Unformatted text preview: rge? How do accountants estimate cash flow from operations?
Describe the general format of the statement of cash flows. How are cash
inflows differentiated from cash outflows on this statement?
From a strict financial perspective, define and differentiate between a
firm’s operating cash flow (OCF) and its free cash flow (FCF). 3.2 The Financial Planning Process financial planning process
Planning that begins with longterm, or strategic, financial plans
that in turn guide the formulation
of short-term, or operating, plans
and budgets. Financial 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. Two key aspects of the financial planning process are cash
planning and profit planning. Cash planning involves preparation of the firm’s
cash budget. Profit planning involves preparation of pro forma statements. Both
the cash budget and the pro forma statements are useful for internal financial
planning; they also are routinely required by existing and prospective lenders.
The financial planning process begins with long-term, or strategic, financial
plans. These in turn guide the formulation of short-term, or operating, plans and
budgets. Generally, the short-term plans and budgets implement the firm’s longterm strategic objectives. Although the remainder of this chapter places primary
emphasis on short-term financial plans and budgets, a few preliminary comments
on long-term financial plans are in order. Long-Term (Strategic) Financial Plans
Lay out a company’s planned
financial actions and the anticipated impact of those actions
over periods ranging from 2 to 10
years. Long-term (strategic) financial plans lay out a company’s planned financial
actions and the anticipated impact of those actions over periods ranging from 2
to 10 years. Five-year strategic plans, which are revised as significant new information becomes available, are common. Generally, firms that are subject to high
degrees of operating uncertainty, relatively short production cycles, or both, tend
to use shorter planning horizons.
Long-term financial plans are part of an integrated strategy that, along with
production and marketing plans, guides the firm toward 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. Such plans tend to be supported by a
series of annual budgets and profit plans. Short-Term (Operating) Financial Plans
Specify short-term financial
actions and the anticipated
impact of those actions. Short-term (operating) financial plans specify short-term financial actions and the
anticipated impact of those actions. These plans most often cover a 1- to 2-year
period. Key inputs include the sales forecast and various forms of operating and
financial data. Key outputs include a number of operating budgets, the cash bud- CHAPTER 3 FIGURE 3.2 Cash Flow and Financial Planning 109 Short-Term Financial Planning
The short-term (operating) financial planning process
Information Needed Sales
Forecast Output for Analysis Production
Plan Pro Forma
Budget Fixed Asset
Balance Sheet Hint Electronic
spreadsheets such as Excel and
Lotus 1–2–3 are widely used to
streamline the process of
preparing and evaluating these
short-term financial planning
statements. get, and pro forma financial statements. The entire short-term financial planning
process is outlined in Figure 3.2.
Short-term financial planning begins with the sales forecast. From it, production plans are developed that take into account lead (preparation) times and
include estimates of the required raw materials. Using the production plans, the
firm can estimate direct labor requirements, factory overhead outlays, and operating expenses. Once these estimates have been made, the firm’s pro forma
income statement and cash budget can be prepared. With the basic inputs (pro
forma income statement, cash budget, fixed asset outlay plan, long-term financing plan, and current-period balance sheet), the pro forma balance sheet can
finally be developed.
Throughout the remainder of this chapter, we will concentrate on the key
outputs of the short-term financial planning process: the cash budget, the pro
forma income statement, and the pro forma balance sheet. Review Questions
3–8 What is the financial planning process? Contrast long-term (strategic)
financial plans and short-term (operating) financial plans.
Which three statements result as part of the short-term (operating) fina...
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