CHAPTER 5: FINANCIAL FORECASTING, CORPORATE PLANNING,

AND BUDGETING

CORPORATE PLANNING
 A formal, systematic, managerial process that is organized by responsibility,
time, and information to assure that strategic planning, project planning and
operational planning are carried out regularly to enable the top management to
direct and control the future of the company.
 Strategic Planning- this involves the creation of strategies that are aimed at
maximizing the entity’s future position, taking into consideration the various
elements and factors that may pervade the company’s internal and external
environments.
 Project Planning- sometimes called capex (capital expenditure) planning or
capital expenditure planning, this entails detail plans involving acquisition of new
property, plant, and equipment, creation of new products, modification,
acquisition, or adoption of new systems, and acquisition of new entities.
 Operational Planning- this is much concerned on how to efficiently and
effectively utilize the entity’s resources to achieve the company’s short-term and
long-term objectives set up during strategic planning.

BUDGETING
 The budget could be defined as a formal statement of a plan presented in
quantitative terms.
 The firms’ formed budget serve as a barometer against which the results of the
daily operations of the company are matched, coordinated, evaluated, and
controlled.
 Management compares the actual figures of company operations vis-a-vis the
budgeted figures and see if there are favorable or unfavorable differences or
variances.
 The firm’s budget is prepared usually for one year. However, this is delineated
with separate budgets presented on a monthly basis or quarterly basis.
 A rolling budget may be also done when a company makes a whole year budget
then makes new budgets on a monthly or quarterly basis.
Reason for Budgeting
 1. Planning- in the development of operational and project plans, proposed
activities should involve profit generation. The profit to be generated in
the execution of the plan is found in the pro-forma or budgeted income
statements. The budgeted income statement helps management in paving
(planning) the way to achieve the desired profit found in the budgeted
income statement.
2. Coordination- budgeting tends to synchronize the firm’s operations,
because the budget serves as a guide as to what the company should
achieve.
3. Control- budget serve as a barometer/yardstick against which the firm
cam measure and compare the actual results of operations.
Budget Manuals
To facilitate budgeting procedures, a budget manual is usually prepared by
management. An average run of the mill budget manual may be composed of the
following:
1. Objectives
2. Definition of authority
3. Responsibilities and duties of persons involved in preparing the budget
4. Procedure of budgetary control
5. Time schedule for preparing the budget
6. Forms of schedules
7. Procedures in obtaining budgeting approval
8. Form and nature of performance report
9. Advantages of budgetary control
Components of the Master Budget
The different functional areas or sub-units of the firm have their own budgets.
These budgets are then fused to form one company-wide budget referred to as master
budget. The typical master budget should contain the following:
1. Operations Budget/Profit Plan- composed of a detailed presentation of
revenues, expenses, and net profit. The formation of this budgeted
income statement came about by the infusion of the different budgets on:
a. Sales
b. Production volume
c. Cost of raw materials
 d. Number of raw materials units to be purchased
e. Cost of direct labor
f. Factory overhead
g. Inventory levels
h. Cost of direct labor
i. Selling expenses
j. Administrative expenses
k. Financing charges
2. Financial Resources Budget- this is mainly made up of:
a. Cash budget
b. Pro-forma or budget Statement of Financial Position (SFP)
c. Projected funds flow statement
3. Capital Expenditures Budget- involves plans on material modification,
acquisition, and disposal of property, plant, and equipment or material
modification, and acquisition or renewal of a firm’s computerized
accounting information system.
4. Budgeted Financial Ratios- the ratios are taken from the pro-forma or
budgeted financial statements prepared.

Process in Preparing the Master Budget

Below are the general guidelines on how to prepare the master budget:
1. The top management formulates the corporate objectives, plans, policies, and
assumptions, which will give direction in the formulation of the budget estimates.
2. Establish or estimate sales projection or targeted sales.
3. Heads or supervisors of different functional areas prepare individual budgets for
their respective areas as well as sub-units or responsibility centers.
4. The corporate planning department of a firms consolidates the individual budgets to
create a draft master budget.
5. Revision of the preliminary drafted master budget is done to come up with the
final draft subject to the approval of the top management.
6. Department heads or supervisors approve the final master budget.

CONSTRUCTION OF THE PRO-FORMA STATEMENT

 In constructing the pro-forma statements, we shall be following the budgetary
process mentioned above.
 One of the most thorough ways in preparing a budget or doing financial
forecasting is by creating a series of pro-forma or projected or budgeted financial
statement
 The procedure is as follow:
1. Establish or estimate sales projection or targeted sales.
2. Create the production budget schedule, which includes the raw materials
costs, and overhead.
3. Create the schedule for selling, administrative, and other expenses.
4. Compute for the net income by preparing the pro-porma income statement
5. Create the proma- cash budget schedule where the estimated cash receipts
and estimated cash disbursements are presented.
6. From the pro-forma income statement and cash budget schedule, you can
now create the pro-forma statement of financial position.

ESTIMATING SALES
The following methods may be done in estimating or forecasting sales:
1. Sales Trend Analysis- under this method, the product life cycle is used in making
the forecast. A rough plotting of the product life cycle could be presented using the
letter “S.”
2. Sales Force Composite Method- under this method, each salesman estimates the
same in his particular territory. Historical sales may be used by each salesman as basis
estimating the probable sales for the next period.
3. Executive Opinion Method- under this method, the views of a number of top
executives are culled to arrive at a sales estimate.
4. Industry Trend Analysis Method- under this method, the relationship between
expected industry sales and the company sales in terms of market share is determined.
5. Correlation Analysis Method- this is a more scientific means of forecasting sales
by using regression analysis. The regression equation is used to determine the cause-
and-effect relationship between sales and the factors affecting it.
6. Multiple Approach Method- this method uses a combination of the various
methods discussed.
CASH BUDGET
 Credit sales or charge sales generate revenue, however, this transaction does not
generate immediate cash. Because of this, we need to translate the pro-forma
income statement into cash flows.
 The net cash flow is the difference between cash inflow and cash outflow. This is
presented in the comprehensive example below:
 Comprehensive example for pro-forma income statement (adopted from Block
and Hirt)
 STEP 1: ESTIMATE SALES
 Table 1: Assumed Projected Sales of DVD and Blue Players (6 months
of 2020)
 STEP 2: ESTIMATE NUMBER OF UNITS TO BE PRODUCED AND
THE GROSS PROFIT.
 Table 2: Assumed Stock of Beginning Inventory
 Table 3: Computation of Estimated Number of Units to Produce
 Table 4: Assumed Cost per unit
 Table 5: Computation of Estimated Production Costs
 Table 6: Computation of Cost of Good Sold and Gross Profit
 Table 7: Computation of the Cost of Ending Inventory
 STEP 3: CREATE THE PRO-FORMA INCOME STATEMENT
 Table 8: Ocin Corporation, Pro-Forma Income Statement, For the 6-
month Period Ended June 30,2020
 STEP 4: PREPARE THE CASH BUDGET
 Table 9: Summary of Monthly Cash Receipts
 Table 10: Computation of the Production Costs
 Table 11: Computation of the Average Monthly Production Costs
 Table 12: Summary of the Monthly Cash Payment (in Php)
 Table 13: Monthly Cash Flow
 Table 14: Cash Budget (including borrowing and repayment)

PRO-FORMA STATEMENT OF FINANCIAL POSITION (SFP)

In creating the current pro-forma statement of financial position, the following
statements are needed:
1. Pro-forma income statement
 2. Pro-forma cash budget; and
3. Prior period pro-forma statement of financial position.

PERCENTAGE-OF-SALES METHOD
 Under this method, the financial forecaster assumes that the accounts found in the
SFP have a percentage relationship with the company’s sales revenue account. It
is important to note that even under this method, it is important to project sales
before all other forecasting.
 The formula used to compute for the Required New Funds (RNF) is:
 RNF = Asset ratio (Sales) - Liability Ratio (Sales) - NPR (new sales) * DPR