Ch.

4: Financial Forecasting,
Planning, and Budgeting

2002, Prentice Hall, Inc.

Financial Forecasting
1) Project sales revenues and
expenses.

Financial Forecasting
1) Project sales revenues and
expenses.
2) Estimate current assets and fixed
assets necessary to support projected
sales.

Financial Forecasting
1) Project sales revenues and
expenses.
2) Estimate current assets and fixed
assets necessary to support projected
sales.
Percent of sales forecast

Percent of Sales Method

Suppose this years sales will total
$32 million.
Next year, we forecast sales of
$40 million.
Net income should be 5% of sales.
Dividends should be 50% of
earnings.

This year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$8m
$16m
$24m
$4m
$4m
$1m
$6m

% of $32m
25%
50%

12.5%
12.5%
n/a
n/a
$15m

$7m
$2m

n/a
$9m
$24m

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a

n/a

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a

n/a

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a

n/a

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a

n/a

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m
$5m

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a

n/a

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m
$5m
$5m

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a

n/a

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m
$5m
$5m
$1m

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a

n/a

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m
$5m
$5m
$1m
$6m

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a

n/a

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m
$5m
$5m
$1m
$6m

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a
$17m

n/a

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m
$5m
$5m
$1m
$6m

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a
$17m

$7m

n/a

Predicting Retained Earnings

Next years projected retained earnings = last
years $2 million, plus:

Predicting Retained Earnings

Next years projected retained earnings = last
years $2 million, plus:
projected
sales

net income
x
sales

(1

cash dividends
- net income )

Predicting Retained Earnings

Next years projected retained earnings = last
years $2 million, plus:
projected
sales

$40 million

net income
x
sales

.05

(1
x

cash dividends
- net income )

(1 - .50)

Predicting Retained Earnings

Next years projected retained earnings = last
years $2 million, plus:
projected
sales

$40 million

net income
x
sales

.05

(1
x

cash dividends
- net income )

(1 - .50)

= $2 million + $1 million = $3million

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m
$5m
$5m
$1m
$6m

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a
$17m

$7m
$3m

n/a

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m
$5m
$5m
$1m
$6m

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a
$17m

$7m
$3m

n/a
$10m

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m
$5m
$5m
$1m
$6m

% of $40m
25%
50%

12.5%
12.5%
n/a
n/a
$17m

$7m
$3m

n/a
$10m
$27m

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m
$5m
$5m
$1m
$6m

% of $40m
25%
50%

12.5%
How
much
12.5%
Discretionary
n/a
Financing
n/a
$17m

$7m
$3m
$10m
$27m

will we
n/a
Need?

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m
$5m
$5m
$1m
$6m

% of $40m
25%
50%

12.5%
How
much
12.5%
Discretionary
n/a
Financing
n/a
$17m

$7m
$3m
$10m
$27m

will we
n/a
Need?

Next year

Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity

$10m
$20m
$30m
$5m
$5m
$1m
$6m

% of $40m
25%
50%

12.5%
How
much
12.5%
Discretionary
n/a
Financing
n/a
$17m

$7m
$3m
$10m
$27m

will we
n/a
Need?

Predicting Discretionary
Financing Needs

Predicting Discretionary
Financing Needs
Discretionary Financing Needed =

Predicting Discretionary
Financing Needs
Discretionary Financing Needed =
projected
total
assets

projected
total
liabilities

projected
owners
equity

Predicting Discretionary
Financing Needs
Discretionary Financing Needed =
projected
total
assets

projected
total
liabilities

projected
owners
equity

$30 million -

$17 million - $10 million

Predicting Discretionary
Financing Needs
Discretionary Financing Needed =
projected
total
assets

projected
total
liabilities

projected
owners
equity

$30 million -

$17 million - $10 million

= $3 million in discretionary financing

Sustainable Rate of Growth

Sustainable Rate of Growth

g* = ROE (1 - b)

where

Sustainable Rate of Growth

g* = ROE (1 - b)

where

b = dividend payout ratio

(dividends / net income)

Sustainable Rate of Growth

g* = ROE (1 - b)

where

b = dividend payout ratio

(dividends / net income)
ROE = return on equity
(net income / common equity) or

Sustainable Rate of Growth

g* = ROE (1 - b)

where

b = dividend payout ratio

(dividends / net income)
ROE = return on equity
(net income / common equity) or
net income
sales
ROE = sales
x assets

assets
x common equity

Budgets
Budget: a forecast of future events.

Budgets
Budgets indicate the amount and
timing of future financing needs.
Budgets provide a basis for taking
corrective action if budgeted and
actual figures do not match.
Budgets provide the basis for
performance evaluation.