CHAPTER 17

Financial Planning and Forecasting Pro Forma Financial Statements
Steps in Financial Forecasting: 
 



Forecasting sales Projecting the assets and internally generated funds Projecting outside funds needed Deciding how to raise funds
17-1

Strategic Planning
1) Mission Statement. Example? 2) Firm s Corporate Scope 3) Statement of Corporate Objectives 4) Corporate Strategies 5) Operating Plan 6) Financial Plan Pro forma / projected FS
17-2

  Corporate planning Financial planning .requires to forecast & analyze a set of financial statement Pro forma financial statements    Sales forecasts regress past years sales Percent of sales method  Additional Funds Needed (AFN) formula 17-3 .

Financial Planning and Pro Forma Statements  Three important uses: Forecast the amount of external financing that will be required Evaluate the impact that changes in the operating plan have on the value of the firm Set appropriate targets for compensation plans 17-4 .

AFN = (A*/S0) S (L*/S0) S M(S1)(RR) AFN = Projected increase in assets Spontaneous increase in liabilities Increase in REs Refer page 557 on details of each components 17-5 .

17-6 . percent of net income not paid as dividend.Definitions of Variables in AFN  A*/S0: assets required to support sales.  (S: increase in sales. called capital intensity ratio.  L*/S0: spontaneous liabilities ratio  M: profit margin (Net income/sales)  RR: retention ratio.

250 17-7 .000 2007E $ 25 300 300 $ 625 625 $1.Preliminary financial forecast: Balance sheets (Assets) Cash and equivalents Accounts receivable Inventories Total current assets Net fixed assets Total assets 2006 $ 20 240 240 $ 500 500 $1.

Preliminary financial forecast: Balance sheets (Liabilities and equity) Accts payable & accrued liab. Notes payable Total current liabilities Long-term debt Common stock Retained earnings Total liabilities & equity 2006 $ 100 100 200 100 500 200 $1.000 2007E $ 125 190 315 190 500 245 $1.250 17-8 .

28 2007E $2.78 17-9 .40 $19.0 1.6 $50.0 16.Preliminary financial forecast: Income statements 2006 Sales Less: Variable costs Fixed costs EBIT Interest EBT Taxes (40%) Net income Dividends (30% of NI) Addition to retained earnings $2.0 $125.500.12 $35.0 43.0 $100.500.0 1.4 $15.6 $65.0 16.0 875.62 $45.000.0 700.200.0 $84.0 $109.0 33.

40x Current ratio 2.00x Payout ratio 30.8 days 43.99x 3.0 days Inventory turnover 8.62% 8.00% 2.00x Total assets turnover 2.77% Ind Avg 20.00% 2.33x 11.00x 2.00% 4.00% 40.52% 7.00% 30.00% .81x 9.00% 15.00x 5.50x Debt/assets 30.00x 4.00% 30.Key financial ratios Basic earning power Profit margin Return on equity 2006 10.8 days 32.25x 7.34% 36.50x 1.00x Fixed assets turnover 4.33x 8.60% Comment Poor Poor Poor Poor Poor Poor Poor OK Poor Poor OK 17-10 Days sales outstanding 43.20% 2007E 10.00% Times interest earned 6.00x 2.

Sales are expected to increase by $500 million. Payables and accruals grow proportionally with sales. Each type of asset grows proportionally with sales. (%(S = 25%) 17-11 .52%) and payout (30%) will be maintained. 2005 profit margin (2.Key assumptions in preliminary financial forecast for NWC      Operating at full capacity in 2005.

000)($500) ($100/$2.7) = $180.500)(0.0252($2. M(S1)(RR) 17-12 .9 million.000)($500) 0.000/$2. using the AFN equation AFN = (A*/S0) S (L*/S0) S = ($1.Determining additional funds needed.

These changes will lead to adjustments in the firm s assets and will have no effect on the firm s liabilities on equity section of the balance sheet or its income statement. without affecting sales.Management s review of the financial forecast   Consultation with some key managers has yielded the following revisions:  Firm expects customers to pay quicker next year. thus reducing DSO to 34 days without affecting sales.  New inventory system to increase the firm s inventory turnover to 10x.  A new facility will boost the firm s net fixed assets to $700 million. 17-13 .

000 2007E $ 67 233 250 $ 550 700 $1.Revised (final) financial forecast: Balance sheets (Assets) Cash and equivalents Accounts receivable Inventories Total current assets Net fixed assets Total assets 2006 $ 20 240 240 $ 500 500 $1.250 17-14 .

60% Comment Poor Poor Poor OK OK Poor Poor OK Poor Poor OK 17-15 Days sales outstanding 43.00% 4.00x Total assets turnover 2.00% 15.50x 1.00% 2.00% 30.40x Current ratio 2.20% final forecast 2007F 10.00x 3.00x Payout ratio 30.00% Times interest earned 6.00% .77% Ind Avg 20.00% 30.33x 10.Key financial ratios Basic earning power Profit margin Return on equity 2006 10.62% 8.0 days Inventory turnover 8.25x 7.00x Fixed assets turnover 4.00x 2.57x 5.00% 40.75x 3.8 days 34.00x 2.34% 36.50x Debt/assets 30.52% 7.00x 11.0 days 32.00% 2.81x 9.

125 .$900 = $225 17-16   .$125 + $625 = $1.What was the net investment in operating capital?  OC2007 = NOWC + Net FA = $625 .125 OC2006 = $900 Net investment in OC = $1.

in OC $125 (0.How much free cash flow is expected to be generated in 2006? FCF = = = = = NOPAT Net inv. 17-17 .6) $225 $75 $225 -$150. in OC EBIT (1 T) Net inv.

353  2006 forecast sales exceed the capacity sales.Suppose fixed assets had only been operating at 85% of capacity in 2005  The maximum amount of sales that can be supported by the 2005 level of assets is:  Capacity sales = Actual sales / % of capacity = $2.85 = $2. so new fixed assets are required to support 2006 sales. 17-18 .000 / 0.

so turnovers would improve.How can excess capacity affect the forecasted ratios?   Sales wouldn t change but assets would be lower. hence lower interest and higher profits  EPS. 17-19 . and TIE would improve. ROE. Less new debt. debt ratio.

more retained earnings. Increase AFN: Need more assets for given sales. rather than 30 days?  Decrease AFN: Trade creditors supply more capital (i. Decrease AFN: Higher profits.e.  Higher profit margin?   Higher capital intensity ratio?   Pay suppliers in 60 days. 17-20 ..How would the following items affect the AFN?  Higher dividend payout ratio?  Increase AFN: Less retained earnings. L*/S0 increases).

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