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Financial Planning and Forecasting: Cash Flows and Financial Statement Analysis

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Financial Statements Balance Sheet Income Statement ... for compensation plans Steps in Financial Forecasting Forecast sales Project the assets needed to ... – PowerPoint PPT presentation

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Title: Financial Planning and Forecasting: Cash Flows and Financial Statement Analysis


1
Financial Planning and ForecastingCash Flows
and Financial Statement Analysis
  • Corporate Finance

Dr. A. DeMaskey
2
Learning Objectives
  • Questions to be answered
  • What are the basic financial statements and how
    are they used?
  • What kinds of financial information do users
    need?
  • What is the difference between accounting income
    and cash flow?
  • How are different sources of income taxed based
    on the U.S. tax code?
  • How are financial statements used by managers to
    improve performance?

3
Financial Statements
  • Balance Sheet
  • Income Statement
  • Statement of Retained Earnings
  • Statement of Cash Flows

4
Cash Flows
  • Net Cash Flows
  • Free Cash Flows
  • Operating Cash Flows

5
MVA and EVA
  • Market Value Added (MVA)
  • Economic Value Added (EVA)

6
Individual Income Taxes
  • Taxable Income
  • Marginal versus Average Tax Rate
  • Taxes on Dividend and Interest Income
  • Capital Gains versus Ordinary Income

7
Corporate Income Taxes
  • Interest and Dividend Income Received by a
    Corporation
  • Interest and Dividend Income Paid by a
    Corporation
  • Ordinary Gains and Losses
  • Capital Gains and Losses
  • Corporate Loss Carry-Back and Carry-Forward

8
Financial Statement Analysis
  • Ratio Analysis
  • Liquidity ratios
  • Asset management ratios
  • Debt management ratios
  • Profitability ratios
  • Market value ratios
  • Du Pont System
  • ROA
  • ROE
  • Expense control (PM)
  • Asset utilization (TATO)
  • Debt utilization (EM)

9
Limitations of Ratio Analysis
  • Large firms
  • Industry averages
  • Inflation
  • Window dressing
  • Accounting practices
  • Operating policies
  • Interpretation of ratios

10
Qualitative Factors
  • Key customer
  • Key product
  • Single supplier
  • Foreign sales
  • Competition
  • Future prospects
  • Legal and regulatory environment

11
Financial Planning and Forecasting Financial
Statements
  • Plans strategic, operating, and financial
  • Pro forma financial statements
  • Sales forecasts
  • Percent of sales method
  • Additional Funds Needed (AFN) formula

12
Pro Forma Financial 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

13
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

14
Sales Forecast
  • Division sales forecasts based on historical
    growth
  • Level of economic activity and overall demand for
    the product
  • Market share for each product line in each market
  • If foreign sales, include currency fluctuations,
    trade agreements, governmental policies, etc.
  • Inflation
  • Advertising campaigns, promotional discounts,
    credit terms, etc.

15
Projecting Pro Forma Statements with the Percent
of Sales Method
  • Project sales based on forecasted growth rate in
    sales
  • Forecast some items as a percent of the
    forecasted sales
  • Costs
  • Cash
  • Accounts receivable
  • Items as percent of sales
  • Inventories
  • Net fixed assets
  • Accounts payable and accruals
  • Choose other items
  • Debt (which determines interest)
  • Dividends (which determines retained earnings)
  • Common stock

16
What are the additional funds needed (AFN)?
Spontaneous liability increase
Increase in retained earnings
Required asset increase
-
AFN
-
17
Summary How different factors affect the AFN
forecast
  • Excess capacity
  • Existence lowers AFN.
  • Base stocks of assets
  • Leads to less-than-proportional asset increases.
  • Economies of scale
  • Also leads to less-than-proportional asset
    increases.
  • Lumpy assets
  • Leads to large periodic AFN requirements

18
Other Techniques for Forecasting Financial
Statements
  • Regression Analysis for Asset Forecasting
  • Relationship between type of asset and sales is
    linear.
  • Get historical data on a good company, then fit a
    regression line to see how much a given sales
    increase will require in way of asset increase.
  • Excess Capacity Adjustments
  • Full capacity sales
  • Target fixed assets-to-sales ratio
  • Required level of fixed assets
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