Financial Forecasting

A. L. Kingshott
Treasurer, Ford of Europe Inc. Ford Motor Cornpan)

B ECAUSE IT
denominator
corporate
IS

activities,
THE ONLY COMMON
for a vast range of
the major part of
to fixed assets, or temporary increases in
working capital requirements,
of the funds, being generated by profits
are in excess
higher the rate of return which can be
earned. A forecast of available funds is a
prerequisite for any investment plan.
any Corporate Plan must be expressed in and by depreciation charges. Many other- The two best known methods of cash
financial terms. The specifically financial wise efficient and profitable businesses forecasting are those based on an analysis
aspect of Corporate Planning, however, have encountered financial difficulties of expected receipts and payments and the
is the management of money. The two during the recent period of bank credit preparation of forecast balance sheets.
most important elements of this are the restrictions in which priorities for the The factors underlying the items forecast
management of money in terms of invest- available cash resources have been estab- in both methods are of course the same,
ment and borrowing, and the protection lished in relation to national economic (sales volumes, prices, costs of labour and
of company assets against changes in considerations rather than commercial materials purchased, etc.) but whereas
national and international currency values supply and demand. The timing of a period the Receipts and Payments forecast lists
by financial means. The management of of economic crisis may coincide with heavy the cash effect of these basic functions a
a company’s foreign exchange exposure cash requirements and if a business is to balance sheet forecast quantifies the profit
position is a topical matter, but because be assured of adequate funds to permit and depreciation cash flows, and reflects
it is of crucial significance to relatively operations to be maintained at a profitable expected changes in the balances of such
few companies, 1 propose in this paper to level a continuing examination of the working capital items as inventories,
discuss only the management of cash forecast cash requirement for at least two receivables and payables as well as showing
resources. This involves the necessity for years ahead is essential. Ford of Britain disbursements for capital expenditures,
cash forecasting. I will begin by discussing enjoyed a cash surplus position for many taxes, dividends, etc. The cash position
cash forecasting as a fairly short term years (it was in fact the Company referred emerges as the balancing item in the
activity, the guise in which it is probably to in the Radcliffe Report as holding balance sheet. The Receipts and Payment
most familiar, and 1 will then proceed to f28m of Treasury Bills at the end of 1958) forecast is most suitable for short periods
discuss the particular problems that emerge and in 1959 had surplus funds of approxi- and should be checked by the preparation
when cash forecasting is extended over mately f70m. Considerable expenditures of a balance sheet at the final date to
the longer periods associated with the on capital facilities, which have been ensure that inaccuracies in certain items
Corporate Planning activity. running at about f40m a year, resulted have not produced balance sheet amounts
in a foreseeable need for borrowed funds. which are clearly contrary to previous
CASH FORECASTING
Cash forecasts were prepared extending experience or established ratios. At Ford
Planning to meet cash requirements is an
3 to 4 years ahead to identify the period forecasts from one month to 3-4 years
essential management function in any
when funds would be needed, to select the ahead are based on the balance sheet
business. It is not enough for the under-
sources of funds most suitable for the method.
taking to make a profit. Cash resources
particular requirements, and to estimate
must be planned to finance a negative cash
the financing costs of the various funding Forecast Balance Sheets
flow in a period when necessary additions
- alternatives. In a period of surplus funds Control on the accuracy of the forecast is
This paper was first presented at the University the need for a forecast of future cash exercised by extracting variance analyses
of Bradford Management Centre Seminar on
levels is no less important. As a general between successive forecasts and by com-
“The Role of Forecasting in Corporate Plan-
ning”, October, 1968. rule the longer funds can be invested the paring the one month forecast with actual.

28 LONG RANGE PLANNING

for Corporate Planning
Planning to meet cash requirements
is an essential management function
in any business. It is not enough for
the undertaking to make a profit.
Cash resources must be planned to
finance a negative cash flow in a
period when necessary additions to
fixed assets or temporary increases
in working capital requirements are
in excess of funds being generated
by profits and by depreciation
charges. In a period of surplus funds,
the need for a forecast of future cash
levels is no less important. A fore-
cast of available funds is a pre-
requisite for any investment plan.
The author discusses in detail the
use of forecast balance sheets and
source and application of funds
statements. He also develops a
cash flow model and examines the
use of the computer for simulating
the financial consequences of
alternative policies.

When compiling the forecast balance which have been charged for these items the effect of changes in the Purchase Tax
sheets it is therefore desirable to comply in the particular profit forecast are used. rate. In compiling the sales and production
with the accounting conventions in use in Because of the delay in making tax pay- volumes which I have referred to previously
the company’s accounts in order that ments profits are shown before tax and as the Production Programme, account
comparisons are not distorted. For ex- tax payments forecast as a separate item. is taken of seasonal fluctuations in con-
ample, several methods of accounting for One of the items included in profit will be sumer demand which make it desirable
Government Grants are currently in either investment income or borrowing to hold a higher level of dealer stocks in
vogue; Ford offsets them against the cost expense which is itself calculated from winter months to maintain production
of the asset and sets up a Receivable for the cash forecast. This is a chicken and levels in the factories. Export requirements
the amount due. If the forecast balance egg situation which is usually resolved by are also seasonal, unfortunately coinciding
sheets took grants into profit then sub- using the cash forecast for the interest to some extent with domestic demand but
sequent comparisons with the Company’s effect of any significant change in cash do not usually result in increased vehicles
actual balance sheet would cease to be from the previous forecast. Using forecasts stocks. Before the introduction of a new
meaningful. of profit before tax, tax, and dividends, model, stocks are built up to ensure that
The Sales and Production vohrne jore- appropriate adjustments can be made to dealers will have vehicles to sell when the
casts used in the cash forecast are those Net Worth, Payables and the Tax Liability announcement is made and this will be
which are developed for the Company’s as appearing in the balance sheet for the reflected at the appropriate times in the
Profit Budget. These will have regard end of the previous period. Depreciation forecast. Forecasts of work in progress
to production capacity and sales demand and amortisation of fixed assets can also are also based on production volumes
which will reflect forecast national eco- be adjusted by the amounts to be charged but may also reflect build up of stocks if
nomic conditions and their expected effect to profit and the gross cost of Fixed Assets certain production facilities are planned
on industry and company volumes. Current increased by forecast facility expenditures to be out of use, perhaps for re-arrange-
year figures are reviewed monthly in the as reduced by Government Grants. ment or modernization.
form of a Production Programme. Those Theoretically, retirements of fixed assets The effect of volume changes on working
for the future years are revised less should also be forecast. As the assets capital items can most clearly be seen
frequently when significant changes have concerned are probably fully written off at the time of the annual vacation shut-
occurred, perhaps quarterly. and their scrap value may not be signifi- down. By the end of this three-week period
Profit forecasts are obtained by meas- cantly more than the cost of removal and payables and vehicle inventories will have
uring variances from the original profit there would be little cash effect and we fallen by more than &lOm.
plan caused by changes in volumes, have not attempted to establish a basis As payment is received for domestic
prices, manufacturing costs, administrative for forecasting asset retirements. vehicles at the time when they become
and commercial expenses, etc. Deprecia- The other major asset categories are accounted sales, no receivable is generated.
tion and amortisation charges and Govern- inventories and receivables. In the motor Dealers however receive normal trade
ment Grants will have been calculated industry inventories comprise stocks of credit terms for spare part sales and all
on the basis of the current Capital Expend- vehicles held by domestic dealers in exports (mainly to Ford associated com-
iture programme. As cash flow is generated addition to normal work in progress items, panies) are payble one month after
by profits before depreciation and amortis- as vehicles are distributed on a sale or shipment. The receivable forecast, there-
ation it is essential that the actual figures return basis to protect the dealers from fore, is built up by reference to the volume

DECEMBER, 1968 29
 forecast and payment terms for the relevant TABLE 1. SCATTER DIAGRAM FORECAST
items of sales and also includes unpaid -_
government grants.
Although cash has been described as Inventory as
End year Sales per Inventory number of
the balancing item of the exercise it is
working day days’sales
important to identify separately the amount g Jz
of non-liquid cash which the business
requires if the amount is significant. This
may comprise petty and undeposited cash
and, if the bank does not give immediate 1964 19,000 336,000 17.7
value for cheques paid in for collection, 1965 21,000 355,000 16.9
the sums in course of collection. If a 1966 23,000 364,000 15.8
borrowing requirements is indicated by 1967 25,000 375,000 15
the forecast this will, of course, be 1968 (forecast) 27,000 378,000 (projection)
increased by forecasting an item of non-
liquid cash. Conversely if most suppliers
are paid immediately prior to the date of
380-
the forecast and the company’s book
position of cash reflects these cheques then
actual cash or borrowing may be different
by the value of the unpresented cheques.
It may not, however, be desirable to
reverse the cheque entries by a transfer
to payables as they will undoubtedly be
presented within a day or two justifying
the conservative approach of treating them
as presented at the bank. This factor
must however be considered when recon-
ciling actual borrowings with forecasts
made on this basis.
The principal current liability items to
be forecast are payables and taxes. Payables
may be related to production volumes
although it is necessary to take into
account any proposed increases in stocks
of raw materials. If capital expenditures
fluctuate significantly and a detailed fore-
cast is available then it is desirable to
forecast these payables as a separate item.
In relating payables to production volumes
it should be recognized that the change
in the provision for payables in the balance
sheet from one period to the next is caused
by two factors having opposite effects;
cash paid to suppliers and new deliveries
of merchandise. Whilst the volume of
new deliveries should in the main have 19 20 21 22 23 24 25 26 27 28
correlation to the preceding month’s
production (assuming 30 day credit terms) Sales per day (JZ thousands)
cash payments should be related to the
previous month, or earlier if the company
is known to be dilatory in paying its
suppliers. The Corporation Tax provisions
can be built up by reference to taxes on
forecast profits and known due dates for balance sheet, the identity and classification may not remain constant at different sales
payments. Where, however, the company is of which will have been discovered by levels and a more realistic forecast may
a collector of Purchase Tax which is paid careful analysis of a current actual balance be obtained by plotting a graph line
to the Excise Authorities periodically, sheet, the difference between assets and representing past experience of inventory
then the provision for unpaid Excise Tax liabilities can be inserted either as cash levels at the actual sales levels and then
will be based on sales volumes in the or borrowings. When referring to the projecting the line to the current sales
appropriate period. methods used for forecasting certain forecast. In this way the changing ratio
Additions to provisions for salaries, balance sheet items I have suggested that of sales to inventories at different sales
wages, holiday pay, PA YE, pension costs these should be related to production or levels will be taken into account. In the
do not usually fluctuate significantly and sales volumes. These relationships are example on Table 1 using a fixed ratio
can be predicted by reference to past sometimes expressed as a ratio, say, of (say) 15 days’ sales 1968 inventories
experience without substantial inaccuracy. inventories being a certain number of of &405,000 would have been forecast
Having forecast all other items in the days’ sales. As shown in Table 1 this ratio instead of &378,000.

30 LONG RANGE PLANNING

 TABLE 2. BALANCE SHEET

Subsequently
established
Actual Forecast Actual
31 August 1968 31 September 1968 31 October 1968 30 September 1968

Cash 19,000 25,000 23,000 22,000

Receivables 619,000 622,000 625,000 614,000

Inventories 969,000 965,000 970,000 969,000

Property, plant and equipment 2,993,ooo 3,018,OOO 3,043,ooo 3,015,oOO

Less : accumulated
depreciation 1,123,OOO 1,143,ooo 1,163,OOO 1,142,OOO

1,870,OOO 1,875,OOO 1,880,000 1,873,OOO

Total Assets g3,477,000 &3,487,000 J?3,498,000 g3,478,000

Bank liabilities 867,000 868,000 754,000 865,000

Payables 813,000 817,000 814,000 816,000

Excise and withheld taxes* 60,090 136,000 35,000 132,900

Corporation taxes 77,000 87,000 97,000 86,000

Salaries and wages 10,000 10,000 10,000 11,000

Vacation and holiday pay 5000 10,000 15,000 10,000

Long term debt 73,000 73,000 73,000 73,000

Net worth 1,572,OOO 1,486,OOO 1,700,000 1,485,OOO

Total Liabilities and Net Worth 63,477,OOO f3,487,000 g3,498,000 L3,478,000

*Includes dividend withholding tax.

Forecast Source and Application borrowings or repayments of borrowings

of Funds are also shown then the final figures will
Although the preparation of a forecast be the closing cash position.
balance sheet (Table 2) will indicate The cash additions section will include:
forecast surplus cash or borrowings at
particular dates, the reasons for the changes
during each period can best be explained . depreciation
by the use of a Source and Application of . payables
Funds Statement (Table 3). This can
comtnence with opening cash and include
sections for cash additions, effect on cash
of changes in working capital accounts
and cash disbursements. If any new
 _ --___-_ ___- _--__- _ -__
TABLE 3. SOURCE AND APPLICATION OF FUNDS STATEMENT
Date of Forecast-31 August, 1966. Amount in J?s. Cash outflow in brackets

Forecast Subsequently Variance

established analysis
Actual from
at 30 Forecast
September 1968 dated 31 August

September October September

Gross Cash and Cash Investment at

Beginning of Period 19,000 25,000 19,000 -

Cash additions :
Profit before tax 24,000 24,000 22,000 (2000) Sales g8000 lower than volume forecast-profit effect
JL3000.
depreciation El000 lower than forecast
Depreciation 20,000 20,000 19,000 (1000) lower level of capital expenditures in September.
Other additions-proceeds of issue
of ordinary shares - 200,000 -

Total Additions 44,000 244,000 41,000 (3000)

=
Effect on cash of changes in non-cash
working capital accounts :
Receivables (3000) (3000) 5000 8000 lower sales level in September
Inventories (5000) - (4000) increased by cost of lower sales g5000 and reduced
by lower deliveries from suppliers dElOO0
Payables (3000) 3000 lower deliveries from suppliers
Other (net)* 39$! (54,000) 36,000 {z$ lower purchase tax collections X.4000-Error in
forecasting Salaries and Wages liability LlOOO
Total 44,000 (65,000) 44,oM) lower than actual

Cash Disbursements
Capitalized facility expenditure (25,000) (25,000) (22,000) 3000 delay in delivery of new machinery.
Dividends and dividend withholding
taxes (58,000) (42,000) (58,000) -
Corporation tax payments - - -

Total disbursements (83,000) (67,000) (80,000) 3000

Borrowing (Repayments) 1000 (114,000) (2000) (3000)

Increase/(Decrease) in Cash 6000 (2000) 3000 (3000)

Gross Cash and Cash Investments

at End of Period 25,000 23,000 22,000

omprises-purchase tax-collection
-payment
7
Change in salaries and wages liability luuu 1080
Vacation and holiday pay liability GO0 GO0 6000 -
5
z
39,000 (54,000) 36,000 (3000)
z B B
0
in fact everything which could fluctuate requirement of working capita1 is bank a. Clearing Bank Deposits which usu:~liy
in either direction but is not listed overdraft. At the present time the banks earn 2 cent Bank Rate.
separately in this section. are under severe restrictions regarding the b. Deposits with Non-clearing
The cash disbursements section will amounts of funds they may lend and have
include: been directed to give preference to manu- and be made for
capital expenditures facturing industry, particularly to ex-
trade investments porters. Interest rates are usually related from
dividend payments to Bank Rate and vary from the “blue- 7h cent p.a. for
income tax payments and chip” level of Bank Rate plus 4 per cent per cent p.a. for one year
other disbursements p.a. reserved for the most credit worthy Rate 7; cent p.a.).
Capital expenditures will represent gross customers, upwards. Acceptance facilities c. Loans to Local Authorities.
expenditures less grants if this is the are also available from banks who will are similar for deposits
accounting practice of the company. accept and discount bills of exchange to with Non-clearing banks and loans
Dividend payments should be shown net finance outstanding Receivables. The mini- may
and the subsequent tax payment should mum acceptance commission charged by this mar-
appear in the appropriate period of the the members of the Issuing Houses ket.
forecast. Association is usually 1 per cent p.a.
d. Reserve CertiJicates. are
If the company is in a borrowing position and the bills are then eligible for discount
then the final cash figure should now be issued 525 earn
at the Fine Bill Rate, usually a fraction
inserted representing the non-liquid cash tax-free interest rate
below Bank Rate. Foreign currencies,
applying the time
requirement and the balancing change in including Euro currencies, can also be
borrowing requirements then entered in per cent p.a. before tax). They can
borrowed subject to Exchange Control
the preceding section as additional bor- used to Corporation and other
approval. Although interest rates on some
due at least two
rowing or as a repayment. currencies may be lower than for sterling
can be
funds the possibility of exchange loss must
held indefinitely they earn interest
The Variance Analysis be considered and if a forward cover
only 24 months. Surrender for
If a reasonable degree of accuracy in contract is arranged the total cost will
at days notice is possible
forecasting methods is to be achieved it usually be found to be more in line with
two but no interest
is necessary to learn by past mistakes. the market rate for sterling funds. Some
are transferable.
These can best be identified by a variance banks can arrange to discount notes or
When comparing the return with
analysis showing reasons for the changes bills drawn against shipment of goods
that
in each figure between one forecast and the between two countries outside Germany.
interest only to date
next and particularly between the one As German Banks can discount this paper
the which
month forecast and the subsequent actual with the Bundesbank at German Bank
the company did not
(Table 3). These may be due to revised Rate (currently 3 per cent) a favourable
always make tax
forecasts of sales or production volumes, discount rate can be quoted and if forward
the date.
changes in credit terms, increases in manu- cover costs are not too high the total cost
facturing costs or even improvements in may be less than for sterling funds. e. Treasury Bills. are issued
the method being used to forecast the Medium term sterling loans have, in each Friday
particular item. recent years, been difficult to obtain the date stipulated duling the
For the purpose of illustration, I have because the institutional lenders have following week and days
included a Source and Application of preferred to secure what have been later. The are
Funds Statement, a Variance Analysis considered historically high interest rates obliged for whole
and a hypothetical Balance Sheet (Tables for as long a period as possible. Some amount
2. 3 and 4) which show the transition of specialist banks have however been formed and compete with
Balance Sheet figures into the Source and to make medium term loans and Euro
Application of Funds Statement and currencies can be borrowed for up to five and domestic Clearing
explain the changes of certain items from years or more. The
fcorecast to actual as a Variance Analysis. Long Term funds can be raised by Clearing own
The pattern of surplus cash and/or issuing Ordinary or Preference shares, requirements from the
borrowing requirements which is not Debenture Stock or Unsecured Loan and do
available will form the basis of the Stock. Alternatively properties can be sold compete the tender
Company’s investment policy and/or bor- and leased back. with less than 84 days life to
rowing programme. The shape of future maturity. The rate
borrowing requirements will determine is normally per cent
the sources of funds to be used and an Investment Policy Bank Rate but can vary according
accurate forecast will avoid over borrowing Investment or surplus funds can also be to expected short-term interest
at rates in excess of those which can be planned to maximize investment income trends and for other reasons.
earned on surplus funds, prevent commit- if the pattern of the sums expected to be
ment fees being incurred on unnecessary available has been forecast. It may be are usually
borrowing facilities and may indicate a advantageous to invest funds presently day) settlement
cheaper form of finance than (say) an available in investment if a subsequent the market pre-
expensive lease-back transaction. period in which surplus cash levels are pared to deal for day
falling is seen to be only temporary and or so later by arrangement. Stocks
Borrowing Programme suitable borrowing sources are known to with less than five years life to
The most usual source of short-term funds be available to finance the deficit. Suitable maturity are dealt
which can be used to finance a temporary forms of short term investments include: for which

DECEMBER, 1968 33
TABLE 4. ASSUMPTIONS FOR BALANCE SHEET AND SOURCE AND a longer period than three to four years.
APPLICATION OF FUNDS STATEMENT although the basic principles are, ot
necessity, the same, the forecasting process
rapidly tends to become very different.
Forecast Actual The reason for this is that in the shorter
September October September term the values of most of the variables
with which one is concerned have been
determined by formal management decision
Trading profit 44,000 44,000 41,000
or else are likely to fluctuate only within
20,000 20,000 19,000
a fairly narrow range: in the longer run.
Depreciation
these same items may not have been
Profit before tax 24,000 24,000 22,000 determined at all, or else could still be
subject to radical alteration.
Tax 10,000 10,000 9000 III the shorter run for instance it is
probable that all the major capital ex-
Profit after tax &I 4,000 ~14,000 rE13,ooo penditure decisions have been taken; in
the longer run it is extremely probable
that the person making the cash forecast
Capital expenditures 25,000 25,000 22,000
will have to work with a different set of
persons and concepts. This will require
Other Working Capital Account Changes (adverse cash effects in a forecast of the future product range,
brackets) sales volumes, spare capacity requirements.
and the changes in stock levels. Not only
Purchase Tax-collection 34,000 35,000 30,000 will the cash forecaster have to take
account of the capacity requirements
-payment - (94,000) - implied by these forecasts. he will also
have to consider where this capacity will
Vacation and holiday pay liability 5000 5000 5000 come from. By the extension of existing
facilities? Or by an Acquisitions policy’?
Receivables (3000) (3000) 5000
The effect of these policies on cash forc-
Payables 4000 (3000) 3000 casts will be very difficult. These forecasts
will, in turn, influence another cash
Inventories 4000 (5000) - forecasting item, the future level of
depreciation. From becoming a fairly
Salaries and wages - - (1000) self-contained exercise, then, the cash
forecasting process in the longer term
gradually extends its sphere of interest to
New share capital proceeds received in October-g200,OOO. cover almost the total of corporate
activity.
Dividend ~100,000 paid net in September E58,OOO cash withholding
tax of ;E42,000 paid in October (included in Excise and withheld
Taxes at September 30, 1968). The Cash Flow Model
Let me illustrate how extensive the infor-
mation required to prepare the long term
cash forecast can become, by reference
payment is made in addition to the h. Sterlitzg Certlficatcs qf Depo.Gt. The to Table 5.
quoted price but the price of an London market is making plans to As can be seen, the format of our Cash
“over five year” stock includes the deal in sterling certificates of deposit. Flow model is almost identical to the one
right to interest accrued smce the The advantage of these certificates we use in our short term forecast but
last half-yearly interest date. As the would be one of marketability com- many, though by no means all, of the items
shorter-dated stocks currently offer pared with normal bank deposit and are calculated on different bases to the
a gross yield ot about 7$-7f per cent they will presumably earn fractionally short term forecasts.
pa. the return is likely to be less less than straight deposits. The Dis- The first item, Gross Cash, presents
attractive than other forms of invest- count Houses operating the second- some problems since historical cash levels,
ment unless a period of falling ary market would also have to take as shown on the balance sheet, very rarely
interest rates is successfully foreseen a “turn” between buyer’s and seller’s represent the actual amounts needed to
and appreciation during the period price thus further reducing the yield run the business; for example, cash levels
the stock is held exceeds the “straight if they could not be held to redemp- may be inflated during a period of rising
line” expectation to maturity. tion. If the return, however, is better profits, low capital investment, and re-
g. Loans to Finance Houses. The larger than “overnight” money or Treasury stricted dividends, thus giving a misleading
Finance Houses usually take deposits Bills then these certificates might be impression. It is necessary, therefore, to
for fixed periods of three months a suitable form of investment in a establish a level of cash required for
or longer at rates broadly comparable period when temporary funds were operating purposes. Once this has been
to those obtainable on loans to Local available. done, projections can be made on the
Authorities. Certain Houses are historical relationship with a key variable
wholly or partly owned by Clearing CASH FORECASTING IN THE such as Cost of Sales.
banks which provides assurance of LONGER TERM This will indicate the level of working
their credit status. When cash forecasting is extended over cash required. If the independently forecast

34 LONG RANGE PLANNING

 TABLE 5. ITEMS INCLUDED IN THE LONG TERM CASH FLOW FORECAST

ITEM FACTORS DETERMINING THE FORECAST

Gross Cash and Cash Investments at Forecast on basis of estimated minimum average working cash
Beginning of Period requirements.

Cash additions:
-Profit before taxes Forecast takes account of: Prices, Product Range, Sales
Volumes, Gross Margins and Fixed Costs.

-Depreciation Asset level after adjustments for additions and retirements,

changes in depreciation techniques, and investment grants.

Other additions:
e.g. Increase in equity finance Forecast on basis of optimum gearing structure and expected
Investment grant receipts rates,‘practice of investment incentives.

Effect on cash of changes in non-cash

working capital accounts:
-Receivables Projected on basis of historical relationship with revenue.
-Inventories Forecast as function of: Raw materials
Work in process
Finished stocks
Projections based upon historical relationships modified for
anticipated changes in corporate level of integration.

-Payables Forecast on basis of historical relationship with cost of sales.

-Accruals and prepayments (net) Forecast on basis of historical experience, e.g. per cent of
current assets.
Other (net)
e.g. Collection:‘payment of purchase tax Forecast depends on expected direct’indirect taxation, and
Investment grants receivables investment incentive structure and rates.

Cash disbursements:
-Capitalized Facility Expenditure Forecast on basis of asset replacement estimates, capacity
expansion programmes, and new model programmes, modified
for changes in price levels, investment incentives, etc.

-Dividends and dividend withholding Forecast on basis of historical payout rates adjusted for anti-
taxes cipatod changes in gearing and tax policies.

-Corporation tax payments Forecast on basis of estimated rates and payment practices.

-Net Interest (on loans, overdrafts, Forecast on estimated bank:market rates in major European
and investments) Capital Markets for shortimedium:long term debt/investments.

-Borrowings:investments Determined according to the cash shortfalls:surpluses indicated

by the cash flow model.

-Repayments Forecast on basis of current and estimated future medium/long

term debt redemption dates.

Gross Cash and Cash Investments at End of Period

levels of receipts and disbursements that stock market investment, which may the manufacturing cost structure? Let u\
senerate a shortfall, it will mean that well provide a haven for short term take the profit as read and move on to the
the “previous” year’s borrowings will have surpluses, is not, in the long term, an next item.
to be increased. If they generate a con- acceptable solution. Although we do not forecast assei
tinuous surplus over the years, even when The determination of profit before taxes retirements in the short term, in the Ion::
most or all long term debt has been is crucial, but this is not the moment to term, this factor has an extremely im-
extinguished, it may mean that a re- consider the techniques in detail except portant effect on the depreciation chnngc
appraisal of debtor, creditor. and in- to say that a larger number of assumptions and a forecast of asset retirements and
\entory assumptions is needed, or even will have to be made relating to corporate replacements must be made. At Ford, a
:I fresh look at dividend policies and profitability in future years. For example, large proportion of capital expenditure
capital investment plans. Obviously in the what products will we be making? How will be composed of new model ar!.!
long run, a company should be able to earn will the prices of raw materials. labour, capacity expansion programmes, bu! th:
:I better rate of return by using its cash an d our own products change‘? Will assets which provide existing capacity \+ill
Internally than by investing it outside. so technological changes significantly affect have to be replaced sooner or later. The

DECEMBER, 1968 35
 estimated asset lives as used for deprecia- policies would the British entry to the is so susceptible to the consequences ot
tion purposes may give a clue to the time Common Market have, or even the forecasting error and uncertainty as cash
at which assets will have to be retired and realization of the “European Company” flow. This is not only because cash flows
replaced, or it may be necessary to make concept 7 are relatively small differences between
an analysis of historical retirements by The last two lines on our cash flow very large magnitudes, but because errors
year of purchase. Changes in depreciation model, Borrowings/Investments and Re- in one variable tend to cause dispropor-
practices will also affect the timing of payments, represent the balancing adjust- tionate errors in others. If there is an
the cash flow in any one year though not ments necessary, with forecast receipts and unanticipated and major change in sale
over a long period. A change in the invest- disbursements, to maintain cash at the volume, it is probable that one will find
ment grant structure would also have a level required for the smooth operation that variable costs will not vary as smoothly
significant effect on depreciation charges of the enterprise. It is the responsibility as one had been led to expect. The dis-
since depreciation is calculated on the net of the Planning Staff to examine whether cussion on the variability of labour costs
cost of the asset. the level of borrowings is acceptable or might be resolved quite suddenly, if not
The other major sources of cash are otherwise. If the level is too high, then expectedly, if there are major changes
investment grant receipts and the proceeds another form of financing may be neces- in the size of the labour force, while
of equity issues, a need for the latter item sary, e.g., equity finance. anticipated changes in inventory costs are
being determined by ratio analysis of I could extend this section considerably, probably too deeply rooted in the un-
balance sheet relationships and, of course, but I think I have written enough to realistic concept of orderly changes to be
the comparative cost of capital. Once indicate that in long term cash forecasting of great use. The “surprise” or “dis-
more, broader issues impose themselves. a great deal less can be taken for granted ruption” costs that result from errors in
For example, what effect would compul- and that there has to be speculation on forecasting tend to be very high and it is
sory employee shareholding have on a wide variety of corporate, industrial, not too much to say that failure to foresee
company financing? It is worthwhile to and environmental trends. This is not just this can endanger the chances of a com-
point out at this stage that we prepare a a matter of emphasis, it is a question of pany’s survival. It is, therefore, of the
forecast balance sheet in conjunction with scale. I would go so far as to say that the greatest importance that the longer term
the cash flow model and use ratio analysis skills required for successful long term cash flow forecast and policy recommenda-
to indicate whether key relationships are cash forecasting are utterly different from tions be made only after the problem of
in disequilibrium. If this is the case, some those required for successful short term the uncertainty surrounding the forecast
of the assumptions may have to be forecasting. has been formally and rigorously analysed.
modified. It is most unlikely that a systematic
Sensitivity Analysis
The next four items, Receivables, In- examination of the probably results of the
Let me hasten to add that the need for
ventories, Payables, and Accruals and combinations of the many alternative
omniscience in long term forecasting can
Prepayments do not present any particular outcomes that can be associated with the
be avoided by the use of some form of
problems, and can all be forecast on the long term cash forecasting process will
sensitivity analysis. This is extremely
basis of historical relationships to key leave the initial policy proposals un-
simple in concept; it is a technique
variables, e.g., average debtor collection changed. Because of the financial con-
designed to show the effect on the
periods, although some modification to sequences of being wrong if the company
forecast of various hypothesized changes
inventory levels may be necessary to reflect is too highly geared in a period of low
in variables which are used in the fore-
changes in the corporate level of integra- profitability, the development of a fairly
casting process. The result is that one can
tion. normal system of policy making which
focus attention and forecasting effort on
Other items which have to be considered can cope with error and uncertainty is
the things that matter rather than on things
are those taxes where the company acts basic to the success of long term cash
that merely change.
as an agent for the Tax Authorities, such forecasting.
I find in practice, however, that the use
as Purchase Tax. A change from purchase I would like to conclude this paper by
of sensitivity analysis requires considerable
Tax to a lower level of Value Added tax saying that the end product of financial
precision of thought if all the implications
on all consumer products at a common forecasting for corporate planning pur-
of the hypothesized changes are to be
rate would be significant, not only because poses is very similar to that required for
properly thought through, and this leads
of the effect on the demand for motor cars, shorter term planning period. The differ-
me to the view that to make a real success
but also because the motor industry acts ence between cash forecasting for the
of long term cash forecasting it is necessary
as an agent for the government in the longer and shorter periods is therefore
to develop a fairly rigorous mathematical
collection of purchase tax from the dealer. a matter of technique. This is because
model of corporate activity which can be
With regard to capital expenditure, the longer term forecast can take much
computerized. Computerization not only
there is no need to enlarge upon what has fewer facts for granted and must therefore
avoids the tedium of manual sensitivity
already been said in connection with be based on a comprehensive review of
analysis, but also allows one to take some
depreciation. both corporate and environmental ac-
account of the complexities of actual
Dividend payments, Withholding Taxes, tivity. As this view is potentially panoramic,
corporate decision making.
and Corporation Taxes require a number it is therefore necessary to develop tech-
of difficult assumptions to be made, Uncertainty niques which reduce redundant effort by
particularly when one considers the prob- The final aspect of long term financial indicating which surprise developments
lems facing international companies. Will forecasting on which I would like to will significantly efTect the forecast if they
exchange control policies be liberalized or concentrate is that of uncertainty. This is actually occur. Finally, because the view
tightened‘? What will be the attitude of an area in which, again, the use of a is also long term, it is necessary in addition
governments on the repatriation of profits‘? computer is advantageous, and it is also to use techniques which can assess the
Could the abandonment of the Corpora- an area which by its very nature is of much robustness of favoured financial policies
tion Tax system in the UK lead to a greater importance to long than short in the face of much larger degrees of error
complete change in gearing and dividend term cash forecasting. There is, 1 think, and uncertainty than is present in shorter
policies. What effect on national taxation no area of a company’s operations which term cash forecasts. n

36 RANGE PLANNING