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Subject Code: BFINMAX

Subject Title: Financial Management
Subject Description: This course provides an introduction to financial management and finance;
cash flows and financial analysis. Topics also include cash flows
estimation; operating and financial leverage; financial planning and
forecasting; managing working capital, cash and marketable securities
management and accounts receivable and inventory management.
No. of Units: 3
Class Schedule: ACT103: Synchronous: Saturday 7:00 am – 10:00 am
Asynchronous: Saturday 10:00 am – 11:00 am
ACT101: Synchronous: Saturday 11:00 am – 2:00 pm
Asynchronous: Saturday 2:00 pm – 3:00 pm
ACT102: Synchronous: Saturday 3:00 pm – 6:00 pm
Asynchronous: Saturday 6:00 pm – 7:00 pm

Course Learning Outcomes:

At the end of this course, the student will be able to:
1. Gain substantial knowledge and information on financial management that will help students in
seeking a career in the field of finance.
2. Have a strong background on the management of working capital.
3. Apply effective and efficient financial management in a given business organization.
4. Integrate and assimilate financial management and accounting principles into meaningful
application through real-life case problem analysis
5. Identify and relate well with financial management and accounting principles, issues and
practices surrounding the finance profession.

About the Instructor:

PROF. MICHAEL ANGELO M. MANAYAO, CPA, MBA
• Master in Business Administration – Far Eastern University
• Graduated from Baliwag Polytechnic College (Cum Laude) – Batch 2018
• Member, PICPA Bulacan

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MODULE 7 – FINANCIAL FORECASTING, PLANNING AND CONTROL

I. Learning Outcomes
The learners are expected to be able to:
1. Understand the concept and perspective of financial planning.
2. Explain the benefits that can be derived from financial planning.
3. Know the elements of a basic financial planning model.
4. Understand the determinants of a firm’s growth rates.
5. Know and apply the financial planning process using the Projected Financial Statement Method (Percent
of Sales Method)

II. Content

Introduction
A lack of effective long-range planning is commonly cited reason for financial distress and failure. Long-
range planning is a means of systematically thinking about the future and anticipating possible problems
before they occur. Planning is said to be a process that at best helps the firm avoid stumbling into the
future backward.

Financial planning establishes guidelines for change and growth in a firm. It focuses on the big picture,
which means that it is concerned with the major elements of a firm’s financial and investment policies
without dealing with the individual components of those policies in detail.

Financial planning formulates the way in which financial goals are to be achieved. A financial plan is
thus, a statement of what is to be done in the future. Many decisions have a long lead time which means
they take a long time to implement. In an uncertain world, this requires that decisions made far in advance
of their implementation. For instance, if a firm wants to build a factory in 2018, it might have to begin
lining up contractors and financing in 2016 or even earlier.

Perspective of Financial Planning

For planning purposes, it is often useful to think of the future as having a short-run and a long-run. The
short-run planning, in practice, usually covers the coming 12 months while financial planning over the
long-run is takes to be the coming two to five years. This time period is referred to as the planning horizon
and this is the first dimension of the planning process that must be established.

The second dimension of the planning process that needs to be determined is the level of aggregation.
Aggregation involves the determination of all of the individual projects together with the investment
required that the firm will undertake and adding up these investment proposals to determine the total
needed investment which is treated as one big project.

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After the planning horizon and level of aggregation are established, a financial plan requires inputs in
the form of alternative sets of assumptions about important variables. This type of planning is particularly
important for cyclical businesses or business firms whose sales are strongly affected by the overall state
of the economy or business cycles.

Benefits that can be Derived from Financial Planning

Due to the amount spent in examining the different scenarios and variables that will eventually become
the basis for a company’s financial plan, it seems reasonable to ask what the planning process will
accomplish.

Among the more significant benefits derived from financial planning are the following:
1. Provides a rational way of planning options or alternatives.
The financial plan allows the firm to develop, analyze and compare many different business
scenarios in an organized and consisted way. Various investment and financing options can be
explored and their impact on the firm’s shareholders can be evaluated. Questions concerning the
firm’s future lines of business and optimal financing arrangements are addressed. Options such as
introducing new products or closing plants might be evaluated.

2. Interactions or linkage between investment proposals are carefully examined.

The financial plan enables the proponents to show explicitly the linkages between investment
proposals for the different operating activities of the firm and its available financing choices. For
example, if the firm is planning on expanding or undertaking new investments and projects, all other
relevant variables such as source, terms and timing of financing are thoroughly examined.

3. Possible problems related to the proposal projects are identified actions to address them are studied.
Financial planning should identify what may happen to the firm if different events take place.
Specifically, it should address what actions the firm will take if expectations do not materialize and
more generally, if assumptions made today about the future are seriously in error. Thus, one objective
of financial planning is to avoid surprises and develop contingency plan.

4. Feasibility and internal consistency are ensured.

Financial planning is a way of verifying that the goals and plans made for specific areas of a firm’s
operations are feasible and internally consistent. The financial plan makes explicit the linkages
between different aspects of a firm’s business such as the market share, return on equity, financial
leverages, and so on. It also imposes a unified structure for reconciling goals and objectives.

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5. Managers are forced to thin about goals and establish priorities.
Through financial planning, directions that the firm would take are established, risks are calculated
and educated alternative courses of action are considered thoroughly.

Financial Planning Models

Financial planning process will differ from firm to firm, just as companies differ in size and products.
However, a basic financial planning model will have the following common elements:
a. Economic Environment Assumption
The plan will have to state explicitly the economic environment in which the firm expects to reside
over the life of the plan. Among the more important economic assumption that will have to be made
are the inflation rates, level of interest rates and the firm’s tax rate.

b. Sales Forecast
An externally supplied sales forecast considered the “driver” shall be the “heart” of all financial
plans. The user of the planning model will supply this value and most other values will be calculated
based on it. Planning will focus on projected future sales and the assets and financing needed to
support those sales.

Oftentimes, the sales forecast will be given as the growth rate in sales rather than as an explicit sales
figure. Perfect sales forecast are not possible, of course, because sales depend on the uncertain future
sate of the economy. To come up with its projections, firms could consult with some businesses
which specialize in macroeconomics and industry projections. Also, evaluating alternative scenarios
does not require sales forecast to be very accurate because the financial planner’s goal is to examine
the interplay between investment and financing needs a different possible sales level, not to pinpoint
what we expect to happen.

Determinant of Growth Rates

A firm’s ability to sustain growth depends explicitly on the following factors:
➢ Profit Margin. An increase in profit margin will increase the firm’s ability to generate funds
internally and thereby increase its sustainable growth.
➢ Dividend Policy. A decrease in the percentage of net income paid out as dividends will increase
the retention ratio. This increases internally generated equity and thus increases sustainable
growth.
➢ Financial Policy. An increase in the debt-equity ratio increases the firm’s financial leverage.
Because this makes additional debt financing available, it increases the sustainable growth rate.
➢ Total Asset Turnover. An increase in the firm’s total asset turnover increases the sales generated
for each peso in assets. This decreases the firm’s need for new asset as sales grow and thereby

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 increases the sustainable growth rate. Notice that total asset turnover is the same thing as
decreasing capital intensity.

c. Pro-forma Statements
A financial plan will have a forecast statement of financial position, income statement, statement of
cash flows and statement of stockholders’ equity. These are called pro-forma or projected statements
which will summarize the different events projected for the future.

d. Asset Requirements
The financial plan will describe projected capital spending. At a minimum, the projected statement
of financial position will contain changes in total fixed assets and net working capital. These changes
effectively the firm’s total capital budget. Proposed capital spending in different areas must be
reconciled with the overall increases contained in the long-range plan.

e. Financial Requirements
The financial plan will include a section about the necessary financing arrangements. This part of
the plan should discuss dividend policy and debt policy. Sometimes firms will expect to raise cash
by selling new shares of stock or by borrowing. In this case, the plan will have to consider what
kinds of securities have to be sold and what methods of issuance are most appropriate.

f. Additional Funds Needed (AFN)

After the firm has a sales forecast and an estimate of the required spending on assets, some amount
of new financing will often be necessary because projected total assets will exceed projected total
liabilities and equity. In other words, the statement of financial position will no longer balance.

Because new financing may be necessary to cover all of the projected capital spending, a financial
“plug” variable must be selected. The plug is the designated source(s) of external financing needed
to deal with any shortfall (or surplus) in financing and thereby bring the statement of financial
position into balance.

The Projected Financial Statement Method

Any forecast of financial requirements involves (a) determining how much money the firm will need
during a given period, (b) determining how much money the firm will generate internally during the same
period, and (c) subtracting the funds generated from the funds required to determine the external financial
requirements.

The projected financial statement method is straightforward, one simply projects the asset requirements
for the coming period, then projects the liabilities and equity that will be generated under normal

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operations and subtracts the projected liabilities/capital from the required assets to estimate the additional
funds needed.

The steps in the procedures are as follows:

Step 1: Forecast the Income Statement.

a. Establish a sales projection.
b. Prepare the production schedule and project the corresponding production costs: direct
materials, direct labor and overhead.
c. Estimate selling and administrative expenses.
d. Consider financial expenses, if any.
e. Determine the net profit.

Step 2: Forecast the Statement of Financial Position.

a. Project the assets that will be needed to support projected sales.
b. Project funds that will be spontaneously generated (through accounts payable and accruals)
and by retained earnings.
c. Project liability and stockholders’ equity accounts that will not rise spontaneously with sales
(e.g., notes payable, long-term bonds, preferred stock and common stock) but may change
due to financing decisions that will be made later.
d. Determine if additional funds will be needed by using the following formula:

The additional financing needed will be raised by borrowing from the bank as notes payable,
by issuing long-term bonds, by selling new common stock or by some combination of these
actions.

Step 3: Raising the Additional Funds Needed.

The financing decision will consider the following factors:
a. Target capital structure;
b. Effect of short-term borrowing on its current ratio;
c. Conditions in the debt and equity markets; or
d. Restrictions imposed by existing debt agreements.

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Step 4: Consider Financing Feedbacks.
Depending on whether additional funds will be borrowed or will be raised through common
stocks, consideration should be given on additional interest expense in the common statement or
dividends, thus decreasing the retained earnings.

Apply the iteration process using the available financing mix until the AFN would become so
small that the forecast can be considered complete.

Financial Planning and Control Process

Business is becoming increasingly competitive and corporate profitability is increasingly dependent upon
operating efficiency. This situation is desirable from a social standpoint, for consumers are getting higher
quality goods at lower prices but intense competition does make life tough on corporate managers.

Financial planning involves making projections of sales, income, and assets based on alternative
production and marketing strategies and then deciding how to meet the forecasted financial requirements.
In the financial planning process, managers should also evaluate plans and identify changes in operations
that would improve results. Financial control moves on to the implementation phase dealing with the
feedback and adjustment process that is required (a) to ensure that plans are followed, and (b) to modify
existing plans in response to changes in the operating environment. The process begins with the
specification of the corporate goals, after which management lays out a series of forecasts and budgets
for every significant area of the firm’s activities.

Financial forecasting analysis begins with projections of sales revenues and production costs. In standard
business terminology, a budget is a plan which sets forth the projected expenditures for a certain activity
and explains where the required funds will come from. Thus, the production budget presents a detailed
analysis of the required investments in materials, labor, and plant necessary to support the forecasted
sales level. Each of the major elements of the production budget is likely to have a sub-budget of its own;
thus, there will be a material budget, a personnel budget and a facilities budget. The marketing staff will
also develop selling and advertising budgets. Typically, these budgets will be set up on a monthly basis,
and as times goes by, actual figures will be compared with projected figures for the remainder of the year
will be adjusted if it appears that the original projections were unrealistic.

During the planning process, the projected levels of each of the different operating budgets will be
combined, and from this set of data the firm’s cash flow will be set forth in its cash budget. If a projected
increase in sales leads to a projected cash shortage, management can make arrangements to obtain the
required funds in the least-cost manner.

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After all the cost and revenue elements have been forecasted, the firm’s projected statements can be
developed. These projected statements are later compared with the actual statements such as:
comparisons can help the firm pinpoint reasons for deviations, correct operating problems, and adjust
projections for the remainder of the budget period to reflect actual operating conditions. Through its
financial planning and control processes, management seeks to avoid cash squeezes and to improve the
profitability of the individual divisions and thus the entire company.

Budgeting
Budgeting is the act of preparing a budget. A budget is a financial plan of the resources needed to carry
out tasks and meet financial goals. It is also a quantitative expression of the goals the organization wishes
to achieve and the cost of attaining these goals. The use of budgets to control a firm’s activities is known
as budgetary control.

The Purpose of the Budget

A budget is a description in quantitative – usually monetary – terms of a desired future result. The process
of preparing the budget requires management at all levels of focus on the future of the business entity.
The benefits that may be realized from a budgeting program are:
1. Defining broad objectives and goals and formulating strategies to achieve such objectives.
2. Coordinating the activities of the organization by integrating the plans of the various parts thereby
pulling everyone in the same direction.
3. Allocating resources to hose parts of the organization where they can be used most effectively.
4. Communicating management’s approved plans throughout the organization.
5. Uncovering and preparing for potential bottleneck in the operations before they occur.
6. Motivating managers to achieve the desired results.
7. Setting a standard or benchmark for evaluating actual performance.

Advantages and Limitations of Budgets

The advantages of budgeting include:
1. It forces planning and exposes situations in which plans of subcomponents are inadequate to attain
the total organization’s objectives.
2. It allows a reiterative process to bring the goals of the organization and the subcomponents into
agreement.
3. It provides a means of communicating organization goals down through the organization and sub-
unit operational limitations up though the organization.
4. It provides a basis for financial planning, sub-unit coordination, resource acquisition, inventory
policy, scheduling and output distribution.
5. It provides a basis by which activity can be monitored, with actual results being compared to the
planned results.

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The limitations of budgeting are
1. Budgets tend to oversimplify the real situation and fail to allow for variations in external factors.
They do not reflect qualitative variables.
2. It is difficult to prepare a detailed budget for an organization that has never existed or for a new
division, product, or department of an existing firm.
3. There may be lack of higher and lower management commitment because of lack of understanding
of the fundamentals of budget preparation and utilization.
4. The budget is only a representation of future plans or a means to the goal of profitable activity and
not an end in itself. It may interfere with the supervisor’s style of leadership and can therefore stifle
initiative.
5. Budget reports usually emphasizes results, not reasons.

Types of Budgets
The types of budgets or the major composition of the master budget are:
1. The Operating Budget
2. The Financial Budget
3. The Capital Investment Budget

The following is a simplified subclassification of the above-mentioned types of budget for a

manufacturing firm:
A. Operating Budget
1. Budgeted Income Statement
a. Sales budget
b. Production budget
• Materials cost budget
• Direct labor cost budget
• Factory overhead budget
• Inventory levels
2. Cost of Sales budget
3. Selling and Administrative budget
4. Financial Expense budget

B. Financial Budget
1. Budgeted Statement of Financial Position
2. Cash Budget
3. Budgeted Statement of Sources and Uses of Funds

C. Capital Investment Budget

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Steps in Developing a Master Budget
The major steps in developing a Master Budget may be outlined as follows:
1. Establish basic goals and long-range plans for the company. These will serve as guidelines in the
preparation of budget estimates.
2. Prepare a sales forecast for the budget period.
3. Estimate the cost of goods sold and operating expenses.
4. Determine the effect of budgeted operating results on assets, liabilities and ownership equity
accounts. The cash budget is the largest part of this step, since changes in many asset and liability
accounts will depend upon the cash flow forecast.
5. Summarize the estimated data in the form of a projected income statement for the budget period and
the projected statement of financial position as of the end of the budget period.

Master Budget Interrelationships

III. Activity – Supplementary

Problem (page 212 – 220)

IV. Activity/Assessment – Visit the MS Teams

V. References
Cabrera, M. and Cabrera, G. (2021-2022) Financial Management, Manila: GIC Enterprises
and Co. Inc.

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