BUS-F 300 1st EditionExam # 3 Study GuideCh 4: Financial ForecastingMost comprehensive means of financial forecasting is to develop a series of pro formafinancial statements With these statements, firm can estimate its future level of receivables, inventory, payables, and other corporate accounts as well as its anticipated profits and borrowing requirementsUse a six month time frame to facilitate analysis, but could be extended to a year or longer Development of pro forma statements: will provide projection of profit the firm anticipates making over a certain period of time1. Establish sales projection2. Determine a production schedule and the associated use of new material, direct labor, and overhead to arrive at gross profit + projected quantity of unit sales + Desired ending inventory- Beginning inventory = Production requirements Value of ending inventory: +Beginning inventory value + total production costs = Total inventory available for sales- Cost of goods sold = Ending inventory 3. Compute other expenses4. Determine profit by completing the actual pro forma statementCash Budget: Translate the pro forma income statement into cash flows of smaller and more precise time frames to anticipate seasonal and monthly patterns of cash inflow and outflow because generation of sales and profits does not necessarily mean there will be adequate cash on hand. Primary purpose is to allow firm to anticipate the need for outside funding at the end of each monthCash receipts: monthly cash collections (inflow)Cash payments: Monthly costs associated with inventory manufactured during the period (material, labor, and overhead) and disbursements for general and administrative expenses, interest payments, taxes, and dividends, and for any new plant and equipment - Equal monthly costs bc assume we are employing level monthly production to ensure maximum efficiency even though sales volume varies month to monthNet cash flow= difference between monthly receipts and payments Pro forma balance sheet: represents cumulative changes in the corp over time First examine prior periods balance sheet and translate those items to present timeExample:Percent of sales method: An alternative to tracing cash and accounting flows to determine financial needs is to assume that accounts on the balance sheet will maintain a given percentage relationship to sales. We then indicate a change in sales level and ascertain our related financing needs- end product for both methods is the determination of the amount of new funds needed to finance the activities of the firm- % to sales method is easier but less meaningful bc do not get a month to month breakdown of data- no percentages are computed for notes payable, common stock, and RE bc theyare not assumed to maintain a direct relationship with sales volume-Once we know how much money we need to finance growth, then decide whether to finance sales growth with notes payable, sale of common stock, or use of long term debt -If operating at full capacity, need to buy new equipment to increase sales, if operating at less than full capacity, only need new current assets Required new funds(RNF) = A/S(S) – L/S(S) – PS* (1-D)A/S= Relationship of variable assets to sales(%)S=Change in sales L/S=Relationship of variable liabilities to sales (%)P=profit margin (%)S* = New sales levelD=Dividend payout ratio Ch 8: Sources of Short-Term Financing -Spontaneous source of funds: an accounts payable growing as the business expands on a seasonal or long-term basis and contracting in a like fashion when business declines -Trade credit is usually extended for 30-60 days, but can “stretch payment period”-Major variable in determining payment period is possible existence of a cash discount-Cash discount: allows a reduction in price if payment is made within a specified time period ( 2/10 net 30 cash discount means you can discount 2% if repay within 10 days, orpay in full within the 30 days)-Cost of failing to take a cash discount: (Discount percent/(100% - Discount percent)) X ((360/(Final due date – Discount period))-Net trade credit: relationship bt accounts receivable and accounts payable, positive when accounts receivable are greater than accounts payable and vice versa -Self-liquidating loan: the use of funds will ensure a built-in or automatic repayment scheme (typical banker prefers these)-2/3 of bank loans are short term in nature-Prime rate: the rate a bank charges its most creditworthy customers and usually increases as a customer’s credit risk gets higher average customer expects to pay 1-2% points above prime, in tight money periods 5% or more is expected -London Interbank Offered Rate (LIBOR)US prime rates compete with the LIBOR for those companies with an international presence or sophisticated enough to use the London Eurodollar market for loans -Compensating balance: A bank may require that business customers either pay a fee forthe service or maintain a minimum average account balance (or both), lower the interestrate the higher the compensating balance -When compensating balances are required to obtain a loan, required amount is usually computed as a % of customer loans outstanding or % of bank commitments toward future loans to a given account (usually 20% for outstanding, 10% for future commitments) -Amount to be borrowed=Amount needed/(1 – c) c = compensating balance as decimal-If it were not for compensating balances, quoted interest rates would be higher or gratuitous services now offered by banks would carry a price tag -Term loan: Credit is extended for 1-7 years, usually repaid in monthly or quarterly installments over its life rather than in one single payment (more use in last decade)only superior credit applicants can qualify (measured by working capital strength, potential profitability, competitive position)Banker and business firm are “climbing into bed together” (bc of length)usually not fixed interest rate, changes with market conditions can be tied to prime rate or LIBOR, usually priced at a premium over one of therate, risk is with borrower -Effective interest rate on loan is based on loan amount, dollar interest paid, length of loan, and method of repayment-Effective rate = (Interest/Principal) X (Days in the year(360)/Days loan is outstanding)-Time is extremely important, so is the way