Professional Documents
Culture Documents
Financial Planning
2-1
Learning outcomes
After finishing this chapter you should be able to:
Understand the financial planning process
2-2
Materials
Handout
Brigham & Houston, Fundamentals of financial
management, chapter 17.
2-3
Outline
2-4
Financial planning
Project the future financial positions of
the firm.
The projected future financial status of
the firm is summarised in pro forma
financial statements
2-5
Elements of Financial Planning
Investment in new assets – determined by
capital budgeting decisions
Degree of financial leverage – determined by
capital structure decisions
Cash paid to shareholders – determined by
dividend policy decisions
Liquidity requirements – determined by net
working capital decisions
2-6
Steps in Financial Forecasting
Sales Forecast – many cash flows depend directly on the
level of sales (often estimated using sales growth rate)
Asset Requirements –the additional assets that will be
required to meet sales projections
Financial Requirements – the amount of financing needed
to pay for the required assets
Project internally generated funds
Plug Variable – determined by management deciding what
type of financing will be used to make the balance sheet
balance.
See effects of plan on ratios and stock price
2-7
Sales forecast
2-8
Percent of Sales Approach
Some items vary directly with sales, while others
do not
Income Statement
Costs may vary directly with sales - if this is the case,
then the profit margin is constant
Depreciation and interest expense may not vary directly
with sales – if this is the case, then the profit margin is
not constant
Dividends are a management decision and generally do
not vary directly with sales – this affects additions to
retained earnings
2-9
Percent of Sales Approach
Balance Sheet
Current assets normally vary directly with sales.
Fixed assets may or may not vary directly with sales.
Accounts payable will also normally vary directly with
sales
Notes payable, long-term debt and equity generally do
not vary directly with sales because they depend on
management’s decisions on capital structure
The change in the retained earnings, a portion of equity
will come from the dividend decision
2-10
2018 Balance Sheet
(Millions of $)
2-11
2018 Income Statement
(Millions of $)
Sales $2,000.00
Less: COGS (60%) 1,200.00
SGA costs 700.00
EBIT $ 100.00
Interest 10.00
EBT $ 90.00
Taxes (40%) 36.00
Net income $ 54.00
Dividends (40%) $21.60
Add’n to RE $32.40
2-12
Other Inputs
2-13
Projecting Pro Forma Statements
with the Percent of Sales approach
Project sales based on forecasted growth rate
in sales
Forecast some items as a percent of the
forecasted sales
Costs
Cash
Accounts receivable
(More...)
2-14
Items as percent of sales (Continued...)
Inventories
Common stock
2-15
Sources of Financing Needed to
Support Asset Requirements
2-16
Implications of AFN
If AFN is positive, then you must
secure additional financing.
If AFN is negative, then you have
more financing than is needed.
Pay off debt.
Buy back stock.
Buy short-term investments.
2-17
Percent of Sales: Inputs
2018 2019
Actual Proj.
COGS/Sales 60% 60%
SGA/Sales 35% 35%
Cash/Sales 1% 1%
Acct. rec./Sales 12% 12%
Inv./Sales 12% 12%
Net FA/Sales 25% 25%
AP & accr./Sales 5% 5%
2-18
2019 Forecasted Income
Statement
2019
2018 Factor 1st Pass
Sales $2,000 g=1.25 $2,500.0
Less: COGS Pct=60% 1,500.0
SGA Pct=35% 875.0
EBIT $125.0
Interest 0.1(Debt18) 20.0
EBT $105.0
Taxes (40%) 42.0
Net. income $63.0
Div. (40%) $25.2
Add. to RE $37.8
2-19
How to Forecast Interest Expense
More…
2-20
Basing Interest Expense
on Debt at End of Year
Will over-estimate interest expense if debt
is added throughout the year instead of all
on January 1.
Causes circularity called financial feedback:
more debt causes more interest, which
reduces net income, which reduces
retained earnings, which causes more debt,
etc.
More…
2-21
Basing Interest Expense
on Debt at Beginning of Year
Will under-estimate interest expense if debt
is added throughout the year instead of all
on December 31.
But doesn’t cause problem of circularity.
More…
2-22
Basing Interest Expense on Average
of Beginning and Ending Debt
More…
2-23
A Solution that Balances Accuracy
and Complexity
Reasonably accurate
2-24
2019 Balance Sheet (Assets)
Forecasted assets are a percent of forecasted sales.
2019 Sales = $2,500
Factor 2019
Cash Pct= 1% $25.0
Accts. rec. Pct=12% 300.0
Inventories Pct=12% 300.0
Total CA $625.0
Net FA Pct=25% 625.0
Total assets $1,250.0
2-25
2019 Preliminary Balance Sheet
(Claims)
2019 Sales = $2,500 2019
2018 Factor Without AFN
AP/accruals Pct=5% $125.0
Notes payable 100 100.0
Total CL $225.0
L-T debt 100 100.0
Common stk. 500 500.0
Ret. earnings 200 +37.8* 237.8
Total claims $1,062.8
2-28
How will the AFN be financed?
2-29
2019 Balance Sheet (Claims)
2-31
AFN Equation
1,250 Assets =
(A*/S0)Sales
1,000 = 0.5($500)
= $250.
0 2,000 2,500
Sales
A*/S0 = $1,000/$2,000 = 0.5 = $1,250/$2,500.
2-34
Assets must increase by $250
million. What is the AFN, based
on the AFN equation?
2-35
How would increases in these
items affect the AFN?
Higher sales:
Increases asset requirements, increases
AFN.
Higher dividend payout ratio:
Reduces funds available internally,
increases AFN.
(More…)
2-36
Higher profit margin:
Increases funds available internally,
decreases AFN.
Higher capital intensity ratio, A*/S0:
Increases asset requirements, increases
AFN.
Pay suppliers sooner:
Decreases spontaneous liabilities, increases
AFN. 2-37
Equation AFN = $184.5
vs. Pro Forma AFN = $187.2.
Why are they different?
2-38
Operating at Less than Full
Capacity
If the company is operating at less than
full capacity, fixed assets required
should be adjusted.
2-39
Operating at Less than Full
Capacity
2-40
Suppose in 2018 fixed assets had
been operated at only 75% of
capacity.
Actual sales
Capacity sales =
% of capacity
$2,000
= = $2,667.
0.75
With the existing fixed assets, sales could
be $2,667. Since sales are forecasted at
only $2,500, no new fixed assets are
needed.
2-41
How would the excess capacity
situation affect the 2019 AFN?
2-42