Chapter 4: Financial Forecasting and Planning
Financial Planning
Important aspect of the firm’s operations it provides a road maps for guiding, coordinating and controlling the firm’s actions to achieve its objectives
Key aspects of financial planning process
Profit planning is usually done by means of pro-forma financial statements
Cash planning involves preparation of the firm’s cash budget
Cash Budget
Statement of the firm’s planned inflows and outflows of cash
Used by the firm to estimate its short-term cash requirement, with particular attention to planning for surplus cash and for cash shortages.
Cash Shortages – the firm must arrange for short term financing notes payable)
Surplus of Cash - the firm can plan for short term investments (marketable securities)
Cash budget gives the financial manager a clear views of the timing of the firm’s expected cash inflows & outflows over a given period.
Steps in preparing Cash Budget
Determine the amount and timing of cash receipts
Determine the amount and timing of cash disbursement
Determine the net cash flow
Prepare the cash reconciliation accounts
Cash Receipts
Forecasted sales
Other cash receipts-dividend receipts & etc
Collection of Account Receivable
Cash Sales
Lagged (After)1 month
Lagged (After)2 month & etc
Cash disbursement
Purchases
Cash Purchases
Payment of Accounts Payable
Lagged (After)1 month
Lagged (After)2 month & etc
Rent payments
Wages and salaries
Tax payment
Fixed asset (payment)
Interest payment
Dividend payment
Loan
Renovation
Other cash disbursement
Point to remember!
Non cash expenses such depreciation does not actually involve any actual cash flows and exclude in cash budget
If have deficit amount normally we have to borrow
If no info given in the question therefore leave the answer as deficit amount!
We only can borrow if in the question stated that the interest on short term loan is given eg: 12%
Financial forecasting
Part of all financial planning of a corporation as it is the basis for budgeting activities and estimating future financing needs
Involves forecasting sales and expenses incurred to generate those sales.
The most widely used method for making such projections is the percent-of-sales method.
Directors typically use an estimate of various expenses, sales & liabilities
Why need for forecasting?
To determine the future financing needs of the firms
Basic steps:
Project’s the firm sales revenues and expenses
Estimate the levels of investment in current and fixed assets that are necessary to support the projected sales
Determine the firm's financing needs throughout the planning period
Percent of sales method of financial forecasting
These numbers are then used to design a pro forma (planned or projected) income statement and balance sheet.
Assets, liabilities & total expenses are estimated as a percentage of sales that are then compared with projected sales.
Spontaneous Item- is the items that vary directly with sales activity (sales increase, spontaneous item also increase)
ASSET
LIABILITY
Non-Spontaneous Item- Any items that do not vary directly with sales and remain constant
ASSET
LIABILITY
Other assets – pattern & goodwill
Fixed asset will only spontaneous if the firm is operating FULL CAPACITY
All current assets
Accruals (taxes payable)
Retained earnings* - (refer to step 4 to compute proforma b’ce sheet)
Account payable
Fixed asset are regarded as non- spontaneous if the firm operating BELOW ITS CAPACITY
Notes payable
Long term debt
Equity
IMPORTANT
Below Capacity - Fixed asset will not change
If question not mentioned either full or below capacity, student should assumed FULL CAPACITY
Full Capacity – Fixed asset will change
If question mentioned to prepare proforma financial statement, students must prepared both i.e proforma income statement & proforma balance sheet
The steps necessary to compute a pro forma balance sheet
Determine the sales growths (in %)
2) Determine the spontaneous item-adjust the item by a factor of 1 + sales growth(%)
3) Project the pro-forma balance sheet values- all non spontaneous item remained unchanged as per balance sheet value
4) Calculate the new level (projected) of retained earnings
5) Determine the additional fund needed (AFN)
The difference between total assets and total liabilities and equity = AFN
This shortfall indicates the external financing (EFN) a.k.a additional fund needed (AFN) , discretionary financing (DFN)
DPR = dividend0/Net Income0
NPM = Net Income0/Sales0
New R/E = R/E0 + [(S1)(NPM)(1-DPR*)]
Sales Growth = Sales Year 1-Sales Year 0
Sales Year 0
Sales growth 50%, therefore spontaneous item value times 1.5