SIMAD UNIVERSITY

Learning objective

1. Introduction financial planning

2. Steps in the Financial Planning Process
3. Cash conversion cycle
4. Cash Budgeting
5. Why Build Financial Plans

Lecturer : Yusuf H. Mohamed Hand out Sub: Corporate finance

 SIMAD UNIVERSITY

Normally, people always think it is not really possible to fulfill all their goals or
dreams without having a High Salary or belonging to a rich family. But it is not the
truth. With the help of Financial Planning you can achieve all your life goals or
dreams.

Financial planning is the process of achieving your life goals by using different
investment options with your current resources through proper and disciplined
money management. So Financial Planning is not only about money, but it is all
about life, about fulfilling your wishes, dreams, aspirations and your enjoyment in
achieving them.

Three major components in the Financial Planning process:

1. Current Resources (CR)

2. Investment Options (IO)
3. Financial Goals (FG)

Steps in the Financial Planning Process:

1. . Define financial goals.

2. Develop financial plans and strategies to achieve goals.
3. Implement financial plans and strategies.
4. Develop budgets to monitor and control progress toward goals.
5. Evaluate results by using financial statements.
6. Revise goals as situations change

Lecturer : Yusuf H. Mohamed Hand out Sub: Corporate finance

 SIMAD UNIVERSITY

Simple Cycle of Operations

The cash cycle starts with cash. Firms use cash to buy raw materials. Raw materials are
converted to finished goods and then sold on credit thus creating receivables. Receivables, when
collected, convert back to cash. This is called the cash cycle

Lecturer : Yusuf H. Mohamed Hand out Sub: Corporate finance

 SIMAD UNIVERSITY

Test

Income Statement Balance Sheet

3rdQtr '04 End 4th qtr '03 End of 4th qtr '04
Sales 4,951 Inventory 453 490
COGS 4,451 A/R 500 552
A/P 335 382

average accounts payable

average accounts receivable Payable period =
Receivable s period = annual COGS/365
annual sales/365

(552 500)/2 (382 335)/2

= =
4,951/365 4,451 / 365

= 38.8 days = 29.4 days

average inventory
Inventory period =
annual COGS/365

(490 453)/2
=
4,451/365

38.7 days

Cash cycle= 38.8+38.7-29.4 = 48.1

Cash Budgeting

The past is interesting for what one can learn from it. The financial managers problem is to

forecast future sources and uses of cash. These forecasts serve two purposes. First, they

provide a standard, or budget, against which subsequent performance can be judged.

Second, they alert the manager to future cash-flow needs. Cash, as we all know, has a habit

of disappearing fast.

Lecturer : Yusuf H. Mohamed Hand out Sub: Corporate finance

 SIMAD UNIVERSITY

Assets 2005 2006 Liabilitie s & Equity 2005 2006

Current Assets 4 5 Current Liabilitie s
Cash 4 5 Bank Loans 5 0
Mark Securities 0 5 Accts Payable 20 27
Inventory 26 25 Total Curr Liab 25 27
Accts Recv 25 30 Long Term Debt 5 12
Total Curr Assets 55 65 Net Worth 65 76
Fixed Assets
Gross investment 56 70
less Depr 16 20
Net Fixed Assets 40 50 Total Liab and
Total Assets 95 115 owner' s equity 95 115

Lecturer : Yusuf H. Mohamed Hand out Sub: Corporate finance

 SIMAD UNIVERSITY

Sources
Issued long term debt 7
Reduced inventorie s 1
Increased accounts payable 7
Cash from operations
Net income 12
Depreciati on 4
Total Sources $31 Income Statement
Uses Sales $350
Repaid short term bank loan 5 Operating Costs 321
Invested in fixed assets 14 Depreciati on 4
Purchased marketable securities 5 EBIT 25
Increased accounts receivable 5 Interest 1
Dividend 1 Pretax income 24
Total Uses $30 .Tax at 50% 12
Increase in cash balance $ 1 Net Income $12

Dynamic used cash as follows

Paid $1 mil dividend.

Repaid $5 mil short term bank loan

Invested $14 mil

Purchased $5 mil of marketable securities

Accounts receivable expanded by $5 mil

Steps to preparing a cash budget

Step 1 - Forecast the sources of cash.

Step 2 - Forecast uses of cash.

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Lecturer : Yusuf H. Mohamed Hand out Sub: Corporate finance

 SIMAD UNIVERSITY

Step 3 - Calculate whether the firm is facing a cash shortage or surplus.

example

Quarter 1st 2nd 3rd 4th

Sales, $mil 87.50 78.50 116.00 131.00

AR ending balance = AR beginning balance + sales - collections

Dynamic collections on AR

Qtr
1st 2nd 3rd 4th
1. Beginning receivable s 30.0 32.5 30.7 38.2
2. Sales 87.5 78.5 116.0 131.0
3. Collection s
. Sales in current Qtr (80%) 70 62.8 92.8 104.8
. Sales in previous Qtr (20%) 15.0 17.5 15.7 23.2
Total collection s 85.0 80.3 108.5 128.0
4. Receivable s at end of period
.(4 = 1 + 2 - 3) $32.5 $30.7 $38.2 $41.2

Qtr
1st 2nd 3rd 4th
Sources of cash
Dynamic forecasted uses of cash
collection s on AR 85.0 80.3 108.5 128.0
Payment of accounts payable
other 1.5 0.0 12.5 0.0
Labor,
Total administration, and other expenses
Sources 86.5 80.3 121.0 128.0
Capital
Uses expenditures
of cash
Taxes, interest,
payment of AP and dividend payments
65.0 60.0 55.0 50.0
labor and admin expenses 30.0 30.0 30.0 30.0
capital expenditur es 32.5 1.3 5.5 8.0
taxes, interest, & dividends 4.0 4.0 4.5 5.0
7
Total uses of cash 131.5 95.3 95.0 93.0
Lecturer : Yusuf H. Mohamed Hand out Sub: Corporate finance
Net cash inflow $45.0 $15.0 $26.0 $35.0
(sources minus uses)
 SIMAD UNIVERSITY

Why Build Financial Plans?

1. Contingency Planning is not just forecasting. Forecasting concentrates on

the most likely outcomes, but planners worry about unlikely events as well as
likely ones.
2. Considering Options Planners need to think whether there are
opportunities for the company to exploit its existing strengths by moving into
a wholly new area.
3. Forcing Consistency Financial plans draw out the connections between the
firms plans for growth and the financing requirements.

Problem one

Item Beginning Ending Average

Inventory $200,000 $300,000 $250,000

Accounts Receivable 160,000 200,000 180,000

Accounts Payable 75,000 100,000 87,500

Lecturer : Yusuf H. Mohamed Hand out Sub: Corporate finance

 SIMAD UNIVERSITY

Net sales (all credit sales) = $1,150,000

Cost of goods sold = COGS = $820,000

Calculating Cash Conversion Cycles

Problem two

On the average 50% of credit sales are paid for in the current month, 30% are paid in the next
month, and the remainder is paid in the month after that. What is the expected cash inflow from
operations in months 3 and 4?
Problem Three
Calculate the cash conversion cycle for the Start Computer Company. Annual sales are
$10 million, and the annual cost of goods sold is $8 million. The average levels of
inventory, receivables, and accounts payable are $2,000,000, $657,534, and $657,534

Real Time Computer Company

$10,000,00
Sales 0 annual
COGS $8,000,000 annual
Inventorie
s $2,000,000 average
AR $657,534 average
AP $657,534 average
Days/year 365

Problem Four
Hormuud, Inc., has net sales of $423,000 with 30 percent of it being credit sales. Its
cost of goods sold is $324,000. The firms cash conversion cycle is 47.9 days. The
firms operating cycle is 86.3 days. What is the firms accounts payable

Problem five
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Lecturer : Yusuf H. Mohamed Hand out Sub: Corporate finance

 SIMAD UNIVERSITY

BECO Electricals estimates that it takes the company 31 days on average to pay off
its suppliers. It also knows that it has days sales in inventory of 54 days and days
sales outstanding of 34 days. What is its cash conversion cycle?

Problem SIX

All sales were on credit. Anjo plc has no long-term debt. Credit purchases in each
year were 95% of cost of sales. Anjo plc pays interest on its overdraft at an annual
rate of 8%. Current sector averages are as follows:

Inventory days: 90 days

Receivable days: 60 days

Payables days: 80 days

Required:

(a) Calculate the following ratios for each year and comment on your findings.

(i) Inventory days

(ii) Receivables days

(iii) Payables days

10

Lecturer : Yusuf H. Mohamed Hand out Sub: Corporate finance