NOTES IN FINANCIAL PLANNING AND FORECASTING

OBJECTIVES
 Discuss the importance of strategic planning and the central role that financial forecasting
plays in the overall planning process.
 Explain how firms forecast sales
 Use the Additional Funds Needed AFN equation and discuss the relationship between asset
growth and the need for funds.
 Use regression to improve forecasts.

SALIENT POINTS
 A company needs a plan, one that starts with the firm’s general goals and details the steps that
will be taken to get there.
 Financial planners begin with a set of assumptions, see what is likely to happen based on those
assumptions, and then see if modifications can help the firm achieve better results.

 Both investors and corporations use forecasting techniques to help value a company’s stock; to
estimate the benefits of potential projects; and to estimate how changes in capital structure,
dividend policy, and working capital policy influence shareholder value.
 If the projected operating results are unsatisfactory, management can “go back to the drawing
board”, reformulate its plans, and develop more reasonable targets for the coming year.
 The funds required to meet the sales forecast simply may not be obtainable. If not, it is
obviously better to know this in advance and to scale back projected operations than to
suddenly run out of cash and have operations grind to an abrupt halt.

The need for external financing depends on the ff key factors

1. Sales growth
2. Capital intensity
3. Spontaneous liabilities-to-sales ratio
4. Profit margin
5. Retention ratio

Sales growth
 Rapidly growing companies require large increases in assets

Capital intensity ratio

 Companies with high assets to sales ratio require more assets for a given increase in sales ;
hence, have a greater need for external financing

Spontaneous liabilities-to-sales ratio

 Companies that spontaneously generate a large amount of funds from accounts payable and
accrued liabilities have a REDUCED need for external financing

Profit margin
 The higher the profit margin, the larger the net income available to support increases in assets ;
hence, the lower the need for external financing

Retention ratio
 (1 – payout ratio)
 Companies that retain a high percentage of earnings rather than paying them out as dividends
generate more retained earnings, thus LESS external financing

THE AFN EQUATION

AFN  Additional Funds Needed
AFN = Projected increase in assets
less Projected increase in spontaneous liabilities
less Increase in retained earnings

Projected increase in assets

(CY Assets / CY Sales) x Peso change in sales

Projected increase in spontaneous liabilities

(CY spontaneous liabilities / CY sales) x Peso change in sales

Increase in retained earnings

(Projected sales x forecasted profit margin) x (1-payout ratio)

Note : Using spreadsheets in the forecasting process, starting with historical statements, ending with
projected statement, and including a set of financial ratios based on those projected statements, will be
taken up in Managerial Accounting – Budgeting / Master Budget