● Most likely
● Optimistic
■ Simulation
➢ External financing required (plug figure) - amount
of financing needed to bring the statement into
balance
■ Can either be a positive or negative value
■ Negative value - indicates that the firm will
generate more financing internally than it
needs to support its forecast growth in assets
● Can be used for repaying debt,
increasing dividends or investing in
new assets
➢ Weakness of assumptions made in Pro-forma
statements:
■ Firm’s past financial condition is an accurate
indicator of its future
■ Managers can force accounts to take on
“desired” values
➢ Strengths:
■ Allows managers to adjust operations to
achieve short-term financial goals
■ Provide a “baseline” for managers to evaluate
ongoing performance as the year begins

❖ 2 main inputs to prepare pro-forma statements:

➢ Financial statements for at least the preceding year
➢ Sales forecast of the coming year

❖ Preparing the Pro Forma Income Statement

➢ Percent-of-sales method - Expresses various
income statement items as percentages of
projected sales (likely percentages of sales for
items in the previous year are used)

❖ Preparing the Pro Forma Balance Sheet

➢ Judgmental approach - firm estimates the values
of certain balance sheet accounts and uses its
external financing as a balancing, or “plug,” figure