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Unformatted text preview: ncial planning process? 110 PART 1 Introduction to Managerial Finance LG4 3.3 Cash Planning: Cash Budgets cash budget (cash forecast) A statement of the firm’s planned inflows and outflows of cash that is used to estimate its short-term cash requirements. The cash budget, or cash forecast, is a statement of the firm’s planned inflows and outflows of cash. It is used by the firm to estimate its short-term cash requirements, with particular attention to planning for surplus cash and for cash shortages. Typically, the cash budget is designed to cover a 1-year period, divided into smaller time intervals. The number and type of intervals depend on the nature of the business. The more seasonal and uncertain a firm’s cash flows, the greater the number of intervals. Because many firms are confronted with a seasonal cash flow pattern, the cash budget is quite often presented on a monthly basis. Firms with stable patterns of cash flow may use quarterly or annual time intervals. The Sales Forecast sales forecast The prediction of the firm’s sales over a given period, based on external and/or internal data; used as the key input to the short-term financial planning process. external forecast A sales forecast based on the relationships observed between the firm’s sales and certain key external economic indicators. internal forecast A sales forecast based on a buildup, or consensus, of sales forecasts through the firm’s own sales channels. Hint The firm needs to spend a great deal of time and effort to make the sales forecast as precise as possible. An “after-the-fact” analysis of the prior year’s forecast can help the firm determine which approach or combination of approaches will give it the most accurate forecasts. The key input to the short-term financial planning process is the firm’s sales forecast. This prediction of the firm’s sales over a given period is ordinarily prepared by the marketing department. On the basis of the sales forecast, the financial manager estimates the monthly cash flows that will result from projected sales receipts and from outlays related to production, inventory, and sales. The manager also determines the level of fixed assets required and the amount of financing, if any, needed to support the forecast level of sales and production. In practice, obtaining good data is the most difficult aspect of forecasting.4 The sales forecast may be based on an analysis of external data, internal data, or a combination of the two. An external forecast is based on the relationships observed between the firm’s sales and certain key external economic indicators such as the gross domestic product (GDP), new housing starts, consumer confidence, and disposable personal income. Forecasts containing these indicators are readily available. Because the firm’s sales are often closely related to some aspect of overall national economic activity, a forecast of economic activity should provide insight into future sales. Internal forecasts are based on a buildup, or consensus, of sales forecasts through the firm’s own sales channels. Typically, the firm’s salespeople in the field are asked to estimate how many units of each type of product they expect to sell in the coming year. These forecasts are collected and totaled by the sales manager, who may adjust the figures using knowledge of specific markets or of the salesperson’s forecasting ability. Finally, adjustments may be made for additional internal factors, such as production capabilities. Firms generally use a combination of external and internal forecast data to make the final sales forecast. The internal data provide insight into sales expectations, and the external data provide a means of adjusting these expectations to take into account general economic factors. The nature of the firm’s product also often affects the mix and types of forecasting methods used. 4. Calculation of the various forecasting techniques, such as regression, moving averages, and exponential smoothing, is not included in this text. For a description of the technical side of forecasting, refer to a basic statistics, econometrics, or management science text. CHAPTER 3 TABLE 3.7 111 Cash Flow and Financial Planning The General Format of the Cash Budget Jan. Cash receipts Less: Cash disbursements Net cash flow Add: Beginning cash Ending cash Less: Minimum cash balance Feb. $XXX $XXG XXA XXH $XXB $XXI XXC XXD $XXD XXE XXK $XXL $XXF Nov. Dec. $XXM ... $XXT XXJ XXN XXU $XXO $XXJ Required total financing Excess cash balance ... $XXV ... XXP XXQ $XXQ $XXW XXR XXY $XXS $XXZ Preparing the Cash Budget The general format of the cash budget is presented in Table 3.7. We will discuss each of its components individually. Cash Receipts cash receipts All of a firm’s inflows of cash in a given financial period. EXAMPLE Cash receipts include all of a firm’s inflows of cash in a given financial period. The most common components of cash receipts are cash sales, collection...
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