FINANCE MANAGEMENT FIN 420 chp 4

Financial Forecasting Chapter 4

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Financial analysis and planning are useful both to help

anticipate future conditions and, more importantly as a

starting point for planning actions that will influence the

future course of events.

Learning objectives

After learning this chapter, you should be able to:

1. Distinguish the concept of financial analysis, planning and

forecasting.

2. Construct the sources and uses of cash flows statement.

3. Construct the cash budget.

4. Develop the pro forma financial statement i.e. the pro forma

balance sheet and income statement.

5. Analyse/interpret the companys performance based on ratio

and cash flows analysis.

Financial Forecasting

GOAL

Chapter 4 Financial Forecasting

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4.0 INTRODUCTION

Financial forecasting concentrate on the expected outcomes from decisions committed by

the firm's management and is a crucial part of the planning process. In essence, forecasting

concern with the future or the financial consequences of present day decision committed by

a financial manager. It is more of a prediction of the expected outcomes and therefore aids

decision-maker to fully use the resources at hand to ensure the planned objectives are met.

It is crucial that all various departments' forecasts are consistent with each other; that is the

basis of forecast must be based on common forecast variables such as inflation, general

level of economic activity, and level of interest to name a few. This is to ensure the various

departments or units will work towards common objective and internal conflicts can be

avoided.

The information-collected will provides managers the basis for planning and coordination of

firm's scare resources to maximize the shareholders' wealth. Forecasting is therefore

important to ensure that the firm is able to operate without any unnecessary delays or shut

down due to mismanagement of resources. For example, in case of funds' shortages the

company may have to discontinue its operations and other complications that may lead to

technical insolvency and bankruptcy. This chapter will focus on forecasting of cash and

funds requirements for the firm over a specified period.

4.1 CASH FLOW ANALYSIS The cash flow cycle shows how the actual net cash flows into and out of the firm during a

specified period. It concerns only with the actual movement of the cash; and as such

expenses on depreciation and sales on credit do not constitute as cash flows.

Figure 4-1; illustrate in details the cash flow cycle within a firm. It shows the effect of various

transactions that causes the cash movement that tends to increase or decrease the funds

accordingly. The shaded rectangle represents the balance sheet accounts where else clear

rectangles represent income statement items. Please refer to Chapter 11 for additional

materials on cash management.


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Figure 4.1 Cash and Materials Flows 4.2 CASH FLOW CONCEPT Cash flow means the difference between the number of dollars that came in and the number

of dollars that went out.

Based on balance sheet identify, the value of a firms assets is equal to the value of its

liabilities plus the value of its equity. Similarly, the cash flow from the firms assets must

equal the sum of the cash flow to creditors and the cash flow to stockholders.

Therefore, the cash flow identify is known as

Sales Inventories

Depreciation

Cash Sales Net fixed Assets

Accounts receivable

Collection of receivable

Issue shares

EQUITY Preferred equity Common equity

Retained earnings

Capital budgeting

Cash and marketable securities

Pay dividends, Taxes and dividends

Borrow funds

Use of labor and buy materials

Accounts payables and accruals

Payments to reduce payables and accruals

Loan repayments

DEBT Notes payable

Long-term borrowings Bonds

Cash flow from assets = cash flow to creditors + cash flow to stockholders


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a. Cash Flow from Assets

It involves three components: operating cash flow, capital spending and

change in net working capital

(i) Operating cash flow

It refers to the cash flow that results from the firms day-to-day

activities of producing and selling. Normally it consists of:

Most of the time the firm must have a positive operating cash flow to

show that a firms cash inflows from its business operations are

sufficient to cover its everyday cash outflows. If a company is having a

negative operating cash flow it means that the company is in trouble.

(ii) Capital Spending

It refers to the net spending on fixed assets. The common items

involve are:

If the net capital spending is positive, it means that the money spend

to purchase fixed assets is than the money received from the sale of

fixed assets. On the other hand, if net capital spending is negative, it

means that the firm sold off more assets than it purchased.

Earnings before interest and taxes (EBIT)

+ Depreciation

- Taxes

Ending net fixed assets

- Beginning net fixed asset

+ Depreciation


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(iii) Change in networking capital

It measures the net change in current assets over current liabilities for

the period being examined. So, change in net working capital is equal

to

This change in net working capital is often referred to as the addition

to networking capital.

b. Cash Flow to Creditors and Stockholders

It represents the net payments to creditors and owners during the year. The

calculation for cash flow to creditors is equal to interest paid less net new

borrowing and cash flow to stockholders (bondholders) is dividends paid less

net new equity raised.

An example of Cash Flow Suppose that a company started the year with RM2,130 in current assets and

RM1,620 in current liabilities, and the corresponding ending figures were

RM2,260 and RM1,710. Beginning net fixed assets were RM500 and ending

net fixed assets were RM750.

During the year, the company had sales of RM600 and cost of goods sold of

RM300. Depreciation was RM150 and interest paid was RM30. Taxes were

RM41 and dividends paid were RM30. Suppose we also know that the

company did not sell any new equity for the year. To calculate cash flow from

assets based on the above example, we should start with:

(i) Operating cash flow (OCF)

OCF = EBIT + Dep Taxes

= RM150 + RM150 RM41

= RM259.00

Ending net working capital

- Beginning net working capital


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(ii) Net Capital Spending = Ending Net Fixed Assets

- Beginning net Fixed Assets

+ Depreciation

= RM750 RM500 + RM150

= RM400.00

(iii) Change in Net Working Capital (NWC)

= Ending net working capital

- Beginning net working capital

= [RM2260 RM1710] [RM2130 RM1620]

= RM550 RM510

= RM40.00

Therefore, putting all the information together, we have cash flow assets

= Operating cash flow (OCF)

- net capital spending

- Change in NWC

= RM259 RM400 RM40

= -RM181

Next, to calculate cash flow to stockholders and creditors. Since there is no

new equity has been raised, therefore cash flow to stockholders is just equal

to cash dividend paid = RM30. From the cash identity, we know that:

Cash Flow from assets = Cash flow to creditors

+ Cash flow to stockholders

- RM181 = Cash flow to creditors + RM30

Therefore, cash flow to creditors

= -RM181 RM30

= -RM211

Since cash flow to creditors is RM211 and interest paid is RM30, then we can

determine net new borrowing

Cash flow to creditors = Interest paid

- net new borrowing

-RM211 = RM30 (net new borrowing)

:. Net new borrowing = (RM30 + RM211)

= -RM241


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This amount shows that the company must have borrowed RM241 during the

year to help finance the fixed asset expansion.

4.3 THE STATEMENT OF CASH FLOWS Those activities that bring in cash are called sources of cash. Those activities that involve

spending cash are called uses (or applications) of cash. We can summarize the sources and

uses of cash in the form of a financial statement and is called the statement of cash flows.

To get started, consider the balance sheets for a company in Table 4.1. Then trace the

changes in the firms balance sheet to see how the firm obtained its cash and how the firm

spent its cash during some time period.

Next, identify either the changes is a use of cash or source of cash. By using a simple

technique, any increase in an asset account or a decrease in liability account is a use of

cash. On the other hand, any decrease in an asset account or an increase in a liability

account is a source of cash.

To further trace the flow of cash through the firm during the year, we need an income

statement as shown in Table 4.2. So an addition to retained earnings in the balance sheet is

just the difference between the net income and the dividend.

Table 4.1 Era Mewah Balance Sheet as at 31/12/97 and 31/12/98 (000s)

ASSETS

31/12/97 (RM000)

31/12/98 (RM000)

Cash Account receivable Inventory Current assets Plant and equipment Less : Accumulated Depreciation Net plant and equipment Total assets

200450550

1,200

2,200

1,0001,2002,400

150 425 625

1,200

2,600

1,200 1,400 2,600


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LIABILITIES AND OWNERS EQUITY

31/12/97

(RM000) 31/12/98 (RM000)

Account payable Notes payable current (9%) Current liabilities Bonds Owners equity Common stock Paid in capital Retained earnings Total owners equity Total liabilities and owners equity

200

0

200600

300600700

1,600

2,400

150 150

300 600

300 600 800

1,700

2.600

Table 4.2 Era Mewah Income Statement (Year Ended 31/12/98)

1998 (RM000s)

Sales Cost of goods sold Gross profit Operating expenses Depreciation Net operating income Interest expenses Net income before taxes Taxes (40%) Net income Dividend To retained earnings

1,450

850 600

40

200 360

60 300 120 180

80 100


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By referring to the balance sheets and income statement we can gather the sources and

uses of cash.

Era Mewah Balance Sheet as at 31/12/97 and 31/12/98

ASSETS 1997

(RM000) 1998

(RM000) Changes Sources Use

Cash Account receivable Inventory Current assets *Plant and equipment Less: Accumulated Depreciation Net plant and equipment Total assets

200450550

1,2002,2001,000

1,2002,400

150425625

1,2002,6001,200

1,4002,600

-50-25+75

+400+200

9 9 9

9 9

* For the fixed assets, we will take the gross for consideration not the net in order to find the current figure of fixed asset sold/purchase

LIABILITIES AND OWNERS EQUITY 1997

(RM000) 1998

(RM000) Changes Sources Use

Account payable

Notes payable-current (9%)

Current liabilities Bonds Owners equity Common stock Paid-in capital ** Retained earnings Total owners equity Total liabilities and Owners equity

200

0

200 600

300 600 700

1,600

2,400

150

150300600

300600800

1,700

2,600

-50

+150

no change no change no change neither a sources nor a use

9

9

From the income statement, the sources will be:

a) NPAT or net income = RM180,000

b) Depreciation = RM200,000

and the use will be:

Payment or dividend = RM80,000

** Retained earnings is neither a source nor a use because the current amount of retained

earnings is already being included in the net profit after taxes or net income.


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ERA MEWAH Cash Flow Statement

For The Year Ended 31/12/98

Beginning cash balance RM200.00

Net Income RM180.00

Plus: Depreciation RM200.00

Accounts receivable RM 25.00

Less: Inventory (RM 75.00)

Accounts payable (RM 50.00)

Net cash flow from operating activity RM280.00

(Cash flow from Investment)

Purchase of Gross

Plant & Equipment (RM400.00)

Net cash flow investment activity (RM400.00)

(Cash flow from Financing)

Dividend paid (RM 80.00)

Plus: Notes payable RM150.00

Net cash flow from financing activity RM 70.00

Net activity decrease in cash (RM 50.00)

Ending cash balance RM150.00

The statement of cash flows presented here is based on an indirect method. The basic idea

is to group all the changes in the financial statements into three categories: operating

activities, financing activities and investment activities.

Analysis: the major sources of cash are from the depreciation, net income and notes payable

whereas the major use will be purchasing fixed assets i.e. plant and equipment.


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What is the difference? For the sources and uses of cash statement, we categories sources & Uses of cash in terms

of operations, working capital and long-term financing.

ERA MEWAH Sources and Uses of Cash Statement

For the year ended 31/12/98 (000)

Cash beginning of year RM200.00

Sources of cash

Operations:

Net Income RM180.00

Depreciation RM200.00

RM380.00 Working Capital:

Dec. in accounts receivable RM 25.00

Inc. in notes payable RM150.00

Total Sources of cash RM555.00

Uses of cash

Working Capital:

Inc. in inventory RM 75.00

Dec. in accounts payable RM 50.00

Long-term Financing:

Fixed-term Financing:

Fixed asset acquisitions RM400.00

Dividends paid RM 80.00

Total uses of cash RM605.00

Net deduction in cash RM 50.00

Cash, end of year RM150.00


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4.4 CASH BUDGETING

The cash budgeting is a detail financial forecasting technique that identifies the cash receipts

(inflows) and disbursements (outflows) relative to its amount and timings of occurrence. For example, let assume that all sales are on credit and collected equally in the month of

sales and one month after. Thus, for July's sales, the cash budgets will recognize 50% of the

cash flow involved in July and the balance is in August.

Thus, cash budget represents cash forecasting set forth the estimates of cash receipts and

disbursements over a specified period of time. It will give indications to the management of

any shortages or excess cash. It helps the financial managers to manage cash more

effectively in order to maximize the firm's value. The development of cash budgets follows

certain steps:

1. Determine the amount and timing of cash receipts. The cash inflows are normally

from cash sales, account receivable and other non operating income; such as receipt

of rental properties and dividends received from holding of other companies common

stock.

2. Determine the amount and timing of cash disbursement. All cash outflows

whether it from operations and/or other bulk purchases such as the purchases of

machinery.

3. Determine the net cash flow. The net cash flows equals to total receipts minus total disbursement.

4. Prepare the cash reconciliation accounts. It takes into account the net cash flow,

beginning cash balance and minimum cash requirement to determine the firm's cash

position after each budgeting period. The cash reconciliation will provide necessary

information for the firm to develop its short-term financing or investment strategies.

To illustrate the preparation of cash budget, consider the following examples. Pearls

Furniture deals with custom-made furniture in which orders received one month before

delivery or sales. Therefore, sales for the following periods can be predicted with relative

accuracy. The company regularly prepares a monthly cash budget for a two-month's period

for planning and controlling purposes. Actual sales for the last four months, along with

forecasted sales for the next four months of 19X2, are presented below (thousands of RM):


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January 360.00 March 320.00 May 290.00 July 350.00 February 400.00 April 310.00 June 330.00 August 400.00

As a practice, Pearls Furniture: 1. Requires 20 percent deposit on all orders one month before sales or delivery, and the

balance can be collected equally in the month of sales and one month after.

2. Cost of goods sold consists of wood products that equal 30 percent of sales.

3. The materials are purchased one month before it is used and 20 percent is paid in

the month of purchase and the balance one-month after.

4. The nature of the operations incurs a high labor cost that accounts for 40 percent of

sales and it is paid for in the month, which it occurs.

5. Other monthly fixed expenses are;

a. Rent RM5,500,

b. General and administrative RM20,000, and

c. Depreciation charges RM6, 500.

d. Selling expenses is equal to 10 percent of sales each month.

6. Pearls also plans to purchase new equipment for RM50,000 in late June in which

RM30,000 will be finance by bank loan with a monthly payment of RM570; of which

RM70 is the interest. The old machine to be replaced can be sold for RM2, 000.

7. Income taxes for the first half of the year are estimated at RM20,000 and will be paid

in June.

8. On May 31, Pearls expects to have cash balance of RM15,000, and the company

likes to maintain a minimum cash balance of RM10,000.

9. The company has a credit line with 12 percent interest per annum.

A complete cash budget for Pearls based on the above variables is presented in Table 4.1.

Students should try to comprehend its development before class lecture and discuss any

misunderstanding and problems encountered with the lecturer during class discussions.

Table 4-1 shows that in the two months period, Pearls will experience cash shortages in the

month June due to the planned purchase of the machine. This indicates the company may

have to resort to:


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1. short-term borrowings (credit line) to cover the deficit, or

2. postpone the purchase until July, or

3. try to increase revenues and simultaneously reduces expenses to avoid cash

shortages.

The company will have cash excess in July that provides the opportunity for the firm to invest

in marketable securities or made an early loan's repayment as it sees fit. If the strategy is to

borrow money to cover the cash deficits, the firm will have to negotiate line of credit facilities

of RM5, 700 for June and repays back in July. Under normal circumstances, the interest on

short-term loan must be serviced monthly as shown in other non-operating expenses for

July.

Table 4.3 Pearls Furniture: Completed Cash Budget for June and July

(In thousands of RM) JUNE JULY Monthly sales tn 330.00 350.00 Notes

OPERATING RECEIPTS Deposits (20% of sales t n+1) 70.00 80.00

Collection of receivable:

Month of transaction (40% of sales t n) 132.00 140.00

1-month lag (40% of sales t n-1) 116.00 132.00

2-month lag (t n-2) 0.00 0.00 Not applicable Total operating receipts 318.00 352.00 Item 1

OPERATING EXPENDITURES Purchases (30% of sales t n+1) 105.00 120.00

Payment on raw material purchases:

Month of transaction (20% of purchases) 21.00 24.00

1-month lag (80% of purchases t n-1) 79.20 84.00

2-month lag (t n-2) 0.00 0.00 Not applicable

Direct labor (40% of sales) 132.00 140.00

Overhead (excludes depreciation) 5.50 5.50

Operating expenses

(selling and Adm. Exp.) 53.00 55.00

Total operating expenditure 290.70 308.50 Item 2


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FACILITIES, TAXES AND OTHERS Plant and equipment expenditures 20.00a 0.00 Refer to note a Taxes paid 20.00 0.00

Principle payment of debt 0.00 0.50c Refer to note c Dividend paid 0.00 0.00

Other non operating expenses (interest) 0.00 0.127d Refer to note d

Less: Other non operating income 2.00b 0.000 Refer to note b Total other expenditure 38.00 0.627 Item 3

NET CASH FLOW 10.70 42.873 Item 4 = 1 2 3

CASH RECONCILIATION Net cash flow 10.70 42.873

Plus: Beginning cash balance 15.00 4.300 Ending cash of t n-1

Ending cash balance 4.30 47.173

Less: Minimum cash balance 10.00 10.000 Minimum cash

Cash excess ( deficit) 5.70 37.173

Note: a Cash paid for the machine; b Disposal of old machine c Principal payment on loan; d Interest for monthly payment and for June's borrowings: RM0.127 = 0.07 + RM5.70 (0.12 / 12)

For further illustrate the cash management strategies, consider the following cash positions

for a particular firm:

Month 1 2 3 4

Cash excess ( deficit) RM20,000 RM20,000 RM60,000 RM10,000

For this particular company, the financial manager can invest RM20,000 temporarily in

January, but must negotiate a credit line of RM60,000 to support its cash requirements for


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the four months' periods to avoid technical insolvency. The firm will borrow RM20,000 in

February and increase its borrowings to the maximum amount of RM60,000 in March.

Consequently the company will pay back all of the borrowings and can plan for short term

investments in marketable securities amounted to RM10,000 for at least one month

depending on the cash position in the following periods.

The development of cash budget, therefore will provides management insight of the cash

position and appropriate strategies can be developed to deal with any of the cash positions,

whether it is a deficit or otherwise.

4.5 PRO-FORMA FINANCIAL STATEMENTS

The most widely used method for forecasting the financial requirements is the percent of

sales method. It is different from the cash budget as it focuses on funds forecasting. It uses

pro-forma financial statements, particularly balance sheet with certain information from

income statement to forecast the funds' requirements for the firm for a particular period.

This method works under the assumption that:

1. The firm's investment in certain assets will vary directly with sales;

2. All spontaneous items in the balance sheet can be expressed as a percentage of

sales; and

3. That percentage will remains constant over a reasonable range of sales.

The company will have to rely on both, internal and external financing to support the funds'

requirement. Internal sources of financing represent funds that are generated from

spontaneous liabilities such as accounts payable and accrual, and from retained earnings.

On the other hand, external sources refer to funds from bonds, common stock, preferred

stock, commercial papers, note payable to name a few.

4.5.1 Spontaneous items.

The spontaneous items represent the balance items that are vary directly with

sales activity. As such, the changes must be spontaneous and arise as a

result of the firm's operations without any prior management effort for

arrangements. In essence, all current assets are spontaneous, and fixed


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asset will only spontaneous if the firm is operating at full capacity. On the

other hand, retained earnings and liabilities such as account payable and

accruals are spontaneous, as it will generate more funds as the firm's

activities increased with the increase in sales.

4.5.2 Non-spontaneous items.

On the other hand, non-spontaneous items will remain constant regardless of

the sales activity. Fixed assets are regarded as non-spontaneous if the firm is

operating below its capacity. Notes payable, long-term debt and equity are

also non-spontaneous as the firm must negotiate and arrange for more

borrowings and issues respectively.

The preceding example deals with a simplified version of percent of sales

method; that is disregarding certain limitations on essential financial ratios

and other financing constraints. Let assume that Sabilla Products plan to

determine the funds' requirement and additional funds needed for fiscal year

of 19X2. The company's current financial data are as follows:

1. Current sales (S0) is RM101 millions,

2. Expected sales (S1) are to increase by 50 percent,

3. Cost of goods sold (COGS) 70% of sales,

4. Other operating expenses' 14% of sales,

5. Net profit margin (NPM) of 9.60%,

6. Dividend payout ratio (DPR) 25%,

7. Marginal tax rate (T) 40%

In addition, the company is operating at full capacity as of 19X1. A complete

balance sheet for the company is presented in Table 4.4.

Table 4.4 Sabilla Products: Balance Sheet as of December 31, 19X1 (millions of RM)

Assets Liabilities and Equity Cash 2.7 Notes payable 1.6

Accounts receivable 15.1 Accounts payable 5.4

Inventory 21.2 Accruals 8.4

Net plant 19.8 Long-term debt 10.2

Equity 33.2

Total assets 58.8 Total liab. & equity 58.8


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There are several ways to solve for additional funds needed (AFN) by the firm to support the sales increased. The most common is pro forma balance sheet approach and an AFN

formula.

4.5.3 Pro forma Balance Sheet

There are several steps involved in developing pro forma balance sheet

statement under percent of sales method:

1. Determine the sales growth. The sales growth is stated in percentage, that is the ratio of change in sales from previous period;

change in sales (S1 S0) divided by old sales (S0).

2. Determine the spontaneous items. All spontaneous items in

balance sheet must be identified disregarding the retained earnings

account.

3. Project the pro forma balance sheet values. All non-spontaneous

items will remains as of previous values in the balance sheet. On the

other hand, spontaneous items are adjusted by a factor of one plus

sales growth. For example 1.5 (=1 + 0.50) for Sabilla Products.

4. Calculate the new level of retained earnings. New level of retained

earnings represents old retained earnings in the balance sheet plus

new retained earnings provided from the forecasted sales.

5. Determine the additional funds needed (AFN). An additional fund

needed is a balancing item that represents the difference between

total assets and total liabilities and equity in the pro forma balance

sheet.

Using the above procedures, pro forma income statement and balance sheet

in Table 4.3 and 4.4 can be developed, respectively. It shows that the

company needs RM11.592 millions of external funds to support the expected

sales growth of 50 percent. The funds needed can be raised from external

sources such as bank loans, issuing bonds, or new preferred or common

shares.


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Table 4-5 Sabilla Products: Pro forma Income Statement 19X2 (millions of RM)

Net Sales 151.500 101 00 (1.50)

Less: Cost of goods sold 106.050 151.50 (0.70)

Gross profit 45.450

Less: Other expenses 21.210 151.50 (0.14)

Operating profit 24.240

Taxes 9.696 24.24 (0.40)

Net profit 14.544

Dividends 3.636 14.544 (0.25)

Additions to retained earnings 10.908 14.544 (1 0.25)

Table 4-6 Sabilla Products: Pro forma Balance Sheet 19X2 (millions of RM)

Assets Liabilities and Equity

Cash 2.7(1.5) 4.050 Notes payable 1.600

Acc. Rec. 15.1(1.5) 22.650 Acc. Payable 5.4(1.5) 8.100

Inventory 21.2(1.5) 31.800 Accruals 8.4(1.5) 12.600

Net plant 19.8(1.5) 29.700 Long-term debt 10.200

Equity (33.2 + 10.908)a 44.108

AFNb 11.592 Total assets 88.200 Total liab. & equity 88.200

Note: a Expected net income with sales growth of 50%:

Net income = S1 (NPM)

= RM151.5 (0.096)

= RM14.544

New retained earnings = Net income (1 DPR)

= RM14.544 (1 0.25)

= RM10.908

b Additional Funds Needed (AFN) is considered as a balancing item;

that is to balance the total assets and total liabilities and equity.


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Note that the value of new retained earnings from 19X2 is added directly to

equity accounts since equity represents the summary of the firms preferred

stock, common stock, paid in capital and retained earnings' accounts. It is

necessary however to increase the retained earnings account only if equity

accounts are itemized.

The balance sheet method as shown in Table 4.7 is relatively slow, especially

if the pro forma balance sheet is not required. The simplified method shown in

Table 4-7 will result in the same answer, but less time consuming.

It will further illustrate the concepts of total funds' requirements to support the

sales increase, and differentiate between the internal generated funds and

external sources of funds. The calculations in Table 4.7, shows that the firm:

1. Needs RM29.40 millions of funds for investment in current and fixed

assets to support the sales increased.

2. Internally generated funds or funds from operations provide RM17.808

millions of the amount needed, and

3. The balance off RM11.592 millions must be met by raising external

funds.

Table 4.7 Sabilla Products: External Funds Requirements 19X2 (millions of RM)

Sales growth: 50%

Current sales: RM101 millions

Total spontaneous assets: RM58.80 millions

Total funds' requirement 58.80 (0.50) 29.400

Less internal funds:

Account payable 5.40 (0.50) 2.700

Accruals 8.40 (0.50) 4.200

Retained earnings (refer to Table 10.4) 10.908 17.808

Additional funds needed or external funds 11.592


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4.5.4 Additional Funds Needed Formula

Another method to solve for additional fund needed is to use a formula; that equals to

required increase in assets less increase in spontaneous liabilities less increase in

retained earnings, less depreciation plus miscellaneous financing requirements:

AFN = (SA0 / S0)S (SL0 / S0)S (S1)(NPM)(1 DPR) Dep1 + OF1

Where SA0 : Amount of spontaneous assets that vary with sales.

S0 : Current sales.

S1 : Projected sales (total) for the following period.

S : Change in sales; S1 minus S0 SL0 : Amount of spontaneous liabilities that vary with sales.

NPM : Net profit margin

DPR : Dividend payout ratio.

OF1 : Other financing requirements for investment purposes

Dep1 : Funds provided by the depreciation charges, if any.

Substituting the available financial information for Sabilla Products, and assuming

that there is no other additional other investment, additional fund needed:

AFN = (RM58.80 / RM101.00)(RM151.50 RM101.00)

((RM5.40 + RM8.40) / RM101.00)(RM151.50 RM101.00)

(0.096)(RM151.50)(1 0.25) 0 + 0

= RM11.592

As shown, both methods give similar results; that is external financing requirements

amounted to RM11.592 millions that must be arranged for 19X2 to support expected

sales increase. The above calculations' states that the depreciation is zero. This is

based on the basic rule of thumb, in which if all assets vary with sales, depreciation

shielded funds were not available as it will be used to replace a portion of the existing

assets. Else, if only current assets vary with sales, the depreciation charges must be

included to offset the total financing requirements.

The funds forecasting provide necessary information for the management to arrange

financing requirements before hand in expectation of the sales increase. This will

ensure the availability of funds on time and in sufficient amount to support the firm's

operations.


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QUESTION 1

You are given the following balance sheets for Syarikat Ikhlas for 2001 and 2002:

Balance Sheet As At December 31 (RM000)

2001 2002

Assets:

Cash

Marketable securities

Accounts receivable

Inventory

Fixed assets

200

300

800

1200

3300

250

400

600

1300

4000

Total Assets 5800 6550

Liabilities and Equity:

Accounts payable

Notes payable

Other current liabilities

Long-term debt

Common stock

Paid-in capital

Retained earnings

300

200

1000

1000

3000

150

150

400

300

900

1200

3200

300

250

Total Liabilities and Equity 5800 6550


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Income Statement for the Year Ending December 31, 2002 (RM000)

Sale

Less : Cost of goods sold

Gross Profit Less : Operating expenses

EBIT

Less : Interest

EBT

Less : Tax

Net Profit After Taxes Less : Dividend Payment

To Retained Earnings

1200

500

700

200

500

100

400

160

240

140

100

Using the above financial information:

a) Construct the cash flow statement for year 2002

(15 marks)

b) Explain the three (3) strategies used for efficient cash management. (5 marks)

QUESTION 2

a) Referring to the balance sheets and the income statement given in Question 1,

calculate the liquidity, activity and profitability ratios for Syarikat Ikhlas for year 2002.

(13 marks)

b) Analyze the companys financial performance according to these three types of

ratios.

(7 marks)


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QUESTION 3

a) FAP Company expects its projected revenues and payments for the first half

of year 2003 to be as follows:

Sales (RM) Purchases (RM)

January

February

March

April

May

June

10,000

20,000

30,000

25,000

35,000

40,000

8,000

18,000

25,000

20,000

30,000

25,000

Fifty percent of the companys sales are on credit. Based on past experiences

it shows 50 percent of credit sales are collected in the month after sales, and

the remainder is collected in the second month after it occurred.

The company pays 100 percent of purchases one month after purchases.

Besides this, the company pays RM15,000 per month for wages and salary.

On March 31, 2003, FAP Company has RM10,000 as the ending cash and

the company maintains RM5,000 as its minimum operating cash.

Prepare a cash budget for the second quarter of year 2003.

(18 marks)

b) Explain briefly the differences between spontaneous and discretionary items

in the preparation of a Pro-Forma balance sheet.

(2 marks)

Documents

FINANCE MANAGEMENT FIN 420 chp 4