Managerial accounting -- in Chapter 3

summary

Cash flow, the lifeblood of the firm, is a key determinant of the value of the firm. The financial manager must plan and manage -- create, allocate, conserve, and monitor -- the firm's cash flow. The goal is to insurer affirms solvency by beating financial obligations in a timely manner and to generate positive cash flow for the firm's owners. Both the magnitude and the risk of the cash flows generated on behalf of the owners determine the firm's value.

To carry out the responsibility to create value for owners, the financial manager uses tools such as cash budgets and pro forma financial statements as part of the process of generating positive cash flow. Good financial plans should result in large free cash flows that fully satisfy creditor claims and produced positive cash flows on behalf of owners. Clearly, the financial manager must use the liver and careful planning and management of the firm's cash flows to achieve the firm's goal of maximizing share price.

Tax depreciation
Depreciation is an important factor affecting a firm's cash flow. The depriciable value of an asset and its depriciable life are determined by using the method accelerated cost recovery system (MACRS) standards in the federal tax code. MACRS group's assets (excluding real estate) into six property classes based on length of recovery. -- 3, 5, 7, 10, 15, and 20 years -- and can be applied over the appropriate period by using a schedule of yearly depreciation percentages for each period.

The firm's statements
The statement of Cash flows is divided into operating, investment, and financing flows. It reconciles changes in the firm's cash flows with changes in cash and marketable securities for the period. Interpreting the statement of Cash flows requires an understanding of basic financial principles and involves both the major categories of cash flow in the individual items of Cash inflow and outflow. From a strict financial point of view, a firm's operating cash flow is defined to exclude interest; the simpler accounting view does not make this exclusion. Of greater importance is a firm's free cash flow, which is the amount of cash flow available to creditors and owners.

Financial planning process
The two key aspects of the financial planning process are cash planning and profit planning. Cash planning involves the cash budget or cash forecast. Profit planning relies on the pro forma income statement and balance sheet. Long-term (strategic) financial plans act as a guide for preparing short-term (operating) financial plans. Long-term plants tend to cover periods ranging from two to 10 years and are updated periodically. Short-term plans most often cover a one to two year period.

The cash planning process
Cash planning process uses the cash budget, based on sales forecast, to estimate short-term cash surpluses and shortages. The cash budget is typically prepared for a one-year period divided into months. It net cash receipts and disbursements for each period to calculate net cash flow. Ending cash is estimated by adding beginning cash to the net cash flow. By subtracting the desired minimum cash balance from the ending cash, the firm can determine required total financing or the excess cash balance. To cope with uncertainty in the cash budget, the sensitivity analysis or simulation can be used. A firm must also consider its pattern of daily cash receipts and cash disbursements.

Pro forma statements
A pro forma income statement can be developed by calculating pass percentage relationships between certain cost and expense items and the firm sales and then applying these percentages to forecasts. Because this approach implies at all costs and expenses are variable, it tends to understate profits when sales are increasing and to overstate profits when sales are decreasing. This problem can be avoided by breaking down costs and expenses into fixed and variable components. In this case, the fixed components remain unchanged from the most recent year, and the variable costs and expenses are forecast on a percentage of sales basis.

Under the judgmental approach, the values of certain balance sheets accounts are estimated, some as a percentage of sales and others by management assumption, and the firm's external financing is used as a balancing, or "plug" figure. A positive value for "external financing required" means that the firm will not generate enough internal financing to support its forecast growth in assets and will have to raise funds externally or reduced dividends. A negative value for "external financing required" indicates that the firm will generate more financing internally then it needs to support its forecast growth in assets and funds will be available for use in repaying debt, repurchasing stock, or increasing dividends.

Simplified approaches for preparing pro forma statements a sing that the firm's past financial condition is an accurate indicator of the future. Pro forma statements are commonly used to forecast and analyzed the firm's level of profitability and overall financial performance said that adjustment can be made to planned and operations to achieve short-term financial goals.