Unit 5 Budgeting Flashcards
3 uses for budgeting
Future Financing Needs - understanding cash flows helps estimate/negotiate financing needs
Corrective Action - knowing changes ahead of time allow time to adjust, improves credibility with lenders
Performance Evaluation - assess targets being met
6 principles to effective budgeting
Know yourself
know key savings, income, expenses
develop savings, income, expense strategies
keep records
use an appropriate method
eliminate consumer debt, minimize long term debt
3 steps to making a cash budget
Determine cash receipts (know income)
Estimate cash disbursements (know expenses)
Create the cash budget
5 steps to make personal budget
Understand goals track savings, income, expenses develop cash budget (set aside money for savings) implement plan compare cash budget to spending
fixed expenditures vs variable expenditures
fixed expense - constant expense don’t have control over
variable expense - expense you have control over and varies from month to month
50/30/20
needs/wants/savings
Items in a cash budget
Cash Receipts (income) Cash Disbursements (expenses) Borrowing (debt)
Why are sales not strictly considered to be the same thing as cash receipts?
Sales include both cash sales and credit sales.
Methods for tracking cash flows
Keeping records of cash flows
Envelope Method
Spreadsheet Method
Computer program
Steps to Monitoring cash flows
Making sure expenses are within budget
identify patterns and changes in cash flows
understand circumstances that need correction
Describe budget revision process.
Make changes to budget to reach goals.
Identify trouble areas.
Implement gradually.
What is Profit forecasting
projected earnings after subtracting costs
balance sheet forecasting
combine profit forecast and sales growth to make ‘pro forma’ balance sheet to understand future implications of financing strategies
2 things growth requires
increase in capital (inventory) and in fixed assets
DFN
discretionary financing needed
aka E(xternal)FN, A(dditonal)FN
How much financing will be needed given expectations in growth.
Budgeting vs Forecasting
Budget - detailed, Forecast broad
Budget - compare to actual, Forecast - no variance analysis
Budget - take action to adjust budget, Forecast - take action within company - credit standards, inventory holdings, etc.
Budget vs Forecast (2)
Budget - outline of direction mgmt wants to go
Forecast - is firm reaching budget goals, show where company is headed
spontaneous accounts
those that vary naturally with sales Cash Accounts Receivable Inventory Accounts Payable Accrued Expenses
discretionary accounts
opposite of spontaneous accounts
bank loans, bonds
Percent of Sales Method
uses sales forecast and historical relationships between sales and other variables to create pro forma statements
pro forma statement
statement that projects an estimate for future periods as if sales grow as predicted
steps in percent of sales method
Project sales revenues and expenses
Forecast change in spontaneous balance sheet accounts
Deal with discretionary accounts
Estimate fixed asset account
Calculate retained earnings (RE)
Determine total financing need (projected total assets)
Calculate DFN
How are spontaneous accounts affected by sales forecasts.
Sales increase leads to proportional change in current assets and current liabilities.
What types of accounts are discretionary? How are they fed into Pct in Sales forecast?
Notes payable
long term financing accounts/debt
common stock
Keep them constant in estimate.
Which 2 accounts are not spontaneous or Discretionary. How are they factored into Pct in Sales forecast?
Fixed Assets: Change in response to sales depends on how much change is needed. Can only buy 100% of a new factory or piece of machinery.
Retained Earnings
Why are retained earnings not spontaneous or discretionary?
Depreciation expense:
Interest Expense
Dividends
Projected RE formula
Old RE + (Projected Sales x Net Margin x Plowback ratio)
Net margin describes percent of sales left as net income
Payout ratio
percent of net income given to shareholders
Plowback ratio
aka retention ratio
1 - payout ratio
percent of net income retained in firm
Balance sheet equation
Assets = Liabilities + Owner Equity
Projected Assets must equal projected financing (Liabilities + Equity)
Formula for DFN.
Projected Total Assets - Projected Total Liabilities - Projected Owner Equity
How to evaluate/use DFN
Negative DFN means no additional financing needed to fund projected sales. Positive DFN means more financing is needed.
Plug
Account used to balance pro forma balance sheet
Discretionary ( up to mgmt what to use to balance pf sheet)
How to forecast change in common assets and liabilities
Derive % of this year’s amount relative to sales
multiply % by projected sales to get projected amount of discretionary items for next year
Retention Ratio
Plowback ratio
SGR
Sustainable Growth Rate
allows firm to keep present financial ratios without issuing new equity
Steady state growth
growth where Profitability Asset Utilization Leverage Payout are constant firm doesn't need to issue new equity to fund growth
SGR formula
ROE x (1-b)
b is dividend payout ratio
1-b is plowback/retention ratio
Why is keeping a high SGR a challenge?
As sales increase, market is saturated, meaning firm needs to offer new products or focus on products with lower profit margins.
Ways to reduce DFN
Slow Sales Growth - increase prices
Examine Capacity Constraints - increase TAT (asset use efficiency)
Lower Dividend payout - increases retention ratio
Increase Net Margin - increases retention ratio
Limitations on SGR
may need to keep prices low, lowering growth
may need to invest in new product development
poor forecasting and budgeting and planning
sales capacity formula
actual sales/% capacity currently in use
How to use sales capacity to determine if additional investment assets is needed.
if current sales x projected growth rate is less than capacity, additional investment in assets is not needed
