Management Consultancy

Chapter 14 Financial forecasting

Advisory services relative to financial management

1. Financial analysis
2. Financial forecasting
3. Working capital management and financing decisions
4. Capital budgeting and financing decisions
5. Dividend policy and external growth through mergers and acquisition

Financial forecasting – allows the firm to anticipate events before they occur particularly the need for
raising funds externally.

Projected Financial Statement

1. Forecast the statement of CI

- Sales projection
- Production schedule and production cost
- Estimate selling and admin expense
- Consider financial expenses
- Determine the net profit
2. Forecast the statement of FP
- Project the assets needed to support the projected sales
- Project funds that will be spontaneously generated (accruals and AP) and by RE
- Project liability and shareholders’ equity accounts that will not rise spontaneously with sales
but may change due to financing decisions that will be made later
- Determine if additional funds will be needed by using the following formula
Additional funds needed (AFN) = required increase in assets – spontaneous increase in
liabilities – increase in RE

Required increase in assets = change in sales x current asset (present) / sales (present)
Spontaneous increase in liabilities = change in sales x current liabilities (present) / sales
(present)
Increase in RE = earnings after taxes (projected) – dividend payment

3. Raising the additional funds needed

- Target capital structure
- Effect of short-term borrowing on its current ration
- Conditions in the debt and equity markets
- Restrictions imposed by existing debt agreements
4. Consider financing feedbacks
- Consideration of additional interest expense in the IS or dividends that decrease the RE
Chapter 15 Working capital

Working capital – sometimes referred to as gross working capital simply refers to current assets.

Net working capital – is the excess of current assets over current liabilities

Working capital management

– involves the determination of the level quality and maturity of each major current asset and
current liability.
– Also refer to the administration and control of current assets and current liabilities to insure that
they are adequate and used effectively for business purposes.

Factors affecting level of current assets

1. General nature of the business and product – trading and manufacturing companies usually require
higher proportions of current assets than service and utility companies do.

2. Effect of sales pattern – the working capital needs will be affected by the nature of the change in sales
or business activity

- if cyclical or seasonal change financing need is considered short term

- secular or permanent change – incremental working capital requires is permanent and require long
term financing.

3. length of the manufacturing process – the longer the period of time required to manufacture the
products of the company the higher the level of working capital requirements is.

4. Industry practices – the industry or line of business with greater proportion of assets readily
convertible to cash can afford to have a lower working capital investment and higher level of current
liabilities.

5. Terms of purchases and sales – the longer the credit period granted by suppliers of merchandise is,
the lower the requirement for permanent working capital is. Meanwhile the longer the credit period
given to customer of the firm is the higher the requirement of working capital is

Permanent working capital – level of working capital required to produce the goods and services
necessary to satisfy demand at its lowest point

Alternative current assets investment policies

Conservative or relaxed current assets investment policy

– relatively large amount of cash marketable securities and inventories are carried and under
which sales are stimulated by a liberal credit policy resulting in a high level of receivables.
 – This policy generally provides the lowest expected return on investment because capital tied up
in current assets either does not earn any substantial income at all or a minimal income if any,
but it entails the lowest risk.

Aggressive or restricted current asset investment policy

- Firm has fewer liquid assets with which to prevent a possible financial failure.
- Holding in cash securities investors and receivables are minimized.
- While risk of financial failure is high because of the small amount of total capital
commitment the profitability rate measured by the rate of return as total assets however is
high

Moderate current assets investment policy

- This is a policy that is between the relaxed and restricted policies

Alternative current assets financing policies

Maturity matching or self liquidating approach

- Moderate approach to current asset financing involves matching to the exten possible the
maturities of assets and liabilities so that temporary current assets are financed with
shortterm nonspontaneous debt and permanent current assets and fixed assets are finance
with long term debt or equity plus spontaneous debt.
- Also known as hedging policy
- Long term debt and equity to finance permanent assets, fixed assets and permanent WC
- Short term financing to cover seasonal and/or cyclical
- Fell in between aggressive and conservative approach

Aggressive approach

- Firm finance all of its fixed assets with long term capital but part of its permanent current
assets is financed with short term nonspontaneous credit.
- Greatest used of short term debt

Conservative approach

- Uses permanent or long term financing source to fiancé all permanent asset and also part of
the temporary current assets and then hold temporary surplus funds as marketable
securities at the trough of the cycle.
- Called for the least

Risk – return trade off

- Aggressive expect high return and high risk

- Conservative lowest return and low risk
-