1、Financial Planning and Forecasting,Financial Plans,Financial plans evaluate the economics behind the strategy and operations. They consist of six steps: Projected financial statements: to analyze the effects of the operating plan on projected profits and financial ratios. Determine the funds needed

2、to support the plan. Forecast funds availability. Establish and maintain a system of controls to govern the allocation and use of funds within the firm. Develop procedures for adjusting the basic plan if the economic forecasts upon which the plan was based do not materialize Establish a performance-

3、based management compensation system.,Sales Forecast,Sales forecasts are usually based on the analysis of historic data. An accurate sale forecast is critical to the firms profitability:,Under-optimistic,Too much inventory and/or fixed assets,Low turnover ratio High cost of depreciation and storage

4、Write-offs of obsolete inventory,Low profit Low rate of return on equity Low free cash flow Depressed stock price,Over-optimistic,Company will fail to meet demand Market share will be lost,Sales Forecast,The Percent of Sales Method,This is the most common method, which begins with the sales forecast

5、 expressed as an annual growth rate in dollar sale revenue. Many items on the balance sheet and income statement are assumed to change proportionally with sales.,The Percent of Sales Method: An Example,*Denotes spontaneous, which means increase spontaneously with sales.,All assets are spontaneous. O

6、n the liability and equity side, Accounts Payable and Accruals are the only spontaneous funds. During the next year, sales increase by 15% resulting in a 15% increase in Total Assets (4,374). Hence, the asset side on next years balance sheet must go up by 15%. Also, the spontaneous funds on the liab

7、ility side must also increase by 15%.,Example (contd):,The spontaneous items on the liabilities side of the projected balance sheet must also increase by 15%.,Example (contd):,Example (contd):,Retained earnings will also increase but not at the same rate as sales. The 2002 amount of RE is the old am

8、ount plus the addition to retained earnings, which we calculated in the projected income statement. Since the TA = TL and the TA have increased to 33,534, while TL have increased to 31,406, there are additional funds needed (AFN) of 2,128 on the liabilities side.,Example (contd):,There are two categ

9、ories of sources for the AFN: Issuance of new stocks (equity) Use some combination of debt In this example, there are internally generated funds from: Retained Earnings Accounts Payable and Accruals,Example (contd):,Financing Feedbacks,If the business issues new debt and common stock, the total amou

10、nt of interest and dividends paid will change. Because interest and dividends must be paid with cash, any increase in these costs will decrease the funds the firm has to investthat is, the amount of income added to retained earnings will be less than originally forecasted. When we consider the effec

11、ts of the increased interest and dividend payments, we find that the AFN is actually greater than originally expected. Financing feedbacksthat is, the effects on the financial statements of actions taken to finance forecasted increases in assetsmust be considered to determine the exact amount of AFN

12、.,Example (contd):,Borrow at 10% (Notes Payable). It means that next year the interest will be 560 + (10% * 2,128),Instead of retaining 1,166, the company retains 1,096 because of the interest. The end results is that the company has to raise 2,128 + 70 = 2198,The AFN Formula,In the formula, we can

13、use either year (2001 or 2002) numbers to arrive at the final result. *A refers to the Total Assets. *L refers to the sum of all spontaneous liabilities (Accounts Payable and Accruals).,Steps in Financial Forecasting,Forecast sales Project the assets needed to support sales Project internally genera

14、ted funds Project outside funds needed Decide how to raise funds See effects of plan on ratios and stock price,Forecasting sales,Review past sales (five to ten years). You can use average growth rate but it may not give you a correct estimate. Use regression slope to compute growth rate. Consider ch

15、anges in economy, market conditions, etc. Improper sales forecast can lead to serious financial planning issues.,After sales forecasting, what is next?,Forecast the COGS (a certain % of sales). Inventory numbers will change with sales. A/R (consider credit policy changes) will change and so will A/R

16、. Accordingly, cash and cash equivalents will change.,Sales forecasting and longer term assets and liabilities,Do they need to be changed as well along with sales? Depends. Existing production capacity relative to the new sales projections.,Ready to prepare the income statement,Start with forecasted

17、 sales Project the COGS Assuming changes in longer term assets and liabilities, forecast depreciation and interest expenses (assumptions required for interest rates / COC, etc.) Compute EBIT.,Ready to prepare the Balance Sheet,Determine the new level of assets (both short-term and longer term). Sepa

18、rate them as operating assets and long term assets. Forecast liabilities (current as well as longer term). Is any common stock or preferred stock to be issued? If so, take into account the changes in these numbers.,Additional funds needed,Forecasted assets and liabilities may not perfectly match. Th

19、e difference is because of AFN or additional funds needed. AFN is the required assets minus the specified sources of financing.,How would increases in these items affect the AFN?,Higher sales: Increases asset requirements, increases AFN. Higher dividend payout ratio: Reduces funds available internal

20、ly, increases AFN.,(More),How would increases in these items affect the AFN?,Higher profit margin: Increases funds available internally, decreases AFN. Higher capital intensity ratio, A*/S0: Increases asset requirements, increases AFN. Pay suppliers sooner: Decreases spontaneous liabilities, increas

21、es AFN.,Projecting Pro Forma Statements with the Percent of Sales Method,Project sales based on forecasted growth rate in sales Forecast some items as a percent of the forecasted sales Costs Cash Accounts receivable,(More.),Items as percent of sales (Continued.) Inventories Net fixed assets Accounts

22、 payable and accruals Choose other items Debt Dividend policy (which determines retained earnings) Common stock,Sources of Financing Needed to Support Asset Requirements,Given the previous assumptions and choices, we can estimate: Required assets to support sales Specified sources of financing Addit

23、ional funds needed (AFN) is: Required assets minus specified sources of financing,Implications of AFN,If AFN is positive, then you must secure additional financing. If AFN is negative, then you have more financing than is needed. Pay off debt. Buy back stock. Buy short-term investments.,How to Forec

24、ast Interest Expense,Interest expense is actually based on the daily balance of debt during the year. There are three ways to approximate interest expense. Base it on: Debt at end of year Debt at beginning of year Average of beginning and ending debt,More,Basing Interest Expense on Debt at End of Ye

25、ar,Will over-estimate interest expense if debt is added throughout the year instead of all on January 1. Causes circularity called financial feedback: more debt causes more interest, which reduces net income, which reduces retained earnings, which causes more debt, etc.,More,Basing Interest Expense on Debt at Beginning of Year,Will under-estimate interest expense if debt is added throughout the year instead of