2003 McGraw-Hill Ryerson Limited

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Financial Forecasting
McGraw-Hill Ryerson 2003 McGraw-Hill Ryerson Limited
Prepared by:

Terry Fegarty
Seneca College
2003 McGraw-Hill Ryerson Limited
Chapter 4 - Outline
What is Financial Forecasting?
3 Financial Statements for Forecasting
Constructing Pro Forma Statements
Basis for Sales Projections
Steps in a Pro Forma Income Statement
Production or Purchases Schedule
Purposes of Cash Budgets
Development of a Pro forma Balance Sheet
Percent-of-Sales Method
RNF and SGR formulas
Summary and Conclusions
PPT 4-2
2003 McGraw-Hill Ryerson Limited
What is Financial Forecasting?
Financial forecasting uses projections to anticipate short-
term financial results and position

Provides lead time to make necessary adjustments before
actual events occur

Helps to plan for significant growth in firm

Can be used as a target for measuring performance

Often required by bankers and other lenders

PPT 4-3
2003 McGraw-Hill Ryerson Limited
Forecasting Vs. Planning Vs. Budgeting
Planning - Setting operational and financial goals, and
choosing strategies and actions for achieving goals

Budgeting - Documenting expected route for achieving goals,
and assigning responsibilities for achieving goals

Forecasting - projecting future position and results without
necessarily considering goals
PPT 4-4

2003 McGraw-Hill Ryerson Limited
3 Financial Statements for Forecasting

Pro Forma Income Statement (I/S)
Cash Budget
Pro Forma Balance Sheet (B/S)

The first step is to develop a sales projection
PPT 4-5
2003 McGraw-Hill Ryerson Limited
Figure 4-1
Development of pro forma statements
Cash
budge
t
Sales
projection
Production
plan
Pro forma
income
statement
Pro forma
balance
sheet
Prior balance
sheet
Other
supportiv
e
budgets
Capital budget
1
2
3
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Basis for Sales Projections
External Factors
Recession or boom?
Export sales?
Consumer spending?
Competition?
New technology?
etc.
Internal Factors
New product lines?
Turnover in people?
Profit targets?
Employee training?
Price changes?
etc
PPT 4-7
2003 McGraw-Hill Ryerson Limited
Wheels
Casters
Quantity
Sales price
Sales revenue
Total
. . . . . .
. . . . .
. . . .
1,000 2,000
$30 $35
$30,000 $70,000
. . . . . . . . . . . . . . $100,000
PPT 4-8
Table 4-1
Projected wheel and caster sales
(first six months, 2003)
Goldman Corporation
2003 McGraw-Hill Ryerson Limited
Steps in a Pro Forma Income Statement

1. Establish a sales projection

2. Determine a production or purchases schedule

3. Forecast other expenses

4. Determine profit
PPT 4-9
2003 McGraw-Hill Ryerson Limited
Production (or Purchases) Schedule

Projected sales -in Units or $
PLUS
Desired ending inventory
MINUS
Beginning inventory
EQUALS
Production (or Purchases)
PPT 4-10
2003 McGraw-Hill Ryerson Limited
Table 4-2
Stock of beginning inventory

Wheels Casters

Quantity . . . 85 180
Cost . . . . $16 $20
Total value . . $1,360 $3,600
Total . . . . . . . . . . . . $4,960
PPT 4-11
2003 McGraw-Hill Ryerson Limited
Table 4-3
Production requirements for six months



Wheels Casters
Projected unit sales (Table 4-1) . . . +1,000 +2,000
Desired ending inventory (assumed to
represent 10% of unit sales for the
time period) . . . . . . . . +100 +200
Beginning inventory (Table 4-2). . . 85 180
Units to be produced . . . . . . 1,015 2,020

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Table 4-4
Unit costs


Wheels Casters

Materials . . . . $10 $12
Labour . . . . 5 6
Overhead . . . . 3 4
Total . . . . $18 $22
PPT 4-13
2003 McGraw-Hill Ryerson Limited


Wheels Casters

Units to be produced (Table 4-3) . . 1,015 2,020
Cost per unit (Table 4-4) . . . . $18 $22
Total cost . . . . . . . . $18,270 $44,440
= $62,710
PPT 4-14
Table 4-5
Total production costs
2003 McGraw-Hill Ryerson Limited
Table 4-6
Allocation of manufacturing costs and
determination of gross profits

Wheels Casters Combined

Quantity sold (Table 4-1) . 1,000 2,000 3,000
Sales price . . . . . $ 30 $ 35
Sales revenue . . . . $30,000 $70,000 $100,000
Cost of goods sold:
Old inventory (Table 4-2)
Quantity (units) . . 85 180
Cost per unit . . . $16 $20
Total . . . . $ 1,360 $ 3,600
New inventory (the remainder)
Quantity (units) . . 915 1,820
Cost per unit (Table 4-4) $18 $22
Total . . . . 16,470 40,040
Total cost of goods sold 17,830 43,640 $61,470
Gross profit . . . . $12,170 $26,360 $38,530
PPT 4-15
2003 McGraw-Hill Ryerson Limited
Table 4-7
Value of ending inventory



Beginning inventory (Table 4-2) . $ 4,960

+ Total production costs (Table 4-5) . 62,710

Total inventory available for sales . 67,670

- Cost of goods sold (Table 4-6) . 61,740

Ending inventory . . . . $ 6,200



PPT 4-16
2003 McGraw-Hill Ryerson Limited

Table 4-8
Pro Forma Income Statement
June 30, 2003
Sales revenue . . . . . . . 100,000
Cost of goods sold . . . . . 61,470

Gross profit . . . . . . . 38,530
Selling, general and administrative expense 12,000

Operating profit (EBIT) . . . . 26,530
Interest expense . . . . . . 1,500

Earnings before taxes (EBT) . . . 25,030
Taxes (20%) . . . . . . . 5,006

Earnings aftertaxes (EAT) . . . 20,024
Common stock dividends . . . . 1,500
Increase in retained earnings . . . $ 18,524


PPT 4-17

2003 McGraw-Hill Ryerson Limited
Purposes of Cash Budgets


Identify cash shortage in advance
Forecast amount available for major expenditures
Basis for arranging financing
Show ability to repay debt
Suggest possible changes in plans
delay capital expenditures
speed up collections
reduce expenses
PPT 4-18
2003 McGraw-Hill Ryerson Limited
Table 4-9
Monthly sales pattern
January February March April May June
$15,000 $10,000 $15,000 $25,000 $15,000 $20,000
PPT 4-19
2003 McGraw-Hill Ryerson Limited
December January February
Sales . . . . . . . $12,000 $15,000 $10,000
Collections:
(20% of current sales) . $ 3,000 $ 2,000
Collections:
(80% of previous
months sales). . . . 9,600 12,000
Total cash receipts . . $12,600 $14,000

March April May June
Sales . . . . . . . $15,000 $25,000 $15,000 $20,000
Collections:
(20% of current sales) . $ 3,000 $ 5,000 $ 3,000 $ 4,000
Collections:
(80% of previous
months sales . . . . 8,000 12,000 20,000 12,000
Total cash receipts . . $11,000 $17,000 $23,000 $16,000


PPT 4-20
Table 4-10
Monthly cash receipts
2003 McGraw-Hill Ryerson Limited
Table 4-11
Component costs of manufactured goods
Materials . . . 1,015 $10 $10,150
Labour . . . 1,015 5 5,075
Overhead . . . 1,015 3 3,045

Casters
Units Cost Total Combined
Produced per Unit Cost Cost
Materials . . . 2,020 $12 $24,240 $34,390
Labour . . . 2,020 6 12,120 17,195
Overhead . . . 2,020 4 8,080 11,125
$62,710
Wheels
Units Cost Total
Produced per Unit Cost
PPT 4-21
2003 McGraw-Hill Ryerson Limited
Total Time Average
Costs Frame Monthly Cost

Materials . . . $34,390 6 months $5,732
Labour . . . . 17,195 6 months 2,866
Overhead . . . 11,125 6 months 1,854

PPT 4-22
Table 4-12
Average monthly manufacturing costs
2003 McGraw-Hill Ryerson Limited
Table 4-13a
Summary of all monthly cash payments (a)
December January February
From Table 4-12:
Monthly material purchase . $4,500 $ 5,732 $ 5,732
Payment for material
(prior months purchase) $ 4,500 $ 5,732
Monthly labour cost . . . 2,866 2,866
Monthly overhead. . . . 1,854 1,854
From Table 4-8:
Selling, general and administrative
expense ($12,000 over
6 months) . . . . . 2,000 2,000
Interest expense . . . .
Taxes (two equal payments)
Cash dividend . . . . .
Also:
New equipment purchases . 8,000
Total payments . . . . $11,220 $20,452
PPT 4-23
2003 McGraw-Hill Ryerson Limited
Table 4-13b
Summary of all monthly cash payments (b)
March April May June
From Table 4-12:
Monthly material purchase . . $5,732 $ 5,732 $ 5,732 $ 5,732
Payment for material
(prior months purchase) . . $5,732 $ 5,732 $ 5,732 $5,730*
Monthly labor cost . . . . 2,866 2,866 2,866 2,866
Monthly overhead . . . . 1,854 1,854 1,854 1,854
From Table 4-8:
Selling, general and administrative
expense ($12,000 over
6 months) . . . . . . 2,000 2,000 2,000 2,000
Interest expense . . . . . 1,500
Taxes (two equal payments) . . 2,503 2,503
Cash dividend . . . . . . 1,500
Also:
New equipment purchases . . 10,000
Total payments . . . . . $14,955 $12,452 $12,452 $27,953
*Adjusted for rounding.
PPT 4-24
2003 McGraw-Hill Ryerson Limited
January February March

Total receipts (Table 4-10) . $12,600 $14,000 $11,000
Total payments (Table 4-13) . 11,220 20,452 14,955
Net cash flow . . . . . $ 1,380 ($ 6,452) ($ 3,955)

April May June

Total receipts (Table 4-10) . $17,000 $23,000 $16,000
Total payments (Table 4-13) . 12,452 12,452 27,953
Net cash flow . . . . . $ 4,548 $10,548 ($11,953)
PPT 4-25
Table 4-14
Monthly cash flow
2003 McGraw-Hill Ryerson Limited
Table 4-15
Cash budget with borrowing and
repayment provisions
1. Net cash flow . . . . . . $1,380 ($6,452.) ($3,955.) $4,548 $10,548 ($11,953.)
2. Beginning cash balance . . 5,000.* 6,380 5,000 5,000 5,000 11,069
3. Cumulative cash balance . . 6,380 (72.) 1,045 9,548 15,548 (884.)
4. Monthly loan or (repayment) 5,072 3,955 (4,548.) (4,479.). 5,884
5. Cumulative loan balance . . 5,072 9,027 4,479 5,884
6. Ending cash balance . . . 6,380 5,000 5,000 5,000 11,069 5,000

Jan. Feb. March April May June
* We assume the Goldman Corporation has a beginning cash balance of $5,000 on January 1, 2003, and it
desires a minimum monthly ending cash balance of $5,000.
PPT 4-26
2003 McGraw-Hill Ryerson Limited
Figure 4-2
Development of a Pro Forma Balance
Sheet
Pro forma
balance sheet
Prior balance sheet

(Unchanged items)
Marketable securities
Long-term debt
Common stock
Cash budget analysis

Cash
Accounts receivable
Plant and equipment
Accounts payable
Notes payable
PPT 4-27
Pro forma income
statement analysis

Inventory
Retained earnings
2003 McGraw-Hill Ryerson Limited

Table 4-16
Balance Sheet
December 31, 2002
Assets
Current assets:
Cash . . . . . . . . . . . . . $ 5,000
Marketable securities . . . . . . . . 3,200
Accounts receivable . . . . . . . . 9,600
Inventory . . . . . . . . . . . . 4,960
Total current assets . . . . . . . . 22,760
Plant and equipment . . . . . . . . . 27,740
Total assets . . . . . . . . . . . . $50,500
Liabilities and Shareholders Equity
Accounts payable . . . . . . . . . . $ 4,500
Long-term debt . . . . . . . . . . . 15,000
Common stock . . . . . . . . . . . 10,500
Retained earnings . . . . . . . . . . 20,500
Total liabilities and shareholders' equity . . . $50,500
PPT 4-28
2003 McGraw-Hill Ryerson Limited

Table 4-17
Pro Forma Balance Sheet
June 30, 2003
Assets
Current assets:
1. Cash . . . . . . . . . . . . $ 5,000
2. Marketable securities . . . . . . . 3,200
3. Accounts receivable. . . . . . . . 16,000
4. Inventory . . . . . . . . . . . 6,200
Total current assets . . . . . . 30,400
5. Plant and equipment . . . . . . . 45,740
Total assets . . . . . . . . . . . $76,140
Liabilities and Shareholders' Equity
6. Accounts payable . . . . . . . . $ 5,732
7. Notes payable . . . . . . . . . 5,884
8. Long-term debt . . . . . . . . . 15,000
9. Common stock . . . . . . . . . 10,500
10. Retained earnings . . . . . . . . 39,024
Total liabilities and shareholders' equity . . $76,140
PPT 4-29
2003 McGraw-Hill Ryerson Limited
2 Methods of Financial Forecasting:

Using Pro Forma, or Projected, Financial
Statements (more exact, time consuming)

Percent-of-Sales Method for the pro forma
Balance Sheet
PPT 4-30
2003 McGraw-Hill Ryerson Limited
Percent-of-Sales Method
A short-cut, less exact, easier method of determining
financing needs (The quick and dirty approach)

Assumes that B/S accounts will maintain a constant
percentage relationship to sales

More sales will mean more assets which will require more
financing

Can be summarized by using the Required New Funding
formula

PPT 4-31
2003 McGraw-Hill Ryerson Limited
HOWARD CORPORATION
Balance Sheet and Percent-of-Sales Table

Assets Liabilities and Shareholders' Equity
Cash . . . . . . $ 5,000 Accounts payable . . . $ 40,000
Accounts receivable . 40,000 Accrued expenses . . . 10,000
Inventory . . . . 25,000 Notes payable . . . . 15,000
Total current assets 70,000 Common stock . . . 10,000
Equipment . . . . 50,000 Retained earnings . . 45,000
Total assets . . . . $120,000 Total liabilities and
shareholders' equity $120,000
$200,000 sales
Percent of Sales

Cash . . . . . . 2.5% Accounts payable . . 20.0%
Accounts receivable . 20.0 Accrued expenses . . 5.0
Inventory . . . . 12.5 25.0%
Total current assets 35.0
Equipment . . . . 25.0
60.0%
PPT 4-32

Table 4-18
2003 McGraw-Hill Ryerson Limited
Table 4-19
Balance sheet with sales increase
HOWARD CORPORATION
Sales $200,000
Sales increase 50.00% $100,000
Assets Before Increase RNF
After
Cash $ 5,000 $ 2,500 $ 7,500
$ 7,500
Accounts receivable 40,000 20,000 60,000
60,000
Inventory 25,000 12,500 37,500
37,500
Total current assets $ 70,000 35,000 105,000
105,000
Equipment 50,000 25,000 75,000
75,000
Total assets $120,000 $ 60,000 $180,000
$180,000
Liabilities and Shareholders Equity
Accounts payable $ 40,000 $20,000 $ 60,000
$ 60,000
Accrued expenses 10,000 5,000 15,000
15,000
Notes payable 15,000 0 15,000
41,000
Total current liabilities $ 65,000 25,000 $90,000
$116,000
Common stock 10,000 10,000
10,000
Retained earnings 45,000 9,000 54,000
54,000
Total liabilities and shareholders equity $120,000 $34,000 $154,000
$180,000
Required new funds 26,000

Selected ratios
Debt/Total assets 65/120 = 0.54 116/180
=.064
Debt/Equity 65/(10+45) = 1.18 116/(10+54)
=1.81
Current ratio 70/65 = 1.08 105/116
=0.91

PPT 4-33
2003 McGraw-Hill Ryerson Limited
Table 4-20
Balance sheet with sustainable sales
increase
HOWARD CORPORATION
Sales $200,000
Sales increase 12.24% $ 24,480
Assets Before Increase RNF
After
Cash $ 5,000 $ 612 $ 5,612 $ 5,612
Accounts receivable 40,000 4,896 44,896
44,896
Inventory 25,000 3,060 28,060
28,060
Total current assets $ 70,000 8,568 78,568
78,568
Equipment 50,000 6,120 56,120
56,120
Total assets $120,000 $14,688 $134,688 $134,688

Liabilities and Shareholders Equity

Accounts payable $ 40,000 $ 4,896 $ 44,896 $ 44,896
Accrued expenses 10,000 1,224 11,224
11,224
Notes payable 15,000 0 15,000
16,834
Total current liabilities $ 65,000 6,120 $ 71,120 $ 72,954
Common stock 10,000 10,000 10,000
Retained earnings 45,000 6,734 51,734 51,734
Total liabilities and shareholders equity $120,000 $12,854 $132,854 $134,688
Required new funds 1,834
Selected ratios
Debt/Total assets 65/120 =0.54 73/135
=0.54
Debt/Equity 65/(10+45) =1.18 73/(10+52)
=1.18
Current ratio 70/65 =1.08 79/73
=1.08

PPT 4-34
2003 McGraw-Hill Ryerson Limited
Review of Formulas
) 1 ( ) ( ) ( 2
1 1
D PS S
S
L
S
S
A
RNF A A =
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|
+
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+
=
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D
1 ) D 1 ( P
S
A
E
D
1 ) D 1 ( P
SGR
T
1
T
4-1
4-2
PPT 4-35
2003 McGraw-Hill Ryerson Limited
Summary and Conclusions
Financial forecasting is used to anticipate events in
advance, particularly a need to raise more money
for the business
A complete forecast would include:
a pro forma income statement
a pro forma balance sheet
a cash budget
The basis for most forecasts is the sales projection
Simplified forecasts can be prepared using the
percent-of- sales method
The SGR and RNF formulas provide insight on the
impact of sales growth on funding requirements
PPT 4-36