Chapter 17

Financial Planning and Forecasting

Forecasting Sales
Projecting the Assets and Internally Generated
Funds
Projecting Outside Funds Needed
Deciding How to Raise Funds
17-1
Preliminary Financial Forecast:
Balance Sheets (Assets)
2012 2013E
Cash and equivalents $ 20 $ 25
Accounts receivable 240 300
Inventories 240 300
Total current assets $ 500 $ 625
Net fixed assets 500 625
Total assets $1,000 $1,250

17-2
Preliminary Financial Forecast: Balance
Sheets (Liabilities and Equity)
2012 2013E
A/P & accrued liabilities $ 100 $ 125
Notes payable 100 190
Total current liabilities $ 200 $ 315
Long-term debt 100 190
Common stock 500 500
Retained earnings 200 245
Total liabilities & equity $1,000 $1,250

17-3
Preliminary Financial Forecast:
Income Statements
2012 2013E
Sales $2,000.0 $2,500.0
Variable costs 1,200.0 1,500.0
Fixed costs 700.0 875.0
EBIT $ 100.0 $ 125.0
Interest 16.0 16.0
EBT $ 84.0 $ 109.0
Taxes (40%) 33.6 43.6
Net income $ 50.4 $ 65.4
Dividends (30% of NI) $15.12 $19.62
Addition to retained earnings $35.28 $45.78
17-4
Key Financial Ratios
2012 2013E Ind Avg Comment
Basic earning power Poor
10.00% 10.00% 20.00%
Profit margin Poor
2.52% 2.62% 4.00%
Return on equity Poor
7.20% 8.77% 15.60%
Days sales outstanding 43.8 days 43.8 days 32.0 days Poor
Inventory turnover 8.33x 8.33x Poor
11.00x
Fixed assets turnover 4.00x 4.00x 5.00x Poor
Total assets turnover 2.00x 2.00x 2.50x Poor
Debt/Assets OK
30.00% 40.40% 36.00%
Times interest earned 6.25x 7.81x 9.40x Poor
Current ratio 2.50x 1.99x 3.00x Poor
Payout ratio OK 17-5
30.00% 30.00% 30.00%
Key Assumptions in Preliminary Financial
Forecast for NWC
• Operating at full capacity in 2012.
• Each type of asset grows proportionally with
sales.
• Payables and accruals grow proportionally with
sales.
• 2012 profit margin (2.52%) and payout (30%) will
be maintained.
• Sales are expected to increase by $500 million.
(%DS = 25%)

17-6
Determining Additional Funds Needed Using
the AFN Equation
AFN = (A0*/S0)S – (L0*/S0)S – M(S1)(1 – Payout)
= ($1,000/$2,000)($500)
– ($100/$2,000)($500)
– 0.0252($2,500)(0.7)
= $180.9 million

17-7
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.
• A new facility will boost the firm’s net fixed assets to
$700 million.
• New inventory system to increase the firm’s inventory
turnover to 10x, without affecting sales.

17-8
Management’s Review of the Financial
Forecast
• These changes will lead to adjustments in the
firm’s assets and will have no effect on the firm’s
liabilities and equity section of the balance sheet
or its income statement.

17-9
Revised (Final) Financial Forecast:
Balance Sheets (Assets)
2012 2013F
Cash and equivalents $ 20 $ 67
Accounts receivable 240 233
Inventories 240 250
Total current assets $ 500 $ 550
Net fixed assets 500 700
Total assets $1,000 $1,250

17-10
Key Financial Ratios: Final Forecast
2012 2013F Ind Avg Comment
Basic earning power 10.00% 10.00% 20.00% Poor
Profit margin 2.52% 2.62% 4.00% Poor
Return on equity 7.20% 8.77% 15.60% Poor
Days sales outstanding 43.8 days 34.0 days 32.0 days OK
Inventory turnover 8.33x 10.00x 11.00x OK
Fixed assets turnover 4.00x 3.57x 5.00x Poor
Total assets turnover 2.00x 2.00x 2.50x OK
Debt/Assets 30.00% 40.40% 36.00% Poor
Times interest earned 6.25x 7.81x 9.40x Poor
Current ratio 2.50x 1.98x 3.00x Poor
Payout ratio 30.00% 30.00% 30.00% OK

17-11
What was the net investment in capital?
Capital2013  NOWC  NetFA
 $625  ($315  $190)  $625
 $625  $125  $625
 $1,125

Capital2012  $900

Net investment in capital  $1,125  $900

 $225

17-12
How much free cash flow is expected to be generated in
2013?
FCF = EBIT(1 – T) – Net investment in capital
= $125(0.6) – $225
= $75 – $225
= -$150

17-13
Suppose Fixed Assets Had Been Operating at Only 85%
of Capacity in 2012
• The maximum amount of sales that can be supported by the 2012 level of assets is:

Capacity sales  Actual sales/% of capacity

 $2,000/0.85  $2,353

• 2013 forecast sales exceed the capacity sales, so

new fixed assets are required to support 2013 sales.

17-14
How can excess capacity affect the forecasted
ratios?
• Sales wouldn’t change but assets would be lower,
so turnovers would improve.
• Less new debt, hence lower interest and higher
profits
• EPS, ROE, debt ratio, and TIE would improve.

17-15
How would the following items affect the
AFN?
• Higher dividend payout ratio?
• Increase AFN: Less retained earnings.
• Higher profit margin?
• Decrease AFN: Higher profits, more retained earnings.
• Higher capital intensity ratio?
• Increase AFN: Need more assets for a given level of
sales.
• Pay suppliers in 60 days, rather than 30 days?
• Decrease AFN: Trade creditors supply more capital
(i.e., L0*/S0 increases).

17-16