Financial Planning and Forecasting Financial Statements - PowerPoint PPT Presentation

Loading...

PPT – Financial Planning and Forecasting Financial Statements PowerPoint presentation | free to download - id: 41a391-MDMyO



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Financial Planning and Forecasting Financial Statements

Description:

CHAPTER 19 Financial Planning and Forecasting Pro-Forma Financial Statements * * * * * * * * * * Higher profit margin: Increases funds available internally, decreases ... – PowerPoint PPT presentation

Number of Views:365
Avg rating:3.0/5.0
Slides: 38
Provided by: Stanisla76
Learn more at: http://www.ohio.edu
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: Financial Planning and Forecasting Financial Statements


1
CHAPTER 19
Financial Planning and Forecasting Pro-Forma
Financial Statements
2
Some Bad Forecasts
  • "Everything that can be invented has been
    invented." --Commissioner, U.S. Office of
    Patents, 1899.
  • "640K ought to be enough for anybody." -- Bill
    Gates, 1981

3
Some Bad Forecasts
  • "But what ... is it good for?" --Engineer at the
    Advanced Computing Systems Division of IBM, 1968,
    commenting on the microchip.
  • "There is no reason anyone would want a computer
    in their home." --President, Chairman and
    founder of Digital Equipment Corp., 1977

4
Some Bad Forecasts
  • "I think there is a world market for maybe five
    computers." --Chairman of IBM, 1943
  • "We don't like their sound, and guitar music is
    on the way out." --Decca Recording Co. rejecting
    the Beatles, 1962.

5
Forecasting
  • What is generally the first item to estimate when
    starting a business?
  • What is the most difficult aspect of forecasting?

6
Steps in Financial Forecasting
  • Forecast sales
  • Project the assets needed to support sales
  • Project internally generated funds
  • Project outside funds needed
  • Decide how to raise funds
  • See effects of plan on ratios and stock price

7
The Sales Forecasting Process
8
Forecasting sales
  • Review past sales (five to ten years).
  • You can use average growth rate but it may not
    give you a correct estimate.
  • Use regression slope to compute growth rate.
  • Consider changes in economy, market conditions,
    etc.
  • Improper sales forecast can lead to serious
    financial planning issues.

9
Sales Forecast
  • Sales forecasts are usually based on the analysis
    of historic data.
  • An accurate sales forecast is critical to the
    firms profitability

Sales Forecast
Under-optimistic
  • Company will fail to meet demand
  • Market share will be lost

Over-optimistic
Too much inventory and/or fixed assets
  • Low turnover ratio
  • High cost of depreciation and storage
  • Write-offs of obsolete inventory
  • Low profit
  • Low rate of return on equity
  • Low free cash flow
  • Depressed stock price

10
  • Forecast future sales based on past sales growth

Sales Estimates for next 2 years
Sales
Growth Rate
Time
94 95 96 97 98 99 00 01 02 03
11
  • Forecast future sales based on past sales growth
  • Also include the effects of any events which are
    expected to impact future sales (new products or
    economic conditions)

Sales
Time
94 95 96 97 98 99 00 01 02 03
12
  • Forecast future sales based on past sales growth
  • Also include the effects of any events which are
    expected to impact future sales (new products or
    economic conditions)

Sales
Time
94 95 96 97 98 99 00 01 02 03
13
Sales Growth Imposes Costs on the Firm
  • Current Assets Inventory, A/R, Cash
  • Fixed Assets Plant and Equipment
  • Will require additional resources

14
What are the affects on the financials?
  • Sold off stores
  • Borrowed money
  • Expanded to new markets
  • Out-sourced labor to China
  • Lowered retail prices
  • Increased advertising
  • Purchased inventory management system

15
The Percent of Sales Method
  • This is the most common method, which begins with
    the sales forecast expressed as an annual growth
    rate in dollar sale revenue.
  • Many items on the balance sheet and income
    statement are assumed to change proportionally
    with sales.

16
A Better Financial Planning Model
The Income Statement
  • The pro forma income statement is generated by
    recognizing all variable costs that change
    directly with sales.
  • Two key ratios are calculated dividend payout
    ratio and retention ratio.
  • The first measures the percentage of net income
    paid out as dividends to shareholders, while the
    second measures the percentage of net income
    reinvested by the firm as retained earnings.

17
A Better Financial Planning Model
The Balance Sheet
  • Some balance sheet items vary directly with sales
    while others do not.
  • To determine which accounts vary directly with
    sales, a trend analysis may be conducted on
    historic balance sheets of the firm.
  • Typically, working capital accounts like
    inventory, accounts receivables and accounts
    payables vary directly with sales.

18
A Better Financial Planning Model
The Balance Sheet
  • Fixed assets do not always vary directly with
    sales. It will do so, only if the firm is
    operating at 100 percent capacity and fixed
    assets can be incrementally changed.
  • The ratio of total assets to net sales is called
    the capital intensity ratio. This ratio tells us
    the amount of assets needed by the firm to
    generate 1 sales.

19
A Better Financial Planning Model
The Balance Sheet
  • The higher the ratio, the more capital the firm
    needs to generate salesthe more capital
    intensive the firm.
  • Firms that are highly capital intensive are more
    risky than those that are not because a downturn
    can reduce sales sharply but fixed costs do not
    change rapidly.

20
A Better Financial Planning Model
Liabilities and Equity
  • Only current liabilities are likely to vary
    directly with sales. The exception here is notes
    payables (short-term borrowings) that changes as
    the firm pays it down or makes an additional
    borrowing.
  • Long-term liabilities and equity accounts change
    as a direct result of managerial decisions like
    debt repayment, stock repurchase, issuing new
    debt or equity.

21
A Better Financial Planning Model
Liabilities and Equity
  • Retained earnings will vary as sales changes but
    not directly. It is affected by the firms
    dividend payout policy.

22
A Better Financial Planning Model
The Preliminary Pro-forma Balance Sheet
  • First, calculate the projected values for all the
    accounts that vary with sales.
  • Second, calculate the projected value of any
    other balance sheet account for which an
    end-of-period value can be forecast or otherwise
    determined.
  • Third, enter the current years number for all
    the accounts for which the next years figure
    cannot be calculated or forecast.

23
A Better Financial Planning Model
The Preliminary Pro-forma Balance Sheet
  • At this point the balance sheet will be
    unbalanced. A plug value is necessary to get the
    balance sheet to balance.
  • First, determine the retained earnings based on
    the firms dividend policy.

24
A Better Financial Planning Model
The Preliminary Pro-forma Balance Sheet
  • Next, the plug figure will represent the external
    financing necessary to make the total assets
    equal total liabilities and equity. This calls
    for management to choose a financing option
    choosing debt, equity or a combination to raise
    the additional funds needed.

25
A Better Financial Planning Model
The Management Decision
  • The first decision relates to the firms dividend
    policy. Should the firm alter its dividend policy
    to increase the amount of retained earning?
  • If external funding is still needed, should the
    firm issue new debt, or issue equity? Or, should
    it be a mix of both?
  • It is important to recognize that while financial
    planning models can identify the amount of
    external financing needed, the financing option
    is a managerial decision.

Go to exhibit 19.6
26
Beyond the Basic Planning Models
Improving Financial Planning Models
  • There are several weaknesses in the previously
    described models.
  • First, interest expense was not accounted for.
    This is difficult to do so until all the
    financing options are finalized.
  • Second, all working capital accounts do not
    necessarily vary directly with sales, especially
    cash and inventory.

Go to exhibit 19.7
27
Beyond the Basic Planning Models
Improving Financial Planning Models
  • Third, how fixed assets are adjusted plays a
    significant role.
  • When a firm is not operating at full capacity,
    sales may be increased without adding any new
    fixed assets.
  • Fixed assets are added in large discrete amounts
    called lumpy assets. Since it requires time to
    get new assets operational, they are added as the
    firm nears full capacity.

Go to exhibit 19.8
28
Beyond the Basic Planning Models
Managing and Financing Growth
  • Managers prefer rapid growth as a goal to capture
    market share and establish a competitive position.
  • Most firms experiencing rapid growth fund the
    growth with debt, increasing the firms leverage
    and putting it at risk.

29
Beyond the Basic Planning Models
External Funding Needed
  • External funding needed (EFN) is defined as the
    additional debt or equity a firm needs to issue
    so it can purchase additional assets to support
    an increase in sales.
  • EFN is tied to new investments the management has
    deemed necessary to support the sales growth.

30
Beyond the Basic Planning Models
External Funding Needed
  • The new investments are the projected capital
    expenditure plus the increase in working capital
    necessary to sustain increases in sales.
    See equation 19.5.
  • Companies first resort to internally generated
    funds in the form of addition to retained
    earnings.

31
Beyond the Basic Planning Models
External Funding Needed
  • Once internally generated funds are exhausted,
    the firm looks to raise funds externally.
    See equation 19.6 and 19.7.

32
Beyond the Basic Planning Models
External Funding Needed
  • First, holding dividend policy constant, the
    amount of EFN depends on the firms projected
    growth rate. Higher growth rate implies that the
    firm needs more new investments and therefore,
    more funds to have to be raised externally.
  • Second, the firms dividend policy also affects
    EFN. Holding growth rate constant, the higher
    the firms payout ratio, the larger the amount of
    debt or equity financing needed.

Go to exhibit 19.9 -19.11
33
How would increases in these items affect the EFN?
  • Higher dividend payout ratio
  • Reduces funds available internally, increases EFN.

(More)
34
  • Higher profit margin
  • Increases funds available internally, decreases
    EFN.
  • Higher capital intensity ratio, A/S0
  • Increases asset requirements, increases EFN.

35
Implications of EFN
  • If EFN is positive, then you must secure
    additional financing.
  • If EFN is negative, then you have more financing
    than is needed.
  • Pay off debt.
  • Buy back stock.
  • Buy short-term investments.

36
Summary How different factors affect the EFN
forecast.
  • Excess capacity lowers EFN.
  • Economies of scale leads to less-than-proportiona
    l asset increases.
  • Lumpy assets leads to large periodic EFN
    requirements, recurring excess capacity.

37
Lumpy Assets
Assets
1,500
1,000
500
Sales
1,000
2,000
500
A/S changes if assets are lumpy. Generally will
have excess capacity, but eventually a small ?S
leads to a large ?A.
About PowerShow.com