1

Financial Management - I
Financial Planning and Forecasting Financial
Statements

Topics
2

Financial planning
Additional Funds Needed (AFN) formula
Pro forma financial statements
Sales

forecasts
Percent of sales method

Financial Planning and Pro Forma

Statements

Three important uses:

Forecast

the amount of external financing

Impact of new operating plan on firms value
Dividend pay out ratio

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

Projecting Pro Forma Statements

5

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

Long term Liabilities

Debt
Dividend

policy (which determines retained

earnings)
Common stock

Sources of Financing
7

Sales & Internal Financing

Required

assets to support sales

Internal financing

Additional funds needed (AFN) is:

Forecasted

assets minus sources of financing

Implications of AFN
8

If AFN is positive, External financing needs to

undertaken
If AFN is negative (surplus of funds)
Repayment

of debt.
Buy back stock
Buy short-term investments

Interest Expense
9

Interest expense is based on daily balance of

debt during the year
There are three ways to approximate interest
expense
Debt

at end of year
Debt at beginning of year
Average of beginning and ending debt

Debt at End of Year

10

Will over-estimate interest expense if debt is

added throughout the year instead of all on
January 1
Causes circularity called financial feedback
more debt results in more interest leads to
reduction in net income
This reduces retained earnings
hence leads to leads more debt

Debt at Beginning of Year

11

Will under-estimate interest expense if debt is

added throughout the year instead of all on
December 31.
But doesnt cause problem of circularity

Average of Beginning and Ending Debt

12

Will accurately estimate the interest payments

if debt is added smoothly throughout the year.
But has problem of circularity.

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2007 Balance Sheet

(Millions of $)
Cash & sec.

20

Accounts rec.
Inventories
Total CA

240
240
$ 500

Net fixed
assets
Total assets

500
$1,000

Accts. pay. &

accruals
Notes payable
Total CL
L-T debt
Common stk
Retained
earnings
Total claims

$ 100
100
$ 200
100
500
200
$1,000

14

2007 Income Statement

(Millions of $)
Sales
Less: COGS (60%)
SGA costs
EBIT
Interest
EBT
Taxes (40%)
Net income
Dividends (40%)
Addn to RE

$2,000.00
1,200.00
700.00
$ 100.00
10.00
$ 90.00
36.00
$ 54.00
$21.60
$32.40

Percent of Sales: Inputs

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COGS/Sales
SGA/Sales
Cash/Sales
Acct. rec./Sales
Inv./Sales
Net FA/Sales
AP & accr./Sales

2007
Actual
60%
35%
1%
12%
12%
25%
5%

2008 Proj.
60%
35%
1%
12%
12%
25%
5%

Other Inputs
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Percent growth in sales

25%

Growth factor in sales (g)

1.25

Interest rate on debt

10%

Tax rate

40%

Dividend payout rate

40%

17

2008 First-Pass Forecasted

Income Statement
Calculations

2008 1st Pass

Sales

1.25 Sales07 =

$2,500.0

Less: COGS

60% Sales08 =

1,500.0

35% Sales08 =

875.0

SGA
EBIT
Interest
EBT

$125.0
0.1(Debt07) =

20.0
$105.0

Taxes (40%)

42.0

Net Income

$63.0

Div. (40%)

$25.2

Add to RE

$37.8

2008 Balance Sheet (Assets)

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Cash
Accts Rec.
Inventories
Total CA
Net FA
Total Assets

Calcuations
1% Sales08 =
12%Sales08 =

2008
$25.0
300.0

12%Sales08 =

300.0
$625.0
625.0
$1,250.0

25% Sales08 =

19

2008 Preliminary Balance

Sheet (Claims)
5
AP/accruals

Calculations

2008 Without
AFN

5% Sales08 =

$125.0

Notes payable
Total CL

100

Carried over

100.0
$225.0

L-T debt

100

Carried over

100.0

Common stk

500

Carried over

500.0

Ret earnings

200

+37.8*

237.8

Total claims

$1,062.8

Additional funds needed

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Required assets = $1,250.0

Specified sources of fin. = $1,062.8
Forecast AFN: $1,250 - $1,062.8 = $187.2
NWC must have the assets to make
forecasted sales, and so it needs an equal
amount of financing. So, we must secure
another $187.2 of financing.

Assumptions about how AFN will

be raised
21

No new common stock will be issued.

Any external funds needed will be raised as
debt, 50% notes payable, and 50% L-T debt.

How will the AFN be financed?

22

Additional notes payable

=0.5 ($187.2) = $93.6.

Additional L-T debt

= 0.5 ($187.2) = $93.6.

2008 Balance Sheet (Claims)

23

AP accruals
Notes payable
Total CL
L-T Debt
Common stk
Ret earnings
Total claims

w/o AFN
$125.0
100.0
$225.0
100.0
500.0
237.8
$1,071.0

AFN
+93.6
+93.6

With AFN
$125.0
193.6
$318.6
193.6
500.0
237.8
$1250.0

24

Increase in these items affect the

AFN?

Higher sales:
Increases

asset requirements, increases AFN.

Higher dividend payout ratio:

Reduces

AFN.

funds available internally, increases

Economies of Scale
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Assets

1,100
1,000

Declining A/S Ratio

Base
Stock

Sales
2,000

2,500

$1,000/$2,000 = 0.5; $1,100/$2,500 = 0.44. Declining ratio shows

economies of scale. Going from S = $0 to S = $2,000 requires $1,000 of
assets. Next $500 of sales requires only $100 of assets.

Lumpy Assets
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Assets

1,500

1,000
500
Sales
500

1,000

2,000

A/S changes if assets are lumpy. Generally will have excess

capacity, but eventually a small S leads to a large A.

Different factors affect the AFN

forecast.
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Excess capacity: lowers AFN

Economies of scale: leads to less-thanproportional asset increases
Lumpy assets: leads to large periodic AFN
requirements, recurring excess capacity

Thanks.