Chapter 4 Financial Forecasting, Planning, and Budgeting

2005, Pearson Prentice Hall

Financial Forecasting
1) Project sales revenues and expenses.

Financial Forecasting
1) Project sales revenues and expenses. 2) Estimate current assets and fixed assets necessary to support projected sales.

Financial Forecasting
1) Project sales revenues and expenses. 2) Estimate current assets and fixed assets necessary to support projected sales.
Percent of sales forecast

Percent of Sales Method

Suppose this years sales will total

$32 million. Next year, we forecast sales of $40 million. Net income should be 5% of sales. Dividends should be 50% of earnings.

This year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $8m $16m $24m $4m $4m $1m $6m $15m

% of $32m 25% 50%

12.5% 12.5% n/a n/a

$7m $2m
$9m $24m

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity

% of $40m 25% 50%

12.5% 12.5% n/a n/a

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m

% of $40m 25% 50%

12.5% 12.5% n/a n/a

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m

% of $40m 25% 50%

12.5% 12.5% n/a n/a

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m

% of $40m 25% 50%

12.5% 12.5% n/a n/a

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m $5m

% of $40m 25% 50%

12.5% 12.5% n/a n/a

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m $5m $5m

% of $40m 25% 50%

12.5% 12.5% n/a n/a

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m $5m $5m $1m

% of $40m 25% 50%

12.5% 12.5% n/a n/a

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m $5m $5m $1m $6m

% of $40m 25% 50%

12.5% 12.5% n/a n/a

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m $5m $5m $1m $6m $17m

% of $40m 25% 50%

12.5% 12.5% n/a n/a

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m $5m $5m $1m $6m $17m

% of $40m 25% 50%

12.5% 12.5% n/a n/a

$7m

n/a

Predicting Retained Earnings

Next years projected retained earnings = last
years $2 million, plus:

Predicting Retained Earnings

Next years projected retained earnings = last
years $2 million, plus:

projected sales

net income x sales

(1

cash dividends - net income )

Predicting Retained Earnings

Next years projected retained earnings = last
years $2 million, plus:

projected sales

net income x sales

(1
x

cash dividends - net income )

$40 million

.05

(1 - .50)

Predicting Retained Earnings

Next years projected retained earnings = last
years $2 million, plus:

projected sales

net income x sales

(1
x

cash dividends - net income )

$40 million

.05

(1 - .50)

= $2 million + $1 million = $3 million

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m $5m $5m $1m $6m $17m

% of $40m 25% 50%

12.5% 12.5% n/a n/a

$7m $3m

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m $5m $5m $1m $6m $17m

% of $40m 25% 50%

12.5% 12.5% n/a n/a

$7m $3m
$10m

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m $5m $5m $1m $6m $17m

% of $40m 25% 50%

12.5% 12.5% n/a n/a

$7m $3m
$10m $27m

n/a

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m $5m $5m $1m $6m $17m

% of $40m 25% 50%

12.5% How much 12.5% Discretionary n/a Financing n/a

$7m $3m
$10m $27m

will we n/a Need?

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m $5m $5m $1m $6m $17m

% of $40m 25% 50%

12.5% How much 12.5% Discretionary n/a Financing n/a

$7m $3m
$10m $27m

will we n/a Need?

Next year Assets Current Assets Fixed Assets Total Assets Liab. and Equity Accounts Payable Accrued Expenses Notes Payable Long Term Debt Total Liabilities Common Stock Retained Earnings Equity Total Liab. & Equity $10m $20m $30m $5m $5m $1m $6m $17m

% of $40m 25% 50%

12.5% How much 12.5% Discretionary n/a Financing n/a

$7m $3m
$10m $27m

will we n/a Need?

Predicting Discretionary Financing Needs

Predicting Discretionary Financing Needs

Discretionary Financing Needed =

Predicting Discretionary Financing Needs

Discretionary Financing Needed =
projected total assets projected total liabilities projected owners equity

Predicting Discretionary Financing Needs

Discretionary Financing Needed =
projected total assets projected total liabilities projected owners equity

$30 million -

$17 million - $10 million

Predicting Discretionary Financing Needs

Discretionary Financing Needed =
projected total assets projected total liabilities projected owners equity

$30 million -

$17 million - $10 million

= $3 million in discretionary financing

Sustainable Rate of Growth

Sustainable Rate of Growth

g* = ROE (1 - b)
where

Sustainable Rate of Growth

g* = ROE (1 - b)
where

b = dividend payout ratio (dividends / net income)

Sustainable Rate of Growth

g* = ROE (1 - b)
where

b = dividend payout ratio (dividends / net income) ROE = return on equity (net income / common equity) or

Sustainable Rate of Growth

g* = ROE (1 - b)
where

b = dividend payout ratio (dividends / net income) ROE = return on equity (net income / common equity) or

net income sales ROE = sales x assets

assets x common equity

Budgets

Budget: a forecast of future events.

Budgets

Budgets indicate the amount and

timing of future financing needs. Budgets provide a basis for taking corrective action if budgeted and actual figures do not match. Budgets provide the basis for performance evaluation.

Example: Cash Budget

Consider Salco Furniture Company, Inc., a regional distributor of household furniture. Management is in the process of preparing a monthly cash budget for the upcoming period (January through April 2004). The following information is used to prepare the cash budget: 30% of Salcos sales are collected one month after the sale and the balance (70%) is collected two month after the sale. Purchase generally 60% of sales and are made one month in advance of anticipated sales. Payments are made in the month following the purchase. For example: January sales are estimated as $60,000; Thus December purchase are $36,000 (0.60 x $60,000)and are paid in January. Wages, salaries, rent, and other cash expenses are recorded in the following table. Purchase of equipment in the amount of $10,000 in January and the repayment of an $8,000 loan in March.

Example: Cash Budget (continued)

In January, Salco will pay $4,000 in interest on its long-term

debt. Interest on the $8,000 short-term note for the period January through March equals $200 and is paid in March. A tax payment of $5,200 is made in March. Salco is currently has a cash balance of $10,000 and maintains a minimum balance of $10,000 to meet any unanticipated shortfall in net cashflow. Additional borrowing is necessary to maintain the minimum cash balance. Borrowing takes place at the beginning of the month in which the funds are needed. Interest on borrowed funds is 12% p.a., or 1% per month, and is paid in the month following in which funds are borrowed.

Salco Furniture Co., Inc., Cash Budget for the Four Month Ended April 30, 2004
Nov
Sales Collections: 1st month (30%) $18,600 $15,000 $18,000 $24,000 $25,500 $62,000

Dec
$50,000

Jan
$$60,000

Feb
$80,000

Mar
$85,000

Apr
$70,000

2nd month (70%0

Total collections Purchases (60% of next months sales) Payments (one month lag) $30,000

$38,500
$57,100 $36,000 $30,000

$43,400
$58,400 $48,000 $36,000

$35,000
$53,000 $51,000 $48,000

$42,000
$66,000 $42,000 $51,000

$56,000
$81,500 $39,000 $42,000

Cash Receipts Collections (see above) $57,100 $58,400 $53,000 $66,000 $81,500

Salco Furniture Co., Inc., Cash Budget for the Four Month Ended April 30, 2004 (continued)
Nov Cash Disbursements Dec Jan Feb Mar Apr

Purchases (see above)

Wages & salaries Rent Other expenses Interest expense on existing debt Taxes Purchases of equipment Loan repayment Total disbursements

$30,000

$36,000
4,000 3,000 1,000 4,000

$48,000
5,000 3,000 500

$51,000
6,000 3,000 1,200 200 5,200

$42,000
4,000 3,000 1,500

10,000 8,000 $58,000 $56,500 $74,600 $50,500

Salco Furniture Co., Inc., Cash Budget for the Four Month Ended April 30, 2004 (continued)
Jan Total cash receipts Total disbursements $58,400 $58,000 Feb $53,000 $56,500 Mar $66,000 $74,600 Apr $81,500 $50,500

Net monthly change

Plus: beginning balance Less: interest on short term borrowing Equals: ending balance before short-term borrowing Financing needed Ending cash balance Cumulative borrowing

$400
10,000 0 10,400 0 10,400 0

$(3,500)
$10,400 0 6,900 3,100 10,000 3,100

$(8,600)
10,000 31 1,369 8,631 10,000 11,731

$31,000
10,000 117 40,883 (11,731) 29,152 0