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Cash Flow Planning

Cash Flow Planning. A billion here, a billion there - pretty soon it adds up to real money. Senator Everett Dirksen Whoever said money can’t buy happiness didn’t know where to shop. Unknown. Financial Obstacles. Sources of Uneven Cash Flow. Seasonality of Business Length of Operating Cycle

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Cash Flow Planning

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  1. Cash Flow Planning A billion here, a billion there - pretty soon it adds up to real money. Senator Everett Dirksen Whoever said money can’t buy happiness didn’t know where to shop. Unknown

  2. Financial Obstacles

  3. Sources of Uneven Cash Flow • Seasonality of Business • Length of Operating Cycle • Lump-sum payments

  4. Seasonality • Many businesses have seasonal sales • Fantastic Catalogue • Clear River Resort • Cheaper to buy after peak • But have to absorb negative cash flow

  5. Working-Capital Time Line Cash collection of receivables Sale Order placed Inventory received Days in inventory Days in accounts receivable a b c d e Cash conversion period Days in accounts payable Cash payment for inventory Source: Terry S. Maness and John T. Zietlow, Short-Term Financial Management (New York: Dryden Press/Harcourt Brace, 1998), p. 4. • Small Business Management, 11th edition • Longenecker, Moore, and Petty • 2000 • South-Western College Publishing

  6. Differences in Cash Flow Cycles Type of Business Comment Manufacturer Lengthy inv. cycle Wholesaler Inventory & A/R Retailer Inventory; no A/R Prof. Service No inv.; A/R Same day serv. No significant amounts

  7. Reducing Inventory • Inventory is serious drain on cash flow • Not as readily financed as receivables • Detailed inventory tracking system • Reduce number of items carried • Speed up shipping process • Just-in-time with suppliers

  8. Days to Collect A/R • Formalize credit-granting process • Send bills out immediately • Use bank lockbox for payments • Send regular statements • Follow-up notices of increasing pressure • Use collection agencies • Factor or borrow against receivables

  9. Payment of A/P • Pay at latest date possible • Take advantage of discounts • Stay in contact with suppliers if late with payment • Pay government before suppliers • Government penalties are expensive, and they can close business

  10. Developing Income Projections • Purposes • Borrowing needs • Tax planning • Purchasing requirements • Forecasting sales • Key to income projection • Usually based on prior year, adjusted for trends

  11. Sales Projection Example: E(99 4th Qtr) = 98 4th qtr. + (99 3rd qtr - 98 3rd qtr)

  12. Sales Projection Example Sales (000) Q1 Q2 Q3 Q4 1999 200 250 200 400 1998 230 275 240 ?

  13. Forecasting Expenses • Variable costs • Costs that vary in relation to sales (sales commissions, utilities, etc.) • Fixed costs • Costs that don’t vary in relation to sales (rent, property taxes, some insurance, mgmt salaries) • Only fixed for some range

  14. Other Projection Issues • Initial losses • Fairly common to lose money in first 1-2 years • Personal compensation • Often forgotten, key part of purchase evaluation • Noncash items • Expenses that do not affect cash flow

  15. Exercise Prepare income projection for first month for Golf Shop

  16. What is Golf Shop Breakeven point? Contribution margin = 50% Fixed costs = $3000 3000/50% = $6,000

  17. Exercise Prepare cash flow projection for first month for Golf Shop

  18. Clear River Resort • Sales • 3/31 100,000 9/30 240,000 • 6/30 150,000 12/31 100,000 • Variable costs • Salaries 40% • COS 25% • Fixed • Operating 30,000 • Depreciation 6,000 • Interest 13,500

  19. Breakeven for Clear River • Sales 100% • Variable cost • Salaries 40% • COS 25% Contribution margin 35% • Fixed costs • Other costs 30,000 • Dep & Int 19,500 Total fixed 49,500 Breakeven = 49,500/35% = 141,429

  20. Using Breakeven to Prove Income Q1 Total Actual sales 100,000 590,000 Breakeven sales 141,429565,716 Excess(shortfall) (41,429) 24,284 Cont. margin 35% 35% Profit (loss) (14,500) 8,500

  21. Developing Cash Flow Projection • Examples in many texts schedule out all inflows and outflows • Generally easier to start with net income, adjust for changes affecting cash flows • This is how a cash flow statement is reported on external financial statements

  22. Cash Flow Adjustments • Timing Differences between income statement and related cash flows • Inventory • Accounts receivable • Non-cash expenses • Capital items • Debt repayments/borrowings • Fixed asset purchases

  23. Resort a Good Investment? Earnings Cash Flow Income 8,500 26,500 Multiple 5 5 42,500 132,500 Is there any salary for them in expenses? What did they invest?

  24. Resort Good Investment? • Earnings is probably right figure to capitalize • Cash flow higher due to depreciation • They will incur repair/replacement costs • They probably aren’t viewing as an income investment

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