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Content Standards
The financial planning process, including budget preparation, cash management, and working capital
management

Performance Standards

The learners will be able to:

1. illustrate the financial planning process
2. prepare budgets such as projected collection, sales budget, production budget, income projected
statement of comprehensive income, projected of financial position, and projected cash flow
statement
3. describe concepts and tools in working capital management

The learners shall be able to:

identify the steps in the financial planning process
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illustrate the formula and format for the preparation of budgets and projected financial statement
explain tools in managing cash, receivables, and inventory
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explain tools in managing cash, receivables, and inventory

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Specific Learning Outcomes

At the end of this lesson, the learners will be able to:
• To know and apply the tools used in planning and forecasting

Week 3
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CHAPTER 3

Planning and Working Capital Management

Planning

What is done in PLANNING and CONTROL?

 Management planning is about setting the goals of the organization and identifying ways to
achieve them.

 This may be broken down into long-term plans and short-term plans.

 In the process of planning, resources have to be identified including manpower resources,

production capacity, and financial resources.

 Once the plan is set, it has to be quantified (in the form of budgets and projected financial
statements) or else it will be useless because there will be no basis for monitoring
performance and hence, no way of gauging success.

 Budgets and projected financial statements are then compared with the actual performance,
which is where the “controlling” function comes into play.

 If the actual performance falls short of the budgets or of the projections, it doesn’t mean that
the management is not doing its function. Reasons have to be identified for the shortfall so
that corrective measures can be made. Also, the analysis will show whether the reasons for
not meeting the projections are due to management incompetence or factors outside of its
control.

 To be effective, controlling must include a reward system for those who deliver and a penalty
for those who do not deliver whose reasons for failing to meet objectives are within their
control.

What Are the Steps in Financial Planning?

1. Set goals or objectives.

The goals of a company can be divided into:

 short-term goals ‒ can be for a year;

 medium-term goals ‒ can be between one and three years; and

 long-term goals ‒ can be five to 10 years or even longer.

2. Identify resources.

Resources include:

 production capacity;

 human; and

 financial.

3. Identify goal-related tasks.

In this step, management must figure out how to achieve an objective.

4. Establish responsibility centers for accountability and timeline.

If tasks are already identified to achieve goals, the next important step to do is to:
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 Identify which department should be held accountable for this task; and

 Set a timeline for the activities, especially for those activities which are not
normally done on a daily basis.

5. Establish an evaluation system for monitoring and controlling.

The management must establish a mechanism which will allow plans to be monitored, which can be
done through quantified plans such as budgets and projected financial statements.

6. Determine contingency plans.

In planning, contingencies must be considered as well. Budgets and projected financial statements
are anchored on assumptions. If these assumptions do not become realities, management must have
alternative plans to minimize the adverse effects on the company.

Working Capital Management

What is WORKING CAPITAL?

 Working capital refers to the current assets used in the operations of the business
including cash, accounts receivable, inventories, and prepaid expenses.

 The amount of resources that a company sets aside to these working capital accounts
can be reduced by current liabilities. The difference between these current assets and
current liabilities used in the operations of the business is net working capital.

Why is management of working capital accounts important?

 The management of working capital accounts is important because they deal with the
day-to-day operations of the business. If the company fails in the management of these
accounts, there will be no expansion to talk about or this can lead to the closure of the
company.

 Good management of working capital accounts allows the company to pay maturing
obligations on time. This helps in developing good business relationships with
suppliers and other vendors such as utility companies.

Why is management of working capital accounts important?

 Good management of working capital accounts also relieves managers of unnecessary

stress and gives them more executive time to improve the business operations.

 Efficient management of working capital accounts can improve company’s earnings

through savings in financing costs and minimizing possible impairment losses from
inventories.

What are the THREE TYPES OF WORKING CAPITAL FINANCING POLICIES?

1. Maturity-matching working capital financing policy

2. Aggressive working capital financing policy

3. Conservative working capital financing policy

Maturity-Matching Working Capital Financing Policy

Based on the MATURITY-MATCHING WORKING CAPITAL FINANCING POLICY…

 Permanent working capital requirements should be financed by:

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Long-term sources including long-term debt and equity such as common stocks and preferred
stocks.

 Temporary working capital requirements should be financed by:

Short-term sources of financing including short-term bank loans, which are called working
capital loans.

Aggressive Working Capital Financing Policy

Under the AGGRESSIVE WORKING CAPITAL FINANCING POLICY…

 Some of the permanent working capital requirements are financed by short-term

sources of financing.

 Managers of some companies adopt this policy because long-term sources of funds
have higher cost as compared to short-term sources of financing. By financing some
of the permanent working capital requirements with short-term sources of financing,
financing cost is minimized which in turn, improves net income.

 However, adopting this policy increases default risk.

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Conservative Working Capital Financing Policy

Based on the CONSERVATIVE WORKING CAPITAL FINANCING POLICY…

 Some of the temporary working capital requirements are financed by long-term

sources of financing.

 Possible reasons why some companies adopt this policy are: (1) management does
not probably want to be stressed too much so that they can concentrate their efforts
on other important concerns that will also benefit the company; and (2) management
would also like to preserve their financial flexibility.
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Management of Working Capital Accounts

Here are the suggested internal controls over CASH.

1. Separating the cashiering function from the recording or accounting function

A basic internal control system should not allow the assignment of custodial function and
recording function to one person, unless you are the owner.

2. Issuing official receipts for collections and summarizing collections in a daily

collection report

It is important to know the collections from business every day as these collections reflect the
health of the company.

3. Depositing collections

A good internal control over cash is by depositing all collections intact. The daily collection
reports are now compared with the deposit slips to find out if all collections are indeed
deposited.

4. Adopting the check voucher system for payments

 If all collections need to be deposited, then payments must be made

through a check voucher system.

 For companies with big operations, there must also be two signatories
in the check to provide check and balance and to minimize the
probability of issuing a flawed check, either to the wrong payee or an
incorrect amount.
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 The check must also be cross-checked by drawing two lines on the
payee section of the check to render the check for deposit only and not
for encashment.

What are the PARTS of a CASH BUDGET?

1. Cash receipts

This section includes collections from receivables, proceeds from loans or issuance of new
shares of stocks, and advances from stockholders.

2. Cash disbursements

This section includes payments to suppliers and other service providers, payments for loans,
and cash dividends.

3. Net cash flow for the period

 This is computed by deducting cash disbursements from the

collections for the period.

 This also provides information regarding the amount of excess cash or

cash deficit for the period.

4. Target cash balance

The target cash balance is the amount of cash that management wants to maintain at all times
given its present level of operations, stability of cash flows, and the macroeconomic and
political conditions.

5. Cumulative excess cash or funding requirements

 This is the most important part of the cash budget where the possible
funding requirements are shown on a cumulative basis.

 This part of the cash budget is very important in planning because if the
management can estimate the amount of cash they will need in the
future and when it will possibly arise, this early, management can
identify the possible sources of cash.

What are the PRIMARY REASONS for HOLDING CASH?

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 The primary reasons for holding cash are for transaction and compensating balance
purposes.

 The secondary reasons for holding cash are for precautionary and speculative purposes.

How can a company MINIMIZE THE POTENTIAL LOSS from UNCOLLECTED ACCOUNTS
RECEIVABLE?

 Minimizing loss from exposure to accounts receivable starts with its origination. This means
the customer who is given credit terms must be credit worthy.

 In large companies, there is a credit committee composed of representatives from sales and
marketing and finance departments who decide which customers should be given credit
terms.

 Small companies also implement the same principle but on a much smaller scale and in a
less formalized manner because they do not have the same resources.

What are the 5 Cs in CREDIT EVALUATION?

1. Character

This refers to the integrity and reputation of the customer.

2. Capacity

This refers to the capacity to pay.

3. Capital

This refers to the amount of capital invested by the owner or, in this case the customer, into
his/her company.

4. Collateral
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This can be guarantees or collateral provided by the customer to support his/her exposure with
the company.

5. Condition

This describes the environment where the company operates which may affect the ability of a
customer to pay including economic and political conditions, the state of competition in the industry
where the company operates, and the prospects of its industry.

What are the INTERNAL CONTROLS that should be considered TO SAFEGUARD

INVENTORIES?

1. Separating the custodial functions from the recording or accounting functions

Just like cash, this internal control measure is also true for inventories and for other types of assets.

2. Aging of inventories

 Aging of inventories allows management to identify the fast-moving items and

the slow-moving items.

 Management must decide what to do with slow-moving items before they

further lose their values. One way to dispose slow-moving items is by
bundling them with other products of the company.

3. ABC Analysis

 This approach classifies inventories into three categories: A, B, and C.

Inventories which are considered most important are classified as A; those at
the middle are classified as B; and the least important are classified as C.

 The main reason for classifying them is to provide the kind of security due to
each category of inventories, meaning the more valuable items have to be
given better security.

Formula and Format for the Preparation of Budgets and Projected Financial Statement

In planning, the goal of maximizing shareholders’ wealth must always be put in mind. Therefore, the
following criteria must be used for an effective planning:

– target a specific area for improvement.

– quantify or at least suggest an indicator of progress.

– specify who will do it.

– state what results can realistically be achieved, given available resources.

-RELATED – specify when the result(s) can be achieved. (Doran, G. T. (1981). "There's a
S.M.A.R.T. way to write management's goals and objectives". Management Review (AMA FORUM)
70 (11): 35–36.

Cayanan, A. (2015) said, a plan is useless if it is not quantified. A quantified plan is represented
through budgets and projected or proforma financial statements. These budgets and pro-forma
financial statements are useful for controlling. They serve as the bases for monitoring actual
performance. Meeting the plans is good. However, failing to meet the plans is not equivalent to failure
if the reasons for not meeting such plans can be justified especially when the reasons are fortuitous in
nature and are beyond the control of management. Measuring actual performance vis a vis the plans
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even at the early start of the year allows the management to assess the company’s performance and
come up with remedial actions if warranted.

The Sales Budget This is how a sales budget is formulated. The most important account in the
financial statement in making a forecast is sales. To forecast means is to plan beforehand. Since
most of the expenses are correlated with sales, the sales budget is formulated. Financial Statement
analysis discussed in your Accounting subjects that cost of sales ratio, gross profit ratio, and variable
operating expenses ratio are based on the sales figure. Given the importance of the sales forecast,
the financial manager must be able to support this figure with reasonable assumptions.

SALES BUDGET Formula: Forecasted unit sales x Price per unit= Total gross sales

The following external and internal factors should be considered in forecasting sales:

Factors that Influence Sales

Let us discuss the external and internal factors that influence sale. External Factors

Macroeconomic Variables. Macroeconomic variables such as the GDP rate, inflation rate, and interest
rates, among others play an important role in forecasting sales because it tells us how much the
consumers are willing to spend. A low GDP rate coupled by a high inflation rate means that
consumers are spending less on their purchases of goods and services. This means that we should
not forecast high sales of the periods of low GDP.

Developments in the Industry. Products and services which have more developments in its industry
would likely have a higher sales forecast than a product or service in slow moving industry. Consumer
trends are always changing, thus the industry should be competitive to be able to appeal to more
customers and stay in the market.

Competition. Suppose you are selling bread and you know that each person in your community eats
an average of one loaf of bread a day. The population of your community is 500 people. If you are the
only person selling bread in your town, then your sales forecast is 500 units of bread. However, you
also have to take account your competition. What if there are 4 other sellers of bread? You will need
to have to divide the sales between the 5 of you. Does this mean your new forecast should be 100
units of bread? Not necessary. You should also know the preference of your consumers. If more of
them would prefer to buy more bread from you, then you should increase your sales forecast. Internal
Factors Production Capacity and manpower. Suppose that you have already evaluated the
macroeconomic factors and identified that there is a very strong market for your product and
consumers are very likely to buy from you. You forecasted that you will be able to sell 1,000 units of
your product. However, you only have 20 employees who are able to produce 20 units each. Your
capacity cannot cover your expected demand hence, you are limited by it. To be able to increase
capacity, you should be able to expand your operations. There is an implications if sales budget is not
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correct. If understated, there can be lost opportunities in the form of forgone sales. If it is too
optimistic, the management may decide to unnecessarily increase capacity or hire more employees
and end up with more inventories. Production Budget What a production budget is and how it is
formulated? A production budget provides information regarding the number of units that should be
produced over a given accounting period based on expected sales and targeted level of ending
inventories. It is computed as follows:

Let us have the following examples:

Company A forecasts sales in units for January to May as follows:

Moreover, Company A would like to maintain 100 units in its ending inventory at the end of
each month.

-Beginning inventory at the start of January amounts to 50 units.

-How many units should Company A produce in order to fulfill the expected sales of the
company?

The answer is here:

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PROJECTED FINANCIAL STATEMENTS

Projected financial statements is a tool of the company to set an overall goal of what the company’s
performance and position will be for and as of the end of the year. It sets targets to control and
monitor the activities of the company.

This lesson has been extensively discussed in your Fundamentals of Accounting 1 and 2. A historical
financial statement is provided for you to make your forecast.

Here are the following reports that may be forecasted:

Projected Income Statement Projected Financial Position Projected Cash Flows

Financial forecasts assist businesses in the attainment of their goals. They are the future
predictions of finances which provide details of actual the results or progress of performances.
Predicting the financial future of a business needs a lot of considerations especially if the business
has not yet been established and has none financial history. The forecasting and making adjustments
will enable a business to become more precise and accurate in numbers in the future.
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What Is Projected Income?

Wood, C. (2020) said the projected income is an estimate of the financial results you'll see from your
business in a future period of time. It is often presented in the form of an income statement, although
it doesn't have to be. The chart above represents a projected income of Company A.

How It's Estimated?

Let's say the ABM Supermarket is considering an expansion. You have decided to put together a
projected income statement for the following year to see if the new products are dominating the
market.
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Projected Financial Position

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The balance sheet shows a business's actual, historical financial positions, while a projected balance
sheet communicates expected changes in future asset investments, outstanding liabilities and equity
financing. Businesses may consider a projection of a balance sheet as to facilitate long-term, strategic
planning which often concern future asset growth and how it may be supported by increased financing
through both debt and equity. It provides the most relevant financial information needed in the
business planning process. The chart above represents a projected Financial Position for 5 years
(Jay, W. 2019).

If you want to predict your business’s cash flow, create a cash flow projection. A cash flow projection
estimates the money you expect to flow in and out of your business, including all of your income and
expenses. The chart above is an example of projected cash flows (Kappel, M. 2019).