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FORECASTING FINANCIAL NEEDS
William M. Kinai
1.1Introduction
A
financial plan
is blueprint in which management analyzes a firm’s financial needs overa duration of time and includes suggestions on how funds may be raised where necessary.Financial plans relate to a specified time period. A financial plan could be either a short-term or long-term plan. A
short-term financial plan
relates to the next 12 months. A
cash budget
is an example of a
 
short-term financial plan.
 
A
long-term plan
relates toperiods longer than 12 months. This session focuses on the formulation of a long-termplan.
1.2Financial Planning Models
On average a financial planning model requires the following elements.
a.
Sales forecast:
This is a forecast of sale to be made over a duration of time infuture. This duration of time is also referred to as the
planning horizon
. The salesforecast takes into consideration expected increase in the production levels over theplanning horizon.
 
b.
Budgeted financial statements:
These are financial statement (profit and lossaccount and balance sheet) at the end of the planning horizon.
c.
Asset requirements:
This is a forecast of the investments required in capital andworking capital over the planning horizon.
d.
Financial requirements:
This is a proposal of how debt and equity funds will beraised to finance investments in capital and working capital over the planninghorizon. It takes into consideration the firm’s dividend policy.
e.
External funds requirement:
This is an estimate of the amount of fund that is tobe raised from outside source to support the expected increases in capital andworking capital over the planning horizon.
1.3Percentage of Sales Financial Planning Model
The
percentage of sales financial planning model
is a tool of long-term financialmanagement. This method takes into consideration the relationship between sales,expenses, assets and liabilities.
William M. Kinai
(williamkinai@yahoo.com; +254 020 2323 858) is the founder and principal of Concert ManagementConsulting, a firm that provides business assessment, business planning, interim management, and executive trainingservices to growing businesses and nonprofit organizations in the East African region including Kenya, Uganda, Tanzania,Rwanda, Burundi, Ethiopia, and South Sudan.Copyright © 2009 William M. Kinai. This article may be reprinted free of charge in any publication or website provided thatthe article is unedited, and that the copyright, author's bio, and contact information appears with each reproduction and/or posting.
 
FORECASTING FINANCIAL NEEDS
1.3.1Items That Move Proportionately to Sales
Some items move in direct proportion to sales, while others are dependent on companypolicies. Company policies are strongly influence by the company’s shareholders. Forexample, the cost of goods sold move in proportion to the level of sales. There is often adirect relationship between the level of sales and additional investments in assets. Abusiness will need to increase investment in assets to achieve an increase in sales. Someliability items such as trade creditors (suppliers who accept to sale to the business undercredit terms) the financing availed will be proportional to the level of sale. The higher thesales the more the purchases and the greater will be the purchases made on credit.
1.3.2Items Influenced by Company Policy
The company’s debt policy will influence the extent to which long term liabilities such asleases and new bond issues will be utilized as a source of additional financing. Thecompany’s dividend policy will provide a guide as to the extent to which retainedearnings will be used as a source of long term financing. Further, the raising of equitycapital is at the discretion of shareholders on recommendation of management. Generally,financing decisions are not directly related to sale but on other factors such as theavailability of found in the capital markets and the company’s polices which reflect thepreferences of shareholders.The percentage of sales financial planning model takes into consideration the relationshipbetween sales and individual cost, assets and liabilities. The following is an illustrationfor how the percentage of sales financial planning model can be applied in forecastingfinancial needs in the context of growing businesses.
1.3.3Percentage of Sales Financial Planning Model: Illustrated
Mwangaza Times Ltd publishes a weekly newspaper under the brand Mwangaza Times.Mwangaza Times current circulation is 120,000 copies annually. The management of Mwangaza Times plans to double circulation to 240,000 copies annually in next 2 years.Mwangaza Times Ltd will purchase a new printing press from International PrintingMachines Ltd. The suppliers of the new industrial printing press will take one year tomanufacture and install the new plant. This new machine will be ready for operation onan industrial scale on 1 January 2010. In the financial year 2010, sales are expected todouble at 240,000 copies annually. Profit and loss account for the financial year ended 31December 2007 and balance sheet as at 31 December 2007 is presented in Exhibit 2.1aand 2.1b.
William M. Kinai
(williamkinai@yahoo.com;+254 020 2323 858) is the founder and principal of Concert Management Consulting, a firm that provides business assessment, business planning, interim management, and executive training services to growingbusinesses and nonprofit organizations in the East African region including Kenya, Uganda, Tanzania, Rwanda, Burundi, Ethiopia,and South Sudan.
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FORECASTING FINANCIAL NEEDS
Exhibit 2.1a Mwangaza Times Ltd.Profit and Loss Accountfor the financial year end 31 December 2008Sh.000Sh.000Sales 20,000Cost of sales and expenses -16,000Net profits before tax 4,000Taxes (30%) -1200Net profits after tax 2,800Dividend1,400Transferred to retained earnings1,400
The following information is available:
a.
Mwangaza Times’ cost of sales and operating expenses amount to 80 percent of sales revenues.
b.
The company faces a 30 percent tax rate.
c.
The company retains half of its profits after taxes.
d.
The company has issued 2,300,000 shares of Sh.10 each.
 
e.
Noncurrent liabilities consist of amounts owing to the holders of a 12 percentinterest bond with a floating charge on the assets of the company. The bonds areredeemable on the 31 December 2015.
f.
The following items are directly proportional to the level of sale:i.Property, plant and equipmentii.Inventoriesiii.Trade debtorsiv.Cashv.Trade creditors
g.
Directors, subject to the approval of shareholders, decide on when to raiseadditional short term debt, long term debt and equity. The directors approve certaintypes of current liabilities such as bank overdrafts. Thus, share capital, noncurrentliabilities and certain types of current liabilities such as bank loans are at thediscretion of directors and shareholders. As a consequence these items will bear norelationship with the level of sales.
h.
The dividend payout and retention rate are at the discretion of the directors subjectto the approval of shareholders. Over the planning horizon both the dividend payout
William M. Kinai
(williamkinai@yahoo.com;+254 020 2323 858) is the founder and principal of Concert Management Consulting, a firm that provides business assessment, business planning, interim management, and executive training services to growingbusinesses and nonprofit organizations in the East African region including Kenya, Uganda, Tanzania, Rwanda, Burundi, Ethiopia,and South Sudan.
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