4-1

FINANCIAL PLANNING
AND CONTROL

Sales forecasts
Projected financial statements

Additional Funds Needed

Also called External Funds Needed (EFN)

Financial control
Hypothetical Data for Northwest
Chemical Company

4-2

Financial Planning and Control

Financial Planning

The projection of sales, income, and assets

based on alternative production and marketing
strategies, as well as the determination of the
resources needed to achieve these projections.
Forecasting also is important for production
planning and human resource planning.

Financial Control
The phase in which financial plans are
implemented; control deals with the feedback and
adjustment process required to ensure adherence
to plans and modification of plans because of
unforeseen changes.

4-3

Financial Planning:
Growth is a key theme behind financial
forecasting. Remember that growth should not be
the underlying goal of a corporation creating
shareholder value is the appropriate goal. In many
cases, however, shareholder value creation is
enabled through corporate growth.
The sales forecast predicts a firms unit and dollar
sales for some future period; generally based on
recent sales trends plus forecasts of the economic
prospects for the nation, region, industry, etc.
We want to forecast if we need external funds
borrowing or a new stock issue

4-4

Percentage of Sales Method

Projected Balance sheet forecasting of AFN
2. Increased sales requires increased assets that must be
financed. We will discuss the strategy for forecasting
assets.
3. Increased sales automatically increases spontaneous
liabilities.
4. Some financing will come from retained earnings.
Depending on the information, we formulate a strategy
for determining RE.
5. If additional funds are needed we have to choose to
finance with external funds -- debt or stock.
6. #5 affects #4 -- thus, we sometimes use an iterative
approach.
1.

Steps to get AFN simple one-pass

forecast balance sheet method
1.
2.
3.
4.
5.

4-5

Calculate RE with the data given (method

varies)
Increase CA and spontaneous liabilities
proportionately with sales
Increase FA if needed based on capacity
information given
Carry over bonds/bank-loans and stock
Calculate TA - (TL+E) = AFN
AFN = additional funds needed from
external sources

Hand out simple example

4-6

Two pass method example:

Northwest Chemical: 2001
Sales Projection
(millions of dollars)
$3,000
$2,500
$2,000
$1,500
$1,000
$500
$0
1996

1997

1998

1999

2000

2001

4-7

4-8

Northwest Chemicals
Oregon producer of Ag Chemicals

Prepare financial forecast, main

assumption is a 25% increase in sales
Want to know how performance/ratios
changes.
One of the hard items is Additional Funds
Needed
We will use the percentage of sales method
of forecasting financial statements. This
will give you a thorough feel for the
process of forecasting financial
statements.

4-9

North West Chemical:

Key Ratios
Profit Margin
ROE
DSO
Inv. turnover
F.A. turnover
T.A. turnover
Debt/ assets
TIE
Current ratio
Payout ratio

NWC
2.52%
7.20%
43.2 days
5.00x
4.00x
2.00x
30.00%
6.25x
2.50x
30.00%

Industry
4.00%
15.60%
32.0 days
8.00x
5.00x
2.50x
36.00%
9.40x
3.00x
30.00%

Condition
Poor

Good
Poor

O.K.

4-10

Projected Financial Statements

Step 1. Forecast the 2001
Income Statement

Key Assumptions

Implications for
fixed assets
and fixed cost?

Interest rate = 8% for any debt.

Operating at full capacity in 2000.
Each type of asset grows proportionally with
sales.
Payables and accruals grow proportionally with
sales.
2000 payout (30%) will be maintained.
No new common stock will be issued.
Sales are expected to increase by $500 million.
(%S = 25%)

4-11

There will be simpler problems than this in

lab

4-12

NWC: Projected
2001 Income Statement:
Sales
Less: VC
FC
EBIT
Interest
EBT
Taxes (40%)
Net. income
Div. (30%)
Add. to RE

2000
$2,000
1,200
700
$ 100
16
$ 84
34
$ 50
$ 15
$ 35

Factor
x1.25
x1.25
x1.25

Initial Forecast
$2,500
1,500
875
$ 125
16
$ 109
44
$ 65
$ 19
$ 46

4-13

Projected Financial Statements

Step 2. Forecast the 2001
Balance Sheet (Assets)
2000

Factor

Initial Forecast

Cash/sec.

$20

x1.25

$25

Accts. rec.

240

x1.25

300

Inventories

240

x1.25

300

Total CA

$500

Net FA
Total assets

500

$625
x1.25

$1,000

At full capacity, so all assets must

increase in proportion to sales.

625
$1,250

4-14

Projected Financial Statements

Step 2. Forecast the 2001
Balance Sheet (Liability & Equity)

AP/accruals
Notes payable
Total CL
L-T debt
Common stk.
Ret. earnings
Total liab./eq.

2000
Factor
$100 x1.25
100
$200
100
500
200
+46*
$1,000

Initial Forecast
$125
100
$225
100
500
246
$1,071

*From projected income statement.

4-15

Projected Financial Statements

Step 3. Raising the
Additional Funds Needed
Forecasted

total assets
Forecasted total claims
Forecast AFN1

=
=
=

$1,250
$1,071
$ 179

NWC must have the assets to make

forecasted sales. The balance sheet must
balance. So, we must raise $179 externally.

4-16

How will the AFN be financed?

Additional notes payable =

0.5 ($179) = $89.50

Additional L-T debt

=
0.5 ($179) = $89.50
But this financing will add 0.08 ($179) = $14.32
to interest expense, which will lower NI and
retained earnings.

4-17

Projected Financial Statements

Step 4. Financing Feedbacks

The effects on the income statement and

balance sheet of actions taken to finance
forecasted increases in assets.

4-18

NWC: 2001 Adjusted Forecast

of Income Statement
1st Pass Feedback 2nd Pass
Sales
$2,500
$2,500
Less: VC
1,500
1,500
FC
875
875
EBIT
$125
$125
Interest
16
+14
30
EBT
$109
$95
Taxes (40%)
44
38
Net. income
$65
$57
Div. (30%)
$19
$17
Add. to RE
$46
$40

4-19

NWC: 2001 Adjusted Forecast

of Balance Sheet (Assets)
1st Pass

Feedback 2nd Pass

Cash/sec.

$25

$25

Accts. rec.

300

300

Inventories

300

300

Total CA

$625

$625

625

625

$1,250

$1,250

Net FA
Total assets

No change in asset requirements.

4-20

NWC: 2001 Adjusted Forecast

of Balance Sheet
(Liabilities & Equity)
1st Pass Feedback 2nd Pass
AP/accruals
$125
$125
Notes payable
100
+89.5
190
Total CL
$225
$315
L-T debt
100
+89.5
189
Common stk.
500
500
Ret. earnings
246
-6
240
Total liab./eq.
$1,071
$1,244

4-21

Results of the
Adjusted Forecast:
Forecasted

assets = $1,250 (no change)

Forecasted claims = $1,244 (higher)
2nd pass AFN
= $
6 (short)
Cumulative AFN
= $179 + $6 = $185.
The $6 shortfall came from reduced net
earnings. Additional passes could be
made until assets exactly equal
liabilities/equity. ex: $6 (0.08) = $0.48
interest 3rd pass.

4-22

North West Chemical:

Adjusted Key Ratios

Profit Margin
ROE
DSO (days)
Inv. turnover
F.A. turnover
T.A. turnover
D/A ratio
TIE
Current ratio
Payout ratio

NWC
2000
2001(E)
2.52%
2.27%
7.20%
7.68%
43.2
43.2
5.00x
5.00x
4.00x
4.00x
2.00x
2.00x
30.00%
40.34%
6.25x
4.12%
2.50x
1.99x
30.00%
30.00%

Industry
4.00%
15.60%
32.0
11.00x
5.00x
2.50x
36.00%
9.40x
3.00x
30.00%

Poor

O.K.

4-23

Analysis of the Forecast:

How does North West
Chemical Compare?

Not very profitable relative to other

companies in the industry.
Carrying excess inventory and receivables.
Debt ratio projected to move ahead of
average.
Overall, not in good shape and doesnt
appear to be improving.

4-24

Capacity Issues

Sales last year $500

Last year at 80% of capacity
Sales will increase 50%
What percentage will fixed cost and fixed
assets increase?

4-25

Other Considerations in
Forecasting: Excess Capacity
Suppose in 2000 fixed assets had been
operated at only 75% of capacity:
Full Capacity Sales

Actual sales
=
% of capacity usage

$2,000
=
= $2,667.
0.75

4-26

Does NWC need additional

fixed assets?
With the existing fixed assets, sales could
be $2,667. Since sales are forecasted at
only $2,500, no new fixed assets are needed.

How would fixed costs change?

Fixed cost would not increase.

4-27

If NWC had been operating at full

capacity, what would its fixed
assets/sales ratio be?
Actual fixed assets
Target FA / sales =
Full capacity sales
$500
=
= 18.75%
$2,667

With the existing fixed assets, sales could

be $2,667. Since sales are forecasted at
only $2,500, no new fixed assets are needed.

4-28

Projected Financial Statements

Step 2. Forecast the 2001
Balance Sheet (Assets)
2000

Factor

Initial Forecast

Cash/sec.

$20

x1.25

$25

Accts. rec.

240

x1.25

300

Inventories

240

x1.25

300

Total CA

$500

Net FA
Total assets

500

$625
x1.25

$1,000

At full capacity, so all assets must

increase in proportion to sales.

625
$1,250

4-29

How would the excess capacity

situation affect the 2001 AFN?

The projected increase in fixed assets was

$125, the AFN would decrease by $125.

Since no new fixed assets will be needed,

AFN will fall by $125.

4-30

NWC: Projected
2001 Income Statement:
Sales
Less: VC
FC
EBIT
Interest
EBT
Taxes (40%)
Net. income
Div. (30%)
Add. to RE

2000
$2,000
1,200
700
$ 100
16
$ 84
34
$ 50
$ 15
$ 35

Factor
x1.25
x1.25
x1.25

Initial Forecast
$2,500
1,500
875
$ 125
16
$ 109
44
$ 65
$ 19
$ 46

4-31

How would the excess capacity

situation affect the 2001 AFN?

Fixed cost would not increase, increasing

EBIT by $175

In turn net income and RE would increase,

thus more internal financing and AFN

would be smaller.

4-32

How would excess capacity

affect the forecasted ratios?
Sales wouldnt change but assets
would be lower, so turnovers would be
better.
Less new debt, hence lower interest, so
higher profits, EPS,ROE.
Debt ratio, TIE would improve.

4-33

2001 Forecasted Ratios:

Profit Margin
ROE
DSO (days)
Inv. turnover
F.A. turnover
T.A. turnover
D/A ratio
TIE
Current ratio
Payout ratio

% of Capacity in 2000
100%
75%
2.27%
2.51%
7.68%
8.44%
43.2
43.2
5.00x
5.00x
4.00x
5.00x
2.00x
2.22x
40.34%
33.71%
4.12%
6.15x
1.99x
2.48x
30.00%
30.00%

Industry
4.00%
15.60%
32.0
8.00x
5.00x
2.50x
36.00%
9.40x
3.00x
30.00%

4-34

Summary: How different factors

affect the AFN forecast.

Dividend payout ratio changes.

If reduced, more RE, reduce AFN.
Profit margin changes.
If increases, total and retained earnings increase,
reduce AFN.
Plant capacity changes.
Less capacity used, less need for AFN.
AP Payment terms increased to 60 days from 30.
Accts. payable would double, increasing
liabilities, reduce AFN.