© 2000 John Petroff
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© 2000 John Petroff |
Cash flows have already been defined in Chapter 2, Section B in general terms. In this chapter, we discuss specific considerations tied to capital budgeting process discussed in this chapter.
1)- Calculation of sales projections:
In the analysis of operating leverage and in capital budgeting, much of the outcome hinges on the quality of sales forecasts. By comparison, cost figures are far more reliable than sales figures. As described in the previous chapter, there are just too many factors that can modify the actual sales from what was planned: customer tastes, level of income, actions by competitors and changes in taxes, laws and regulations. It is incumbent on the analyst, therefore, to verify the projections. Consumer preferences, competing product descriptions, competitors' promotional strategies and anticipated product innovations must be gleaned from articles in the press, interviews and research. Likewise most realistic economic forecasts must justify the sales projections. Major corporate decisions pertaining to product lines or choice of plant, and decisions on mergers and acquisitions may be predicated on the accuracy of these predictions.
2)- Projected cash flow from investing activity:
An outside analyst can be helped considerably if the financial statements include a pro forma cash flow statement. In it, the cash flow from investing activity will show company's plans for fixed assets to be purchased or salvaged in the coming year.
As described in Chapter 8, Section J-3 , free cash represents reserves of liquidity which have not yet been committed. This free cash has little impact on current assets, but it is of major consideration in connection with fixed assets and the ability to incur significant expenses. Making accurate predictions of sales, production and profits are signs of good management. Being prepared for the unexpected is a sign of excellent management. An unplanned management move can be a response to a threat from a competitor: for instance, in having to undertake a defensive promotional campaign, or having to undertake a capital expenditure connected with a new product discovery by another firm. Or the unexpected can be an opportunity resulting from a change in customer tastes that gives rise to a new sales potential to be exploited immediately. In both cases, speed in committing capital to fixed resources is crucial. Contracting an outside loan may be either too time consuming or carry the risk of alerting competitors. Thus, the importance of free cash in fixed assets strategy.
See review questions Q-10F.1 through Q-10F.5.
See research assignment R-10F.1.
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