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Financial Management
Financial Forecasting
Aug 6, 2010
Table of Contents
FINANCIAL FORECASTING...........................................................................................2
Usefulness of Financial Forecasting.........................................................................2
II. Limitations of Financial Forecasting.................................................................2
III. Cases when a company may not find forecasting a justifiable investment......2
IV. Financial Forecasting Techniques .....................................................................2
Subjective Forecasting (Judgmental Approach)...................................................2
Trend Analysis ........................................................................................................3
Correlation Forecasting...........................................................................................7
FORECAST FINANCIAL STATEMENTS...........................................................................8
FORECAST INCOME STATEMENT..............................................................................9
FORECAST BALANCE SHEET..................................................................................10
ASSETS...............................................................................................................11
LIABILITES..........................................................................................................11
CAPITAL..............................................................................................................11
PERCENTAGE OF SALES METHOD ......................................................................13
CASH FORECAST.................................................................................................14
PROBLEM: PROFORMA BALANCE SHEET WITH CHOICE OF FINANCING...................16
Required:...............................................................................................................16
Answers: ...............................................................................................................16
CASE ANALYSIS: CHAMPION CATTLE FARMS, INC. (A)...............................................20
COMPANY BACKGROUND.......................................................................................20
GUIDE QUESTIONS:................................................................................................22
I. Time Context.................................................................................................22
II. Viewpoint.......................................................................................................22
III. Statement of the Problem..............................................................................22
IV. Objectives......................................................................................................22
V. Areas of Consideration.....................................................................................22
VI. Alternative Courses of Actions.........................................................................23
VII. Recommendation...........................................................................................24
VIII. Detailed Plan of Actions..................................................................................24
Divine Grace Kuan 8/06/2010 1

FINANCIAL FORECASTING
 Estimates of the overall impact of the management strategy and program of action;
 Provide a comprehensive picture of a company’s future financial status and
performance and guide managerial decision making;
 Estimates of bottom line effect;
 Improve the quality of planning at all levels of the organization;
 Makes clarity in communicating targets to stockholders;
 Enables lower management to determine the level of efforts it should exert to attain
forecast results;
 Support plans, integrate the views of managers and communicate goal throughout
the company;
Usefulness of Financial Forecasting
• They support short- term and long-term managerial plans;

• They provide a comprehensive view of the intended results of the investment and
financing decisions of management;
• They improve the planning process throughout the organization;
II. Limitations of Financial Forecasting
• Inherent uncertainty of future events and the judgmental nature of forecasts

• Takes time and is costly
III. Cases when a company may not find forecasting a justifiable

investment
• When companies does not incur substantial cost for being caught unprepared;
• When the company can insure itself against adverse situations;
IV. Financial Forecasting Techniques
Subjective Forecasting (Judgmental Approach)
 A method of forecasting that uses the forecaster’s experience and opinion

about the future business conditions and capability of the company
Advantage:
a) A manager assimilates his awareness of operating conditions into the
forecast.
b) A manager is more committed to achieving the objectives of plans that are
based on his own forecasts.
c) Subjective forecasts only require an expert.
Disadvantage:
a) When managers realize that top management uses forecasts as
standards of performance, managers might not reveal the actual operating
conditions to the top management.

Trend Analysis
 A quantitative trend predict financial variables using past data. This are
prediction methods that derive patterns from past data.
3 Methods:
ABC COMPANY: INVENTORY AND SALES OVER TIME

(in million pesos)
Year Sales Inventory

1 53 14
2 35 15
3 63 22
4 83 19
5 127 39
6 132 36
7 140 29
8 179 25
9 190 29
10 228 44
11 303 57
12 476 80
13 525 71
14 532 87
Table above shows future sales inventory based on past performance trends
1. One-Period Forecasting Method
- Forecasts the next period’s value based only on the last period’s value. This
method is also useful for very short forecast periods while chances that sales
will increase next year are very good, tomorrow’s sales may be more or may
be less than yesterday’s sales. Yesterdays sales would be the best predictor of
tomorrow’s sales.
 Useful for very short forecast periods

 It is not a preferred forecasting technique because it is all that can be
done by a forecaster who could not find any sound basis for his forecast.
2. Forecasts Based on Average Growth Rates

 Simple Growth Rate

Relates the change in the variable over the number of periods that have
elapsed.
Variable t+n
= Variable t + g x Variable t
where g = (variable t+n – variable t )

(variable t ) x n
ABC Company would like to forecast its sales for year15 using the past average
annual growth rate.
g = (P532M – P53M) = 64.6%

P53 x 14
Sales (Year 15) = Sales (Year 14) + Growth rate x Sales (Year 14)
= P 532M + (0.646 x P532M)
= P 875.7M
 Average Compound Growth Rate

Uses the compounding formula in future value analysis. The base period is the
starting point of calculation of the growth rate
Future value = Present value x (1 + g)n
g = (Future Value/Present value) 1/n - 1
Variable t+n = Variable t + g x Variable t

1/n
where g = variablet+n ___

1
variablet
ABC Company wants to determine the compound growth rates of its sales and
inventory for the past 13years and to forecast for year15 on this basis .
g (Sales) = (P532M/P53M) 1/13 - 1 = 0.194 or 19.4%
g (inventory) = (P87M/P14M) 1/13 - 1 = 0.151 or 15.1%
Sales Year 15 = Sales + Growth rate x Sales Year 14

Year 14
= P 532M + (19.4% x P532M)
= P 635.2M
Inventory Year 15 = Inventory Year 14 + Growth rate x Inventory Year 14

= P 87M + (15.1% x P87M)
= P 100.14M
 A method that does ignore other information in deriving the prediction model is not
likely to be a very powerful forecasting model.

800
700
600
500
400
300
200
100
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14
This graph compares the two growth rate methods
3. Forecasts Based on Financial Data in Time Series

Time series forecast reveal patterns from past data. An example of time series model
is a Linear Regression with time as dependent variable.
This responds to the limitations of the two growth rate techniques. The time series
analysis assumes that the dependent variable changes in a linear pattern over time
Variable = a + b x t
where t = (1,2,….,n) corresponds to n time periods, with t=1 representing Year 1
 Coefficient of determination (R-squared/ r2) – the summary measure of the

degree fit of the regression line.
 The higher the R-squared, the higher is the degree of reliability of the regression
equation as a tool.

ABC Company wants to develop the regression forecast models using the time series
regression approach for sales and inventory. Then the company wants to apply these
models To forecast sales for year 15.
X Y xy x2 y2
Year Sales
1 53 5 2,809
3 1
2 35 7 1,225
0 4
3 63 18 3,969
9 9
4 83 33 1 6,889
2 6
5 127 63 2 16,129
5 5
6 132 79 3 17,424
2 6
7 140 98 4 19,600
0 9
8 179 1,432 6 32,041
4
9 190 1,710 8 36,100
1
10 228 2,280 10 51,984
0
11 303 3,333 12 91,809
1
12 476 5,712 14 226,576
4
13 525 6,825 16 275,625
9
14 532 7,448 19 283,024
6
105 3,066 31,7 1, 1,065,20

91 015 4
Linear Regression table for the first 14 years of the company
b= n (∑xy) - (∑x) (∑y)

n (∑x2) - (∑x) 2
= 14 (31,791) – (105)(3,066)
14 (1,015) – (105) 2
= 445,074 – 321,930
14,210 – 11,025
= 123,144/3,185 = 38.66
a=y–bx
= 219 – 38.66 (7.5)
= 70.98

Sales (Year 15) = P70.98M + (38.66M x 15)
= P70.98M + P579.9M
= P 650.88 M
 The regression technique is a better predictor of long-term trends. The regression

model calculates one growth (or decline) rate using all past data.
 Growth trend techniques are more suited for short-term projections.
Correlation Forecasting
1. Ratio Technique – assumes a constant relationship between two variables. The

relationship must be established from past experience and management policy.
ABC Company forecasts sales next year at P 540M. The company wants to control
inventory at 15% of sales.
Forecast Inventory = Planned Ratio x Forecast Sales

= 0.15 X P540M
= P81M
2. Regression Analysis
Establishes the relationship between actual levels of inventory and sales.
ABC company wants to estimate the regression equation that relates inventory to
sales based on its performance and to forecast inventory given the sales forecast
of P540M.
x Y xy x2 y2
53 14 74 2,80 19
2 9 6
35 15 52 1,22 22
5 5 5
63 22 1,38 3,96 48
6 9 4
83 19 1,57 6,88 36
7 9 1
127 39 4,95 16,12 1,52
3 9 1
132 36 4,75 17,42 1,29
2 4 6
140 29 4,06 19,60 84
0 0 1
179 25 4,47 32,04 62
5 1 5
190 29 5,51 36,10 84
0 0 1

228 44 10,03 51,98 1,93
2 4 6
303 57 17,27 91,80 3,24
1 9 9
476 80 38,08 226,576 6,40
0 0
525 71 37,27 275,625 5,04
5 1
532 87 46,28 283,024 7,56
4 9
3,066 567 176,922 1,065,204 30,585
Computation:
b = n (∑xy) - (∑x) (∑y)

n (∑x2) - (∑x) 2
= 14 (176,922) – (3,066)(567)
14 (1,065,204) – (3,066) 2
= 2,476,908 – 1,738,422
14,912,856 – 9,400,356
= 738,486/14,912,856
= 0.134
a=y–bx
= 40.5 – 0.134 (219)
= 11.15
R2 = 0.92
Inventory = a + b x sales
= P11.15M + (0.134 x P 540M)
= P11.15M + P 72.36M
= P 83.51M
 Regression analysis provides sound forecasts only if future operations expected to

remain similar to those in the past.
 Suppose a company has undergone major changes in its line of businesses. Then, its
past data are not a valid basis for deriving correlation.
 In that case, the regression method is not relevant, and the analyst would be better
off with ratio and subjective methods.
FORECAST FINANCIAL STATEMENTS
1. Cash flow forecast – a summary of planned cash receipts and disbursements of a

company. It predicts the future liquidity position of the company.
Is valuable planning tool for managing cash collections, investment residual cash,
meeting operating expense and repaying debts.
2. Forecast Balance Sheet – shows the planned levels of assets and financing of a
company. It shows a company’s future asset position and solvency.

This facilitates the task of finding sources of funds. It also provides standards for
future performance.
3. Forecast Income Statement – shows the expected future profit performance of a

company and its projects. It is the basis for controlling the costs of operations and for
achieving the sales targets.
PREPARING FORECAST FINANCIAL STATEMENTS
FORECAST INCOME STATEMENT
Sales Forecast – Management prepares a sales forecast using either subjective,

trend or statistical correlation methods. The other officer reviews the result then
management initiates the preparation of an income statement forecast.
Cost of Goods – management estimates cost of goods and other requirements and
past cost levels of these items. Here they must forecast the future prices of these inputs.
Expenses - analyst must derive a relationship between operating expenses and

sales.
Other income and Expense – Analyst must forecast the net income, interest
expenses, tax expense to complete the income statement.
Example:
 XYZ Company, a shoe manufacturer and retailer, is conducting its financial planning
for the next year, 19x1. Sales for the current year, 19x0, are at P100,000 (all figures
in thousand pesos). Management expects sales to be 20% higher in 19x1.
 All goods are purchased from wholesalers. XYZ Co. adds a markup of 40% on cost.
 Depreciation, included in the cost of goods sold, amounts to P8,000 for the year.
 The company pays salesmen on commission basis. For next year, 19x1, management
will increase the commission rate to 5% of sales.
 Fixed operating expenses are expected to remain at the same levels as in 19x0, or at
8% of sales.
 Interest expense for 19x1 is 10% of the beginning balance of its short-term bank loan
of P36,000.
 The company has other income of P 2,000.
XYZ COMPANY
FORECAST INCOME STATEMENT, 19X1
(in thousand pesos)
Actual Forecast Forecasting Method Used
19x0 19x1
Net Sales 100,00 120,00 Expected growth rate in 19x1

0 0
Cost of Goods Sold 71,42 85,71 Ratio of CGS to Sales
9 4
Gross Profit 28,57 34,28 Mark-up of 40% on cost

1 6
Operating Expenses:
Sales Commissions 4,00 6,00 New commission rate for 19x1
0 0
Fixed 7,00 7,00 Same as 19x0
0 0
Variable 8,00 9,60 At 8% of sales
0 0
Income from operations 9,57 11,68
1 6
Other income 2,00 2,00 Same as 19x0
0 0
Interest Expense 6,30 3,60 Current interest cost of short-term
0 0 debt
Income before Tax 5,271 10,08
6
Provision for Tax 1,84 3,53 35% on income tax
5 0
NET INCOME 3,426 6,556
FORECAST BALANCE SHEET
Balance Sheets are forecast in relation to
 Activity factors like sales and cost of goods

 Forecast changes in policies
 Planned fixed assets expansion
Activities in Forecasting Balance Sheets
 Forecast balance of all assets except cash

 Forecast balance of all liabilities and equities except bank loan
 Determine the “plug” figure in a forecast balance sheet.
PLUG Figure
 A forecast cash surplus if the company’s total liabilities and capital

exceed total assets
 A forecast short-term bank loan if the company’s total assets including
an assumed minimum cash balance, exceed total liabilities and capital
ASSETS
• Cash – equal to the ending balance of a cash flow forecast. It is assumed at the
minimum balance.
• Accounts Receivable – considers the forecast sales level, credit policy and
expected bad debts.
Example: If accounts receivable were 8.33% of sales corresponding to a 30-
day collection period:
Forecast A/R = 8.33% of forecast sales

= 30 days x forecast sales/360
• Inventory – uses the past relationship between costs of goods sold and
inventory level, and considers the desired stock level in the future.
Forecast Inventory = Days’ Inventory x Forecast Purchases/360
 Estimates of net fixed assets are made by adding the amount of planned additional
capital expenditures and deducting the planned disposition of fixed assets and
depreciation to the previous balance of this account.
 Other minor items remain at the previous year’s level.
LIABILITES
• Accounts Payable – relate past balances of this account and purchases and
company payment policies
Forecast A/P = (Credit Period/360) x Purchases for the year
• Income Tax Payable – corresponds to the taxes due for the following year.
• Long-term debt – relies on the forecasts of future financing.
• Accruals and other liabilities – rely on prior years’ patterns.
• Short-term bank loan – the PLUG or balancing figure. If assets exceed liabilities
without the loan:
Bank Loan = Total Assets – Liabilities (except bank loan) + Stockholders’

Equity
CAPITAL
• Capital – takes into account the beginning balance of capital plus planned new stock
issues for the next period.
• Revaluation capital - any other capital accounts

• Retained Earnings – increase due to forecast net income and decrease due to
future dividends
Example:
• XYZ Company wants to prepare a forecast balance sheet to determine whether it

should request for more bank loan. Management plans to maintain the present cash
balance of P5(all figures in millions).
• It intends to control inventory to 60 days of stocks and hold customer accounts at 30
days.
• Investments and prepaid accounts will be maintained at the previous balances.
• A major expansion in several stores will increase net fixed assets to P56 from the
previous balance of P46. Depreciation for the year amounted to P8.
• Suppliers have just tightened their credit terms from 60 to 45 days due to unusually
large export orders.
• No capital stock issues are being considered, nor is there any appraisal of properties
contemplated in the future.
• Dividends of P3 will be paid in the following year.
XYZ COMPANY
FORECAST BALANCE SHEET, 19X1
(in thousand pesos)
Assets Actual Forecast Forecasting Method Used
19x0 19x1
Cash & temporary 5,000 5,000 Same as 19x0
investments
Accounts Receivable 8,000 10,000 Turnover of 12 times sales
Merchandise Inventory 11,161 14,286 Turnover of 60 days' cost of
sales
Prepayments 3,000 3,000 No change over 19x0
Investments 7,500 7,500 No change over 19x0
Fixed Assets 46,000 56,000 Plant expansion for 19x1, net of
depreciation
Total Assets 80,661 95,786
Liabilities & Stockholders' Equity

Accounts Payable 11,000 10,714 Supplier credit reduced to 45
days
Notes Payable 36,000 PLUG Balancing amount
Income Tax Payable 2,161 3,530 19x1 income tax payable
Total Liabilities 49,161 60,730
Capital Stock 12,000 12,000 No new capital stock issue in

19x1
Other capital accounts 7,000 7,000
Retained Earnings 12,500 12,500 19x0 balance plus net income
net of dividends
Total Stockholders' 31,500 31,500
Equity

Total Liabilities & SHE 80,661 92,230
PERCENTAGE OF SALES METHOD
 Useful for external analysts who do not have access to management’s plans.
 Assets are proportionate to sales under the principle of turnover or capital intensity.
Asset Turnover = Sales

Assets
Capital Intensity = Assets

Sales
 Under this principle, every asset that supports sales should likewise increase by a
reasonably stable, if not constant, proportion. Exceptions are assets that are not
directly related to the business of a company, for example, investments, other assets
and intangibles.
XYZ COMPANY
FORECAST BALANCE SHEET, 19X1
(in thousand pesos)
Actual Percent of Forecast
19x0 Sales 19x1
Assets
Cash & temporary 5,0 0. 9,6
investments 00 05 00
Accounts Receivable 8,0 0. 9,6
00 08 00
Merchandise Inventory 11,1 0. 13,2
61 11 00
Prepayments 3,0 0. 3,6
00 03 00
Investments 7,5 7,5
00 00
Fixed Assets 46,0 0. 55,2
00 46 00
Total Assets 80, 98,

661 700
Liabilities & Stockholders'

Equity
Accounts Payable 11,0 0. 13,2
00 11 00
Notes Payable 36,0 PLUG 48,0
00 44
Income Tax Payable 2,1 0. 2,4
61 02 00
Total Liabilities 49, 63,

161 644
Capital Stock 12,0 12,0

00 00
Other capital accounts 7,0 7,0
00 00
Retained Earnings 12,5 16,0
00 56
Total Stockholders' Equity 31, 35,

500 056
Total Liabilities & SHE 80, 98,

661 700
CASH FORECAST
Cash Receipts
a) Cash sales
b) Collections of accounts receivables
c) Proceeds of new loans
d) Proceeds from sales of capital stock
e) Proceeds from sale of fixed assets or investments
Cash Disbursements
a) Payments of accounts payable

b) Cash purchases
c) Loan amortization
d) Payment of other liabilities
e) Capital expenditure and other acquisitions
f) Dividends
 Cash Receipts from Sales:

= Beginning Balance of A/R + Sales on account – Ending balance of A/R
 Payment of Purchases:
= Beginning Balance of A/P + Purchases on account – Ending balance of A/P
XYZ COMPANY
CASH FLOW FORECAST, 19X1
(in thousand pesos)
Souces of Information
Cash balance, December 31, 5,000 Previous year's balance sheet
19x0
Cash inflow from sales 118,000 Total sales and other income, net of increase
in accounts
Cash inflow from other 2,000
income
Total operating cash inflows 125,000
Cash outflow from purchases 81,125 Cost of goods net of depreciation plus
increase in accounts payable and inventory
Cash expenses 22,600 Total fixed and variable expenses
Payment of taxes 2,161 Operating balance + tax due - closing
balance
Total operating cash 105,886
outflows
Net Operating Cash Flows 19,114
Cash Flow from Investing Activities

Acquisition of new fixed 18,000 Increase in fixed assets + depreciation
assets
Total Investing Cash Flows 18,000
Cash Flow from Financing Activities

Dividends Paid (3,000) Net income - change in retained earnings
Interest Paid (3,600) From income statement
Additional Bank Loan 10,486 Increase in bank loans
Total Financing Cash Flows 3,886
Cash Balance, December 31, 5,000

19x1

PROBLEM: PROFORMA BALANCE SHEET WITH CHOICE OF
FINANCING
The balance sheet of Havalari, Inc. as of December 31, 19x1 is shown below
(figures in thousand pesos):
Cash 300 Accounts Payable 300

Accounts Receivable 650 Accrued Expenses 50
Inventory 400 Bank Loan 150
Total current assets 1,350 Total current liabilities
500
Net fixed assets 4,200 Long-term debt 1,000
Total assets 5,550 Common Stock 3,000
Retained Earnings 1,050

Total Equities 5,550
Sales during 19x1 were P8million. Havalari expected sales to increase to P12million in 19x2.
Existing agreements with its long-term creditors required the company to maintain a long-
term debt to equity ratio of 0.25. Havalari expected to maintain its net profit margin of 5% in
19x2. The company paid 30% of its net income as dividends.
Flor Havalari, president of the company, knew that the company had to increase its
inventories and customer credit and to expand its cheese-making plant to meet the large
increase in sales for 19x2. She believed that these should increase in the same proportion as
sales. Havalari did not want to issue in new common stocks in 19x2.
Required:
a.) Prepare a forecast balance sheet for 19x2 using the percentage-of-sales method.
b.) Evaluate the financial position of Havalari, Inc., as of December 31, 19x1 compared
to the previous year. What risk does the company face in 19x2 assuming that it
achieves its sales target?
Answers:
a. Prepare a forecast balance sheet
Projected Net Income = Expected Sales X Expected Net Profit

= P12,000 x 0.05
= P 600
Projected Returned Earnings = Net Income x 30%

= P 600 x 0.30
= P 180
Retained Earnings, 19x2 = Beginning Retained Earnings + Net Income – Retained

Earnings
= P 1,050 + P600 – P180
= P 1,470
Long-Term Debt, 19x2 = Equity x Long-term debt-to-equity ratio

= P 4,470 x 0.25
= P 1,117.50

Bank Loan (PLUG) = Total Assets – (Liab. (except bank loan) + Stockholders’
Equity)
= P 8,325 – (P 1,642.5 + P 4,470)
= P 2,212.50
Percentage of Sales Method
Calculations to determine percentage
Cash = Cash / Sales

= 300 / 8,000 = 3.75 %
Accounts Receivable = Accounts Receivable / Sales

= 650 / 8,000 = 8.12%
Inventory = Inventory / Sales

= 400 / 8,000 = 5%
Net Fixed Assets = Net Fixed Assets / Sales

= 4,200 / 8,000 = 52.50%
Accounts Payable = Accounts Payable / Sales

= 300 / 8,000 = 3.75%
Accrued Expense = Accrued Expense / Sales

= 50 / 8,000 = .625%
Calculation to determine forecast amount
Cash = Cash % ( Sales Forecast)

= 3.75 % (12,000) = P450
Accounts Receivable = Accounts Receivable % ( Sales Forecast)

= 8.12% (12,000) = P975
Inventory = Inventory % ( Sales Forecast)

= 5% (12,000) = P600
Net Fixed Assets = Net Fixed Assets % ( Sales Forecast)

= 52.50% (12,000) = P6,300
Accounts Payable = Accounts Payable % ( Sales Forecast)

= 3.75% (12,000) = P450
Accrued Expense = Accrued Expense % ( Sales Forecast)

= .625% (12,000) = P75

HAVALARI, INC.
FORECAST BALANCE SHEET
AS OF DECEMBER 31, 19X2
(in thousand pesos)
Actual Percent Forecast
19x0 of 19x1
Sales
Assets
Cash 300. 3.75% 450.
00 00
Accounts Receivable 650. 8.125% 975.
00 00
Inventory 400. 5.00% 600.
00 00
Total current assets 1,35 2,025

0.00 .00
Net Fixed Assets 4,200. 52.50% 6,300.

00 00
Total Assets 5,55 8,325

0.00 .00
Liabilities & Stockholders'

Equity
Accounts Payable 300. 3.75% 450.
00 00
Accrued expenses 50. 0.625% 75.
00 00
Bank Loan 150. 2,212.
00 50
Total current liabilities 50 2,737
0.00 .50
Long-term debt 1,000. 1,117.
00 50
Total Liabilities 1,50 3,855
0.00 .00
Capital Stock 3,000. 3,000.
00 00
Retained Earnings 1,050. 1,470.
00 00
Total Liabilities & SHE 5,55 8,32

0.00 5.00
b. Evaluation of Financial Performance

Actual Forecast
19x0 19x1
Profitability Ratios:
Net Profit Margin 5% 5%
* The company will have a net profit margin of 5% in two years.
600,
Return on equity (ROE) 400,000 000
Inventory / Retained Earning 4,050,000 4,470,000

9.88% 13.42%
* The company has the capacity to generate returns since there is a 35.83% ROE
600,
Return on assets (ROA) 400,000 000
2,025,
Inventory / Current Assets 1,350,000 000
29.63% 29.63%
* The company has a stable return on assets.
Turnover Ratios:
8,000,00 12,000,
Total Assets Turnover 0 000
1,350,00 2,025,
Sales / Current Assets 0 000
6 times 6 times
8,000,00 12,000,
Fixed Assets Turnover 0 000
4,200,00 6,300,
Sales /Fixed Assets 0 000
2 times 1 time
* The company will decrease its fixed assets turnover by half
12,000,
Accounts Receivable Turnover 8,000,000 000
Sales / Account Receivables 650,000 975,000
12 times 12 times
Days' Receivables 30 30
* The company has a good and stable collection terms on its receivables.
Liquidity Ratios:
Current Ratio 1,350,000 2,025,000
Current Assets / Current
Liabilities 500,000 2,737,500
2.7 0.74
950, 1,425,
Quick Ratio 000 000
Assets/ Current Liability 500,000 2,737,500
1.90 0.52
* The company has a low liquidity ration which means they may have a hard time paying their debts
Leverage Ratios:
3,855,
Debt-to-asset ratio 1,500,000 000
Total Liabilities/Total Assets 1,350,000 2,025,000
1.11 1.90
* The company may exceed the company’s debt-to-asset ratio by 1 for the two years based on the
forecast which means that debts exceed the company's resources
3,855,
Debt-to-equity ratio 1,500,000 000
Total Liability/Retained
Earnings 4,050,000 4,470,000
0.37 0.86
* The debt-to-asset ratio will increase by more than 100% and this might create great financial
exposure for the creditors.
CASE ANALYSIS: CHAMPION CATTLE FARMS, INC. (A)
“This is a critical time for my cattle farm. I need a bank loan to run my
cattle-fattening farm to full capacity.“ explain Albert Lim to the branch manager of
the Development Bank if Batangas(DBB), Gloria Santos. Today, March 6, 1998, Lim,
Owner-manager of Champion Cattle Farms Inc. requested an P8 million loan from
DBB.
“I promise to look closely into your request” replied Santos. “But may I
request for a detailed estimate of the amount and timing of your financing
requirements? Send in your latest financial statements as well”
Lim left the bank’s office and began to prepare a letter to DBB explaining
Champion Cattle Farms financial situation.
COMPANY BACKGROUND
Champion Cattle Farms, Inc. was set up in South Batangas Province by

Albert Lim in January 1998. Its operation involved buying yearling cattle (about 12-18
months old) from the cattle raising areas of Masbate Province and intensively farm-
feeding them for about six month until they weighed about 100-120 kilograms. The
cattle were then sold to traders who in turn sold them to meat dealers in Manila.
Terms of purchase and sale of live cattle were on cash.
The farm was initially financed by an inheritance of Lim amounting to P 8.5

million. When he received this inheritance, he immediately purchased the farm and
built facilities for a feed-lot operation on a site in Calatagan, South Batangas. He
chose the location because of good access to the port for easy transport of cattle, the
availability to feed supply, and good workers to tend and feed lot. The few pieces of
equipment needed for his operation, mainly feeding and cleaning equipment, were
acquired using Lim’s capital.
When the first batch of yearlings were purchased in January, Lim thought
about spreading out his feed-lot operation into monthly batches of about 200-300
head of cattle. His farm and equipment could handle 1,8000 head of fully-grown
cattle. By June, an inventory of 1,200 to 1,800 head of cattle in six weight category
would be achieved. While Lim could determine that range of inventory to be kept at
all times (which he called “regular” level of inventory), the exact number would
depend on the availability of yearlings from Masbate ranchers, purchase price, and
his own financial resources. In the past, there were lean months of supply when there
were failures in foaling, bad weather and other problems. In other periods, there were
surplus supply of yearlings when small cattle ranchers wanted to raise cash for town
fiestas or for financial support of their families or children attending school in Manila
Champion Farms could only obtain credit for a minor portion of its feeds and
veterinary supply. Many suppliers of feeds in the Batangas area were small business
operators and traders supplied by companies based in Manila. Initial purchases of
yearling is January and February were made using available cash. By the end of
February, Lim realized that he did not have sufficient cash to purchase stocks in six
monthly batches. At this point, he decided to request for bank financing at the DBB.
Lim personally knew its branch manager. DBB was known for its lending program to
cattle farmers in Batangas.
Cattle Feed Lot Operations
Champion Farms purchased yearlings at an average price of P3,000 per head

“on-the-hoof” and these were delivered to the farm. The average weight of these
yearlings was 40kg. Estimated costs over a six-month feeding period for each head of
cattle are shown in Table 1.
Feed Operation
Table1. Cost Per Head of Culture
Item Cost(in Pesos)
Purchased Feeds 3,740
Wages of Farm Labor 320
Veterinary Supplies 105
Farm Overhead Costs 35
Total P 4,200
A fully Frown cattle weighed an average of 100kg. and could be sold “on-the-
hoof” for P80kg in nearby cattle market auctions. Marketing cost were not incurred.
Lim kept other overhead cost under control. Expenses which were not associated
with feed-lot operation were limited to the salary of a farm manager. Ely Tio, who
kept cost records and facilities cost like insurance, office supplies, etc. He estimated
monthly overhead expenses at P10,000.
Tio purchased feeds on cash-on-delivery basis except from a dealer of a

Manila company which sold on 21-day credit term. Champion Farms had a credit limit
from this dealer of P150,000. Lim noted that his cash balance reached dangerously
low levels in late February. He requested Tio to prepare a balance sheet as of
February 28 as shown in Exhibit 1.
CHAMPION CATTLE FARMS, INC.(A)

Balance Sheet
As of February 28, 1998
(in Thousand Pesos)
Assets
Cash 456
Feeds inventory 134
Cattle stock inventory 2,950
Equipment 460
Land and building 4,550
Total Assets 8,550
Liabilities and stockholder’s equity
Accounts payable 150

Common Stock 8,400
Total Liability and Stockholder’s Equity 8,550
On the first week of March, lim made his usual trip to Masbate and came back
with 90 heads of yearling cattle. Immediately, he went to Santos of DBB to explain
Champion Farms Problem “ We need the bank load because we shall sell our January
batch only in July. Please give us a one-year loan of at least P8 Million.”, he said as he
presented his cost estimates and balance sheet to Santos,
GUIDE QUESTIONS:
a. Why does Champion Farms need financing? What possible sources of funds can be
accessed by Champion Farms?
b. Prepare a cash budget. Estimate the amount and timing of financing needed by
Champion Farms.
c. What funding source is most suitable for the financial need and condition of
Champion Farms? If DBB grants a bank loan, what are Champion Farms sources of
repayment of the loan? Will these sources be sufficient to pay off the loan at the end
of the year?
I. Time Context
March 6, 1998
II. Viewpoint
Albert Lim, owner-manager of Champion Cattle Farms
III. Statement of the Problem
Albert Lim does not have enough funds to maximize his farm capacity due to lack of
funding.
IV. Objectives
• To be able to maximize the resources and profitability of the farm

• To have enough cash to attain his goal of having 1,200 – 1,800 heads of cattle in hid farm.
• To have other source of funds that will fit his needs.
V. Areas of Consideration

A. Internal Environment
1. Strengths
• The farm and equipment could handle 1,800 head of fully-grown cattle.
• Lim kept overhead cost under control. Expenses which were not associated
with feed-lot operations were limited to the salary of a farm manager, The
estimated monthly overhead expenses at P 10,000.
• Terms of sale of live cattle were on cash.
• They have control over funding and other direct costs because they have their
loyal small feed suppliers and Tio’s many years of experience in livestock farms.
2. Weakness
• He can only sell the cattle after six months until they weighed 100-120
kilograms.
• The farm was initially financed by Albert Lim’s inheritance, He had no other
source of financial support.
• Gross Margin Percentage: 10% (P800/P8,000)
Selling Price 8,000
Cost of Cattle 7,200
Gross Profit 800
B. External Environment
1. Opportunities
• Development Bank of Batangas (DBB) was known for its lending program to
cattle farmers in Batangas.
• Lim personally knew DBB’s branch manager, Gloria Santos.
• Champion Farms had a credit limit from the dealer of feeds in Manila of P
150,000. The credit term is 21 days.
• A fully grown cattle weighed an average of 100kg and could be sold on-the-
hoof for P80.kilo in the nearby cattle market auction, here market cost is not
incurred
• The Batangas location has good access to the port for easy transport of cattle,
feed supply and food workers to tend the feed lot.
2. Threats
• There were lean months of supply when there were failures in foaling, bad
weather and other problems.
• Champion Farms could only obtain credit for minor portion of its feeds and
veterinary supply.
• Terms of purchase of yearling cattle were on cash basis.
• There were surplus supply of yearlings when small cattle ranchers wanted to
raise cash for town fiestas or for financial support of their families or children
attending schools in Manila.
• The number of yearlings will depend on the yearlings of Masbate ranchers,
purchase prices.
VI. Alternative Courses of Actions

ACA 1: Unsecured bank loan of up to three years
Advantages: Can be easily given/approved

less risky since there is no other assets at stake
Can solve their funding problems immediately
Disadvantages: May result to additional cost for the company due to its higher interest
ACA 2: Secured bank loan payable in nine years using the existing inventories,
equipment and real estate as collateral
Advantages: Can be easily given/approved

He can request for a higher amount of loan
Payment terms can be more flexible
favorable interest and payment terms.
Disadvantages: May be more risky when there is default on payment.
ACA 3: Offer stocks to possible shareholders.
Advantages: There is a possibility to have bigger investment
Disadvantages: It will be a difficult to find investors who is willing to invest in a starting

business.
VII. Recommendation
ACA 2: Secured bank loan payable in nine years using the existing
inventories, equipment and real estate as collateral
VIII. Detailed Plan of Actions
NATURE OF ACTIVITY PERSON DURATION

RESPONSIBLE
Submit all the needed requirements to Albert Lim Immediately
DBB
Review submitted documents Gloria Santos 2 weeks
Meet with Albert Lim and discuss terms Gloria Santos 1 day
Approve requested loan Gloria Santos 1 day
Open and maintain regular account in DBB Albert Lim 1 day
Assess monthly Cash and ensure that the Albert Lim Regularly
monthly

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Financial Management

Divine Grace Kuan 8/06/2010 1

Usefulness of Financial Forecasting

• They support short- term and long-term managerial plans;

II. Limitations of Financial Forecasting

• Inherent uncertainty of future events and the judgmental nature of forecasts

III. Cases when a company may not find forecasting a justifiable

IV. Financial Forecasting Techniques

Subjective Forecasting (Judgmental Approach)

 A method of forecasting that uses the forecaster’s experience and opinion

Divine Grace Kuan 8/06/2010 2

ABC COMPANY: INVENTORY AND SALES OVER TIME

Year Sales Inventory

1. One-Period Forecasting Method

 Useful for very short forecast periods

2. Forecasts Based on Average Growth Rates

 Simple Growth Rate

where g = (variable t+n – variable t )

g = (P532M – P53M) = 64.6%

 Average Compound Growth Rate

Future value = Present value x (1 + g)n

g = (Future Value/Present value) 1/n - 1

Variable t+n = Variable t + g x Variable t

where g = variablet+n ___

g (Sales) = (P532M/P53M) 1/13 - 1 = 0.194 or 19.4%

g (inventory) = (P87M/P14M) 1/13 - 1 = 0.151 or 15.1%

Sales Year 15 = Sales + Growth rate x Sales Year 14

Inventory Year 15 = Inventory Year 14 + Growth rate x Inventory Year 14

Divine Grace Kuan 8/06/2010 4

This graph compares the two growth rate methods

3. Forecasts Based on Financial Data in Time Series

 Coefficient of determination (R-squared/ r2) – the summary measure of the

Divine Grace Kuan 8/06/2010 5

105 3,066 31,7 1, 1,065,20

Linear Regression table for the first 14 years of the company

b= n (∑xy) - (∑x) (∑y)

Divine Grace Kuan 8/06/2010 6

 The regression technique is a better predictor of long-term trends. The regression

1. Ratio Technique – assumes a constant relationship between two variables. The

Forecast Inventory = Planned Ratio x Forecast Sales

Divine Grace Kuan 8/06/2010 7

3,066 567 176,922 1,065,204 30,585

b = n (∑xy) - (∑x) (∑y)

 Regression analysis provides sound forecasts only if future operations expected to

FORECAST FINANCIAL STATEMENTS

1. Cash flow forecast – a summary of planned cash receipts and disbursements of a

Divine Grace Kuan 8/06/2010 8

3. Forecast Income Statement – shows the expected future profit performance of a

PREPARING FORECAST FINANCIAL STATEMENTS

FORECAST INCOME STATEMENT

Sales Forecast – Management prepares a sales forecast using either subjective,

Expenses - analyst must derive a relationship between operating expenses and

Net Sales 100,00 120,00 Expected growth rate in 19x1

Divine Grace Kuan 8/06/2010 9

NET INCOME 3,426 6,556

FORECAST BALANCE SHEET

Balance Sheets are forecast in relation to

 Activity factors like sales and cost of goods

Activities in Forecasting Balance Sheets

 Forecast balance of all assets except cash

 A forecast cash surplus if the company’s total liabilities and capital

Forecast A/R = 8.33% of forecast sales

Forecast Inventory = Days’ Inventory x Forecast Purchases/360