108 PART 1 Introduction to Managerial Finance
financial planning process
Planning that begins with long-
term, or strategic,financial plans
that in turn guide the formulation
of short-term, or operating,plans
and budgets.
long-term (strategic)
financial plans
Lay out a company’s planned
financial actions and the antici-
pated impact of those actions
over periods ranging from 2 to 10
years.
short-term (operating)
financial plans
Specify short-term financial
actions and the anticipated
impact of those actions.
LG33–3 Explain why a decrease in cash is classified as a cash inflow (source)and
why an increase in cash is classified as a cash outflow (use)in preparing
the statement of cash flows.
3–4 Why is depreciation (as well as amortization and depletion) considered a
noncash charge?How do accountants estimatecash flow from operations?
3–5 Describe the general format of the statement of cash flows. How are cash
inflows differentiated from cash outflows on this statement?
3–6 From a strict financial perspective, define and differentiate between a
firm’s operating cash flow (OCF)and its free cash flow (FCF).3.2 The Financial Planning Process
Financial planning is an important aspect of the firm’s operations because it pro-
vides road maps for guiding, coordinating, and controlling the firm’s actions to
achieve its objectives. Two key aspects of the financial planning process are cash
planningand profit planning.Cash planning involves preparation of the firm’s
cash budget. Profit planning involves preparation of pro forma statements. Both
the cash budget and the pro forma statements are useful for internal financial
planning; they also are routinely required by existing and prospective lenders.
The financial planning processbegins with long-term, or strategic,financial
plans. These in turn guide the formulation of short-term, or operating,plans and
budgets. Generally, the short-term plans and budgets implement the firm’s long-
term strategic objectives. Although the remainder of this chapter places primary
emphasis on short-term financial plans and budgets, a few preliminary comments
on long-term financial plans are in order.Long-Term (Strategic) Financial Plans
Long-term (strategic) financial planslay out a company’s planned financial
actions and the anticipated impact of those actions over periods ranging from 2
to 10 years. Five-year strategic plans, which are revised as significant new infor-
mation becomes available, are common. Generally, firms that are subject to high
degrees of operating uncertainty, relatively short production cycles, or both, tend
to use shorter planning horizons.
Long-term financial plans are part of an integrated strategy that, along with
production and marketing plans, guides the firm toward strategic goals. Those
long-term plans consider proposed outlays for fixed assets, research and develop-
ment activities, marketing and product development actions, capital structure,
and major sources of financing. Also included would be termination of existing
projects, product lines, or lines of business; repayment or retirement of outstand-
ing debts; and any planned acquisitions. Such plans tend to be supported by a
series of annual budgets and profit plans.Short-Term (Operating) Financial Plans
Short-term (operating) financial plansspecify short-term financial actions and the
anticipated impact of those actions. These plans most often cover a 1- to 2-year
period. Key inputs include the sales forecast and various forms of operating and
financial data. Key outputs include a number of operating budgets, the cash bud-