FIL 440 - Ahlgrim

Ch. 12 Forecasting

Ch. 12 Financial Planning and Forecasting Financial Statements
• Other MBA courses focus on strategic plans, operations, and organizational behavior • Strategic plans are statements that provide a vision for the company
– Mission/purpose, scope/businesses, objectives, and strategies – Help to define a direction for the company

The Financial Plan
• Assesses the firm’s anticipated performance under alternate operating plans by forecasting financial statements • Some benefits
– Estimate effects of proposed operating changes (what if…?) – Project future financing needs? – Establish a performance based compensation system – Use as a benchmark to monitor actual performance

• Operating plans provide more implementation guidance over the short-term (1-5 years)
– Specific tasks and responsibilities

Forecasting Financial Statements: Percent of Sales Method
• Forecasted items are a percent of future sales • ASSUMPTION: Many financial statement items increase proportionately with sales
– COGS, Cash, A/R, inventory – ?Fixed assets (at full capacity)? – Spontaneous liabilities (A/P, accruals)

Sales Forecast
• Forecasting depends on ability of marketing/sales to gauge demand for product • Entire chapter is worthless without accurate sales forecast • Improving sales forecasts
– Recent history – New products – Competition

• Other items – SG&A(?), debt, common stock

• May look at some sensitivity analysis and contingency plans

1

00 60.00 9. Costs EBIT Less Interest EBT Taxes (40%) Net Income Dividends Add.00 10.00 115.00 100. bonds.00 24. Project I/S based on sales forecast – May need information to project interest expense 3.00 15. 6.00 2.00 16.00 40.00 Forecast basis Growth % of Sales 10%*Avg Debt .35 22. Costs/Sales (1.00 33.00% 2011 2. so all assets (including FA) grow (proportionally) with sales • Payables and accruals grow (proportionally) with sales • No growth in financing accounts (N/P.185. To ret. earnings 2.see (f) 1.000. Analyze relationship of sales to I/S and B/S items 2.15 95.00 55. 4.200/2000) Cash/Sales AR/Sales Inv/Sales Net Fixed Assets/Sales AP & Accruals/Sales (20/2000) = 60% = 1% = 14.5% = 19.00 1.00 60.900.300.Ahlgrim Ch.5% = 25% = 5% Percent of Sales Method • Step 2: Forecast the Income Statement 2010 Sales Op.65 15% growth 2 . Project B/S Determine AFN and external funds Financing feedbacks Analysis and testing • Operating at capacity. 5. 12 Forecasting Steps in Forecasting Financial Statements: % of Sales 1.509 Case Assumptions Percent of Sales Method • Step 1: Analyze Historical Ratios Op.FIL 440 .00 22. and stock) • Total dividends will grow 15% • Projected sales growth of $300 million (15%) • Historical financial statements on p.

00 Forecasted Claims = $1.00% % of Sales % of Sales % of Sales % of Sales 1.200 Forecast basis Percent of Sales Method • Step 3: Forecast the Balance Sheet 2011 Accounts payable & Accruals Notes payable Total current liabilities Long-term bonds Total debt Common stock Retained earnings Total common equity Total liabilities and equity 2010 100.00% 14.FIL 440 .35 Where will this money come from? • Company adjusts the financial statements to reflect financing strategy 3 .00 300.65 1.00 195.237.00 Forecast basis % of Sales Carry-over Carry-over Carry-over RE10 + D RE11 5.00 80.00 1.35 Percent of Sales Method • Step 4: Raising the AFN • Company needs to decide upon financing strategy • Suppose at end of year.00 200.380.65 522.50% 19.00 180.00 500.Ahlgrim Ch.65 Percent of Sales Method • Step 3: Forecast the Balance Sheet You will notice that the Balance Sheet does not balance: Forecasted Assets = $1.00 80.00 715.00 520.65 AFN = $ 142.380 2011 115.237.00 300.00% $ 23 334 449 805 575 1.200. company takes out line of credit – N/P increase 142. 12 Forecasting Percent of Sales Method • Step 3: Forecast the Balance Sheet 2010 Assets Cash Accounts receivable Inventories Total current assets Net plant and equipment Total assets $ 20 290 390 700 500 1.00 520.00 700.00 222.50% 25.

00 222.00 857.00 200.FIL 440 .00 500.35 300.00 Accounts payable & Accruals Notes payable Total current liabilities Long-term bonds Total debt Common stock Retained earnings Total common equity Total liabilities and equity – – – – – – – A* = Assets that are tied directly to sales S0 = Sales during the last year L* = Liabilities that increase spontaneously S1 = Total sales projected for next year ∆S = Change in sales M = Profit Margin RR = Percent of net income retained or (1 .00 520.35 520.00 180.65 1.00 300.00 80.35 337.00% AFN Equation • AFN = (A*/S0) ∆S .Payout Ratio) Self-Supporing Growth Rate • What is the maximum growth rate so the company needs no external capital? • Use AFN equation with: S1=S0 x (1+g) DS = S1 .380.00 1.65 522.S0 = S0 x (1+g) . 12 Forecasting Percent of Sales Method 2010 100.200.00 700.MS1(RR) 2011 115.Ahlgrim Ch.00 222.00 Forecast basis % of Sales AFN Carry-over Carry-over RE10+ D RE11 5.(L*/S0) ∆S .S0 = gS0 AFN = 0 Solve for g Step 6: Analysis • Review financial ratios • Implementation of strategies (“what if”) and impact on financial results 4 .

60 10.00 2.00 22.00% 15.40 60.15 6.00 62.20 93.Ahlgrim Ch.00% 5 .00 % of Sales % of Sales % of Sales 11.50% 25. 12 Forecasting Key Ratios Profit Margin ROE DSO Inventory Turnover Fixed Asset Turnover Debt/Assets TIE Op.00 14.50% 5.00% 6.381 Forecast basis 2011 23.00 1.00 115.300.20% 4.150.00 529.0% 93.1% 1.35 50.3% 1.00 60.FIL 440 .139.00 33.67 4.13 4.35 22.64% 40. Costs / Sales Actual 2010 1.00 253. To retained earnings 2.00 2.15 11.43% 6.00 621.0% Industry 2.00 58.0% Forecast 2011 1.80% 52.35 53.00 161.00 5.00% 23.0% After 40.25 Previous Assets Cash Accounts receivable Inventories Total current assets Net plant and equipment Total assets $ 23 334 449 806 575 1.00% Percent of Sales Method • Tighten A/R and Inventory management 2011 2. rec.31% 53.93 5.300.92 95.00 60.0% 5.00 40.13x 19.0% 95./Sales Inventory turnover Inventory/Sales Fixed Assets/Sales Op.00 10.13 4.00 345.67x 15.65 % of Sales 93.00% 23.0% Percent of Sales Method • More efficient company Previous New Forecast basis Sales Op Costs EBIT Less Interest EBT Taxes (40%) Net Income Dividends Add.SGA/Sales 53.00 55.0% Proposed Improvements Before DSO (days) Accts.00 101.185.67 95.74% 11.

33% 13. 6 . recurring excess capacity. • Lumpy assets: – Leads to large periodic AFN requirements.00 250.00 222.00 715.00 80.31% After -$115 +$162 9.Ahlgrim Ch.25 1.237.FIL 440 . • Economies of scale: – Also leads to less-than-proportional asset increases.92% Case Questions • What if operating at 75% capacity? – Effects on AFN? – Effects on projected ratios? Improving asset projections • Previously.00 300.00 195.65 RE10 + DRE11 522.25 550.00 195. % of sales remained fixed • How do B/S items actually increase with sales? • Excess capacity: – Existence lowers AFN.00 80. 12 Forecasting Percent of Sales Method • Tighten A/R and Inventory management Accounts payable & Accruals Notes payable Total current liabilities Long-term bonds Total debt Common stock Retained earnings Total common equity Total liabilities and equity Previous Forecast basis 115.00 520. • Base stocks of assets: – Leads to less-than-proportional asset increases.45% 6.65 2011 115.25 Impact of Current Asset Improvements Before AFN Free cash flow ROIC ROE +$142 -$96 5.00 715.00 300.265.65 1.00 520.

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