CHAPTER 17

Financial Planning and

Forecasting

Forecasting sales
Projecting the assets and
internally generated funds
Projecting outside funds needed
Deciding how to raise funds
17-1

Preliminary financial
forecast:
Balance sheets2005
(Assets)
2006E
Cash and equivalents

20

25

Accounts receivable

240

300

Inventories

240

300

$ 500

$ 625

500

625

$1,000

$1,250

Total current assets

Net fixed assets
Total assets

17-2

Preliminary financial forecast:

Balance sheets (Liabilities and
equity)
Accts payable & accrued
liab.
Notes payable
Total current liabilities
Long-term debt
Common stock
Retained earnings
Total liabilities & equity

2005
2006E
$ 100 $ 125
100
190
200
315
100
190
500
500
200
245
$1,000 $1,250
17-3

Preliminary financial
forecast: Income
statements
2005
Sales
Less: Variable costs

2006E

$2,000.0 $2,500.0
1,200.0

1,500.0

700.0

875.0

$100.0

$125.0

16.0

16.0

$84.0

$109.0

33.6

43.6

$50.4

$65.40

Dividends (30% of NI)

$15.12

$19.62

Addition to retained earnings

$35.28

$45.78

Fixed costs
EBIT
Interest
EBT
Taxes (40%)
Net income

17-4

Key financial ratios

2005

2006E

Ind Avg

Comme
nt

10.00%

10.00%

20.00%

Poor

Profit margin

2.52%

2.62%

4.00%

Poor

Return on equity

7.20%

8.77%

15.60%

Poor

Days sales
outstanding

43.8
days

43.8
days

32.0
days

Poor

Inventory turnover

8.33x

8.33x

11.00x

Poor

Fixed assets
turnover

4.00x

4.00x

5.00x

Poor

Total assets
turnover

2.00x

2.00x

2.50x

Poor

Debt/assets

30.00%

40.34%

36.00%

Basic earning power

OK
17-5

Key assumptions in
preliminary financial forecast
for NWC

Operating at full capacity in 2005.

Each type of asset grows proportionally
with sales.
Payables and accruals grow
proportionally with sales.
2005 profit margin (2.52%) and payout
(30%) will be maintained.
Sales are expected to increase by $500
million. (%S = 25%)
17-6

Determining additional funds

needed, using the AFN
equation
AFN = (A*/S0)S (L*/S0) S M(S1)(RR)
= ($1,000/$2,000)($500)
($100/$2,000)($500)
0.0252($2,500)(0.7)
= $180.9 million.

17-7

Managements review
of the financial forecast

Consultation with some key managers has yielded the

following revisions:
Firm expects customers to pay quicker next year,
thus reducing DSO to 34 days without affecting
sales.
A new facility will boost the firms net fixed assets
to $700 million.
New inventory system to increase the firms
inventory turnover to 10x, without affecting sales.
These changes will lead to adjustments in the firms
assets and will have no effect on the firms liabilities
on equity section of the balance sheet or its income
statement.
17-8

Revised (final) financial

forecast:
Balance sheets (Assets)
2005

Cash and equivalents

20

2006E
$

67

Accounts receivable

240

233

Inventories

240

250

$ 500

$ 550

500

700

$1,000

$1,250

Total current assets

Net fixed assets
Total assets

17-9

Key financial ratios final

forecast
2005

2006F

Ind Avg

Comme
nt

10.00%

10.00%

20.00%

Poor

Profit margin

2.52%

2.62%

4.00%

Poor

Return on equity

7.20%

8.77%

15.60%

Poor

Days sales
outstanding

43.8
days

34.0
days

32.0
days

OK

Inventory turnover

8.33x

10.00x

11.00x

OK

Fixed assets
turnover

4.00x

3.57x

5.00x

Poor

Total assets
turnover

2.00x

2.00x

2.50x

Poor

Debt/assets

30.00%

40.34%

36.00%

Basic earning power

OK
17-10

What was the net investment

in operating capital?

OC2006 = NOWC + Net FA

= $625 - $125 + $625

OC2005 = $900

Net investment in OC
$900
= $225

= $1,125

= $1,125 -

17-11

How much free cash flow is

expected to be generated in
2006?
FCF =
=
=
=
=

NOPAT Net inv. in OC

EBIT (1 T) Net inv. in OC
$125 (0.6) $225
$75 $225
-$150.

17-12

Suppose fixed assets had only

been operating at 85% of
capacity in 2005

The maximum amount of sales that can

be supported by the 2005 level of
assets is:

Capacity sales = Actual sales / % of

capacity
= $2,000 / 0.85 = $2,353

2006 forecast sales exceed the capacity

sales, so new fixed assets are required
to support 2006 sales.
17-13

How can excess capacity

affect the forecasted
ratios?

Sales wouldnt change but assets

would be lower, so turnovers
would improve.
Less new debt, hence lower
interest and higher profits

EPS, ROE, debt ratio, and TIE would

improve.
17-14

How would the following

items affect the AFN?

Higher dividend payout ratio?

Higher profit margin?

Decrease AFN: Higher profits, more retained

earnings.

Higher capital intensity ratio?

Increase AFN: Less retained earnings.

Increase AFN: Need more assets for given

sales.

Pay suppliers in 60 days, rather than 30 days?

Decrease AFN: Trade creditors supply more
capital (i.e., L*/S0 increases).
17-15