FINANCIAL

FORECASTING FOR
STRATEGIC
GROWTH
Introduction
Long Range Planning - means of
systematically thinking about the
future and anticipating possible
problems before they occur.
Financial Planning – establishes
guidelines for change and growth in
a firm- concerned with the major
elements of a firm's financial and
investment policies.
What is Financial Planning?
- Formulates the way in which financial
goals are to be achieved/to be done in
the future
 Growth as Financial Management Goal
• Appropriate goal – increasing the market value of the owner’s
equity
• Growth – desirable consequences of good decision making
• Growth rate – summarizing various aspects of a firm’s financial
and investment policies
Perspective of Financial Planning
• Short-run Planning – covers the coming 12 months
• Long-run Planning – covers the coming 2 to 5 years

• Dimension
1) Time period - planning horizon
2) Aggregation – involves the determination of all the individual projects
3) Inputs in the form of alternative sets of assumptions
WHAT ARE THE BENEFITS THAT CAN BE
DERIVED FROM FINANCIAL PLANNING?
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. 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.
Interactions or Linkages between investment proposals are
carefully examined.
- The financial plan enables the proponents to show explicitly the
linkages between investments proposals for the different operating
activities of the firm and its available financing choices.

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.
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. It also imposes a unified
structure for reconciling goals and objectives.

Managers are forced to think 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 MODEL
Common Elements;
1. Economic Environment Assumptions
- the plan will have to state explicitly the economic
environment in which the firm expects to reside over
the life of the plan. Among of these are Inflation rates,
level of interest rates and the firm's tax rate.
2. Sales Forecast
• an extremely supplied sales forecast-considered the
“driver” shall be the “heart” of all financial plans. Planning
will focus on the projected future sales and the assets and
the financing needed to support those sales.

• Sales forcast will be given as the Growth Rate in Sales

rather than as an explicit sales figure.
Determinants of Growth Sales
• Profit Margin - an increase in profit margin will increase
the firm's ability to generate funds internally and thereby
increase sustainable growth.
• Dividend Policy - a decrease in the percentage of net
income paid out as dividends will increase the retention
ratio. These 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 Turn Over - 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
asstes as sales grow and thereby increases the
sustainable growth.
3. Pro forma Statements
A financial plan will always have a forecast financial
statements. These are called pro forma or projected
statements which will summarize the different events
projected or the future.
4. Asset Requirements
• A common element of a financial plan that describes the
projected capital spending as well as the proposed uses
of net working capital.
5. Financial Requirement
The financial plan will include a section about the necessary
financing arrangements. This part of the plan should
discuss dividend policy and debt policy.
Forecast of financial requirements involves:
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.
c) Subtracting the funds generated from h funds required to
determine the external financial requirements.
 FINANCIAL PLANNING PROCESS
1. Sales forecast for the next five years or so;
2. Assets required to meet the sales target are determined;
3. Decision is made concerning how to finance the required
assets;
4. Income statements and statement of financial position
can be de projected;
5. Earning per share as well as the key ratios can be
forecasted.
6. 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.

Financial “plug” variable- 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.
 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.
Illustrative Case 15-1. Financial Forecasting (Percent
of Sales Method)
The Millenium Company has the following statements which are representative of the
company’s historical average.
Income Statement

Sales P 2,000,000.00
Cost of Sales 1,200,000.00
Gross Profit 800,000.00
Operating Expenses 380,000.00
Earnings before interest and taxes 420,000.00
Interest expense 70,000.00
Earnings before taxes 350,000.00
Taxes (35%) 122,500.00
Earnings after taxes P 227,500.00

Dividends P 136,500.00
Solution:
Step 1: Forecast the Income Statement
The projected income statement will show the following:

Income Statement

Sales P 2,400,000.00
Cost of Sales 1,440,000.00
Gross Profit 960,000.00
Operating Expenses 456,000.00
Earnings before interest and taxes 504,000.00
Interest expense 70,000.00
Earnings before taxes 434,000.00
Taxes (35%) 151,900.00
Earnings after taxes P 282,100.00

Dividends (36%) P 101,600.00

 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.

ADDITIONAL FUNDS NEEDED = REQUIRED INCREASE

IN ASSETS - SPONTANEOUS INCREASE IN LIABILITIES
- INCREASE IN RETAINED EARNINGS

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.
Projected Statement of Financial Position
Supporting Computations:

(1) Cash = 2.5% × 2.4M sales

(2) Accounts receivable = 20% of 2.4M
(3) Inventory = 37.5% × 2.4M
(4) No percentages are computed for fixed assets, notes payable,
long-term debt, ordinary shares and retained earnings because they
are not assumed to maintain a direct relationship with sales volume.
For simplicity, depreciation is not explicitly considered.
(5) Accounts payable = 12.5% of 2.4M
(6) Accrued expenses = 0.5% of 2.4M
(8) Retained earnings = 300000 + 282100
AFN = 3500
Step 3.Raising the Additional Funds Needed
• Additional funds needed (AFN) - is the amount of money a
company must raise from external sources to finance the increase
in assets required to support increased level of sales. Additional
funds needed (AFN) is also called external financing needed.
• Additional funds needed - method of financial planning assumes
that the company's financial ratios do not change. In response to
an increase in sales, a company must increase its assets, such as
property, plant and equipment, inventories, accounts receivable,
etc. Part of this increase is offset by spontaneous increase in
liabilities such as accounts payable, taxes, etc., and part is offset
by increase in retained earnings.
The Financing decision will consider the
following factors:
a. Target capital structure
b. Effect of short-term borrowing on its current ratio.
c. Conditions is the debt and equity markets, or
d. Restrictions imposed by existing debt agreements.
 Additional Financing Needed (AFN) Formula:

Additional funds needed = Required Increase in assets - Spontaneous increase in liabilities - Increase in retained earnings

Where:

Current Assets (Present)

Required Increase in Assets = Change in Sales x
Sales (Present)

Current Liabilities (Present)

Spontaneous Increase in Liabilities = Change in Sales x
Sales (Present)

Increase in retained earnings

= Earnings after taxes - Dividend Payment
Applied to Millenium Co., AFN is computed
as Follows:
Example: 1,200,000 280,000
AFN = 400,000 x - 400,000 x - 282,100 - 101,600
2,000,000 2,000,000

= 240,000 - 56,000 - 180,500

AFN = 3,500
 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 income
statement or dividend, thus decreasing retained earnings.

Apply iteration process using the available financing mix

until the AFN become so small that the forecast can be
considered complete.
 Projected Income Statement Projected Statement of Financial Position
For 2015 For 2015

2014 2015 Forecast 2014 2015 Forecast

Actual First Pass Feedback Second Pass Actual First Pass Feedback Second Pass
Sales ₱6,000 ₱6,600 ₱6,600 Assets

Operating Costs 5,432 5,975 5,975 Cash ₱20 ₱22 ₱22

Earnings before interest and taxes 568 625 625 Accounts receivable 750 825 825

Less: Interest Expense 176 176 10 186 Inventories 1,230 1,353 1,353

Earnings before taxes 392 449 439 Total current assets 2,000 2,200 2,200

Taxes (40%) 157 180 -4 176 Net PPE 2,000 2,200 2,200

Net income before preference dividend 235 269 263 Total assets 4,000 4,400 4,400

Dividends preference 8 8 8
Net income available to ordinary ₱227 ₱261 ₱255 Liabilites and Equity

Dividends to ordinary 116 125 6 131 Accounts payable ₱120 ₱132 132
Addition to retained earnings 136 124 Notes payable 220 220 56 276
Accruals 280 308 308
Total current liablities 620 660 716

Long-term liabilities 1,508 1,508 56 1,564

Total liablities 2,128 2,168 2,280

Preference shares 80 80 80
Ordinary shares 260 260 112 372

Retained earnings 1,532 1,668 -12 1,656

Total equity 1,872 2,008 2,108

Total liabilities and equity before AFN ₱4,000 ₱4,176 4,388

Additional Funds Needed (AFN) ₱12

Total liabilities and equity ₱4,400
THANKS