Professional Documents
Culture Documents
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
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;
• When companies does not incur substantial cost for being caught unprepared;
• When the company can insure itself against adverse situations;
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.
A quantitative trend predict financial variables using past data. This are
prediction methods that derive patterns from past data.
3 Methods:
- 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.
Variable t+n
= Variable t + g x Variable t
ABC Company would like to forecast its sales for year15 using the past average
annual growth rate.
Sales (Year 15) = Sales (Year 14) + Growth rate x Sales (Year 14)
= P 532M + (0.646 x P532M)
= P 875.7M
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 .
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
Variable = a + b x t
where t = (1,2,….,n) corresponds to n time periods, with t=1 representing Year 1
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
a=y–bx
= 219 – 38.66 (7.5)
= 70.98
Correlation Forecasting
ABC Company forecasts sales next year at P 540M. The company wants to control
inventory at 15% of sales.
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
Computation:
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
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.
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.
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
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
PLUG Figure
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:
• Inventory – uses the past relationship between costs of goods sold and
inventory level, and considers the desired stock level in the future.
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.
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.
• Short-term bank loan – the PLUG or balancing figure. If assets exceed liabilities
without the loan:
CAPITAL
• Capital – takes into account the beginning balance of capital plus planned new stock
issues for the next period.
• Retained Earnings – increase due to forecast net income and decrease due to
future dividends
Example:
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
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.
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
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
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
Divine Grace Kuan 8/06/2010 14
Financial Management
Financial Forecasting
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
The balance sheet of Havalari, Inc. as of December 31, 19x1 is shown below
(figures in thousand pesos):
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
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
Assets
Cash 300. 3.75% 450.
00 00
Accounts Receivable 650. 8.125% 975.
00 00
Inventory 400. 5.00% 600.
00 00
600,
Return on equity (ROE) 400,000 000
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:
Divine Grace Kuan 8/06/2010 19
Financial Management
Financial Forecasting
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.
“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
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
Divine Grace Kuan 8/06/2010 20
Financial Management
Financial Forecasting
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
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.
Cash 456
Feeds inventory 134
Cattle stock inventory 2,950
Equipment 460
Divine Grace Kuan 8/06/2010 21
Financial Management
Financial Forecasting
Land and building 4,550
Total Assets 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 does not have enough funds to maximize his farm capacity due to lack of
funding.
IV. Objectives
V. Areas of Consideration
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.
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
VII. Recommendation
ACA 2: Secured bank loan payable in nine years using the existing
inventories, equipment and real estate as collateral
Assess monthly Cash and ensure that the Albert Lim Regularly
monthly