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Unformatted text preview: Forecasting the Balance Forecasting the Balance Sheet
Chapter 9 Breaking down the balance sheet
Breaking down the balance sheet Working Capital PP&E and Intangibles Other LongTerm Assets & Liabilities Common Equity Cash and Debt Working Capital
All about waiting Waiting for what?
Waiting for what? Accounts receivable waiting for customers to pay you Accounts payable waiting to pay your vendors Accrued expenses waiting to pay your employees Inventory waiting to sell goods Working Capital
Working Capital Noncash current assets minus Non interestbearing current liabilities Tied up in working capital
Tied up in working capital For each working capital item, it's only a matter of weeks or months before the asset or liability turns to cash. In the meantime it is "tied up in working capital". Think of these working capital items as temporary holding bins for cash that will soon come into the firm or leave the firm. Forecasting working capital
Forecasting working capital Working capital grows with a business' sales and costs. As a company grows, more customers will owe it money, it will need more products in the warehouse to support order volume and it will owe more money at any point in time to vendors and employees. As a result, working capital items are commonly forecasted as a percentage of sales or costs. Forecasting Working Capital
Forecasting Working Capital Working Capital items are impacted by sales and COGS and NOT directly impacted by the Capital Structure As a result, we can forecast Working Capital before forecasting the Company's Cash and Debt levels. Forecasting Accounts Forecasting Accounts Receivable Accounts Receivable represent Sales that have not yet been collected So it makes sense to express A/R as a percentage of Sales. For now… use a constant percentage of sales Days Sales Outstanding
Days Sales Outstanding Also called Days Receivable
How many days of Sales are tied up in Accounts Receivable Days Receivable = Accounts Receivable Sales/365 How long it takes to receive a dollar of Revenue in cash from customers from the date product is shipped Forecasting Inventory
Forecasting Inventory Inventory is expensed to COGS when sold. So Inventory should be expressed as a % of Total COGS and NOT as a % of sales. For now, use a constant percentage of COGS Inventory Turnover (Turns)
Inventory Turnover (Turns) Inventory Turns measure the number of times the company cycles through its Inventory, on average, through the year. Divide Cost of Goods Sold by Inventory to determine how many times per year the company cycles through all of its Inventory Inventory Turns = Total COGS Inventory Forecasting Accounts Payable
Forecasting Accounts Payable Accounts Payable has to do with the expense side of the Income Statement Forecast AP as a % of Total COGS Forecasting Prepaid and Accrued Forecasting Prepaid and Accrued Expenses Both of these should be as a % of COGS Net Working Capital Net Working Capital Working Capital Assets minus Working Capital Liabilities Net Working Capital provides a summary measure of the amount of Cash "tied up" in Working Capital. What if net working capital is $10M
What if net working capital is $10M People owe this company $10.0 million more than the company owes others Once all isresolved, the firm will have an additional $10.0 million in cash Until this happens, that $10.0 million is not available to put in the bank or pay down Debt. It is "tied up" as a Net Working Capital investment Changes in net working capital
Changes in net working capital Last years net working capital minus this years net working capital This is how much additional outside capital you need to inject into the firm in order to sustain your assumed level of sales If net working capital increases…
If net working capital increases… Cash was used up in the business. The firm must invest additional cash to fund the need So you should expect to see a negative cash impact as the business grows What about PP&E
What about PP&E Net PP&E increases each period by the amount of Capex and decreases by the amount of Depreciation. This is why we do the operating buildup first Start with Gross PP&E
Start with Gross PP&E The company's cumulative investment in Property, Plant and Equipment increases each year by the new investment made: (Gross)PP & E t = PP & E t −1 + CAPEX t Accumulated Depreciation
Accumulated Depreciation The cumulative Depreciation related to the Property, Plant and Equipment owned (an allowance for the consumption of PP&E Accum. Depreciation = Accum. Depreciationt1 Depreciationt Remember to subtract Depreciation, since Accumulated Depreciation is a negative number. Net PP&E
Net PP&E Gross PP&E minus Accumulated Depreciation Intangibles
Intangibles Include Goodwill, patents, trademarks and Capitalized Financing Costs. Intangible Assets decrease over time as these assets are Amortized. This is a very similar concept to Depreciation. Goodwill is an Intangible asset that is created when a company is Purchased. Forecasting Intangibles
Forecasting Intangibles Intangiblest = Intangiblest1 Amortizationt Amortization
Amortization The process of writing off the cost of an asset. In the case of a bank loan, the bank will typically charge the lender a fee for taken out a loan. This fee is usually written off, or amortized, over the life of the loan. Capitalized Financing Costs
Capitalized Financing Costs Capitalized Financing Costs decrease each year by the amount of the related Amortization of Financing Costs: CapFinCostt= CapFinCostt1 Amortizationt Other Longterm assets
Other Longterm assets Look at the footnotes If you can identify and forecast the individual line item, do so A common assumption is to hold these accounts flat over time CAUTION: other longterm CAUTION: other longterm assets/liabilities Note: A common mistake is to drop the balances to zero in the next year. That is sometimes correct, but you need to be aware of its impact.
If you had a liability of $100 on your books at the end of the last historical year and showed the liability dropping to zero the following year, you'd be implying it was paid in cash.
The model would suck up cash as a result of your assumption unless you recognized the change as being noncash on your Cash Flow Statement. Equity
Can become quite complex Equity: some simplifying Equity: some simplifying assumptions Assume the company doesn't have any Preferred Equity, which allows us to focus on Common Equity. Also assume that no Equity is issued or bought back by the firm. Equity is now easy to forecast
Equity is now easy to forecast Common Equity increases each period by the amount of Net Income calculated on the Income Statement:
Equityt=Equityt1 + Net Incomet Assuming that all net income is retained Cash and Debt
Cash and Debt These are two related accounts that we won't be ready for until we finish the Cash Flow Statement. The Cash Flow Statement is needed to tell us how much Cash the business generated to repay Debt or put in the bank ...
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