Financial Planning and

Forecasting

Financial Planning Process

A firms financial plan involves decisions

about:
Liquidity
Working Capital
Inventories
Capital Budgeting
Capital Structure
Dividends

The Financial Plan

Financial planning is the process of
evaluating the impact of alternative
investing and financing decisions of the
firm.
Every financial plan has three components:
A model
Inputs
Outputs

The model is a set of mathematical

relationships between the inputs and the
outputs.

The Financial Plan

Inputs to the model may include:
Projected sales
Collections
Costs
Interest rates
Exchange rates
The outputs of the financial plan are:
Pro forma financial statements
A set of budgets

Pro forma financial statements are

projected financial statements.

The Financial Plan

The planning horizon is the length of time that the
financial plan projects into the future.
Short-term financial plans
Usually have a planning horizon of one year or
less.
Are detailed and very specific.
Long-term financial plans
Usually have a five- or ten-year planning
horizon.
Tend to be less detailed.
A planning cycle specifies how frequently plans
are reviewed and updated.
The planning horizon is also renewed with each
update.
Short-term plans are updated more frequently
than long-term plans.

Financial Statement Analysis (using % of Sales

method)

Micri Drive Company

Sales
Cost
Depreciation
Total Op Cost
EBIT
Interest
EBT
taxes (40%)
NI Before Preferred
Dividend
Preferred Dividend
NI Common equity
Shares of Common
equity
Dividend per Share
Dividends to common
Additions to RE

Income Statement
Actual 2004
Forecast for 2005

$3,000
2,616.20
100
2,716.20
283.8
88
195.8
78.3
117.5
4
112.5
50
1.15
57.5
56

Financial Statement Analysis (using % of Sales method)

Microdrive Company Balance Sheet in (million dollars)

Actual 2004
Forcast 2005
Assets

Cash
10
ST Investments
0
Accounts Receivable
375
Inventories
615
Total CA
1000
Net Plant and Equipment
1000
Total Assets
2000
Liabilities and Equities

Accounts payable
60
Accruals
140
Notes Payable
110
Total CL
310
LT Bond
754
Total Liabilities
1064
Preferred Stock
40
Common Stock
130
RE
766
Total Common Equity
896
Total Liabilities & Equity
2000
Additioanl Fund Needed

Additional Fund Needed

Let
A/S0 = Percentage of required assets to
sales
L/S0 = the increase in spontaneous
liabilities per dollar increase in sales.
S0 = current level of sales.
g = projected growth rate in sales.
S1 = Total Sales projected for the next
year
M = net profit margin on sales.
RR= Retention rate.

Additional Fund Needed

AFN = {Required increase in assets
( A/S0 )* ^S} {Spontaneous
increase liabilities ( L/S0 )*^S}
{ Increase in Retained Earnings (MS1
* RR) }
Try to apply the above formula for
Micro Drive Income statement and
Balance Sheet to achieve the AFN
Data.

Problem

Mahalakshmi Nautical Company expects sales of Rs 2.4 million next year

and the same amount following year. Sales are spread evenly throughout the
year. On the basis of the following information, prepare a forecast income
statement and balance sheet for year end:
Cash: Minimum 4 percent of annual sales.
Accounts receivable: 60-day average collection period based on annual
sales.
Inventories: Turnover of eight times a year.
Net fixed assets: Rs 500,000 now. Capital expenditures equal to
depreciation.
Accounts payable: One months purchases.
Accrued expenses: 3 percent of sales.
Bank borrowings: Rs 50,000 now. Can borrow up to Rs 250,000.
Long-term debt: Rs 300,000 now, payable Rs 75,000 at year end.
Common stock: Rs 100,000. No additions planned.
Retained earnings: Rs 500,000 now.
Net profit margin: 8 percent of sales.
Dividends: None.
Cost of goods sold: 60 percent of sales.
Purchases: 50 percent of cost of goods sold.
Income taxes: 50 percent of before-tax profits.

Short Term Financial

Budgets
..Extension of Financial
Planning

Budget
A Budget is a detailed schedule of
the financial activity and it can be of
the following types as per the need
and requirement of the business:
Sales Budget
Advertising Budget
Cash Budget
A Budget can be a short term as well as
long term but usually it is perceived to
be a short term plan of business work.

Budget
Clearly stated strategic, operating
and financial objectives.
Assumptions on which the plan is
based.
Description of underlying strategies.
Contingency plans for emergencies.
Budgets, classified by
time period
division
type

Cash Budget
Cash budgets
Project and summarize cash inflows and
outflows.
Show monthly cash balances.
Show any short-term borrowing needed to
cover cash shortfalls.

They are usually based on sales forecasts.

They are usually constructed on a monthly
basis.
More frequent planning may be warranted.

Problem
As a cash manager of Tyler Paints, you
are required to prepare a cash budget
for April, May, and June. Sales in the
first three months of the year were
$400,000, $500,000, and $600,000,
respectively. Projected sales for April
through July are given below. Mark
Accounts receivable level at the end
Month:
April
May
June
July
of June,
Projected
Sales:
$1,200,000 $1,000,000 $1,000,000 $500,000

Continue.
Tyler collects 20% of its sales in the month of
the sale. An additional 45% is collected in the
month following the sale, and the remaining
35% is collected two months after the sale.
Purchases amount to 60% of next months sales,
and are paid for in the month prior to the sale.
Wages equal 20% of the current months sales,
while other fixed expenses (such as rent) are
$120,000 per month. Tyler expects to pay taxes
of $200,000 in June.
Tylers policy is to have a monthly cash balance
of $450,000 for liquidity reasons. Any shortages
will be met by short-term borrowings. Surplus
cash will be used to pay off such loans.

1) Overview of Corporate
Finance.
2) How Corporation Issues shares.

Common Stock
Treasury Stock
Stock that has been repurchased by the
company and held in its treasury.
Issued Shares
Shares that have been issued by the
company.
Outstanding Shares
Shares that have been issued by the
company and held by investors.

Common Stock
Authorized Share Capital
Maximum number of shares that the
company is permitted to issue, as
specified in the firms articles of
incorporation.

Par Value
Value of security
shown on
certificate.

Retained
Earnings
Earnings not paid
out as dividends.

Common Stock
Book Value vs. Market Value
Book value is a backward looking
measure. It tells us how much capital the
firm has raised from shareholders in the
past. It does not measure the value that
shareholders place on those shares today.
The market value of the firm is forward
looking, it depends on the future
dividends that shareholders expect to
receive.

Common Stock
Example - H.J. Heinz Book Value vs. Market Value (1/2001)
Total Shares outstanding = 350 million

Common Shares ($.25 par)

108
Additional paid in capital
344
Retained earnings 4,887
Treasury shares at cost - 2,908
Other
- 888
Net common equity (Book Value)
1,543

Common Stock
Example - H.J. Heinz Book Value vs. Market Value
(1/2001)

Total Shares outstanding = 350 million

January 2001 Market price =

$40/sh
# of shares
x 350
Market Value $14.0 billion

Preferred Stock
Preferred Stock - Stock that takes
priority over common stock in
regards to dividends.
Net Worth - Book value of common
shareholders equity plus preferred
stock.
Floating-Rate Preferred - Preferred
stock paying dividends that vary with
short term interest rates.

Corporate Debt
Debt has the unique feature of allowing the
borrowers to walk away from their obligation
to pay, in exchange for the assets of the
company.
Default Risk is the term used to describe the
likelihood that a firm will walk away from its
obligation, either voluntarily or involuntarily.
Bond Ratings "are issued on debt
instruments to help investors assess the
default risk of a firm.

Patterns of Corporate
Finance
Firms may raise funds from external
sources or plow back profits rather
than distribute them to shareholders.
Should a firm elect external
financing, they may choose between
debt or equity sources.

Venture Capital
Venture Capital
Money invested to finance a new firm

Since success of a new firm is highly

dependent on the effort of the managers,
restrictions are placed on management by the
venture capital company and funds are usually
dispersed in stages, after a certain level of
success is achieved.

Initial Offering
Initial Public Offering (IPO) - First offering
of stock to the general public.
Underwriter - Firm that buys an issue of
securities from a company and resells it to
the public.
Spread - Difference between public offer
price and price paid by underwriter.
Prospectus - Formal summary that provides
information on an issue of securities.
Underpricing - Issuing securities at an
offering price set below the true value of
the security.

General Cash Offer

Seasoned Offering - Sale of securities by a
firm that is already publicly traded.
General Cash Offer - Sale of securities open
to all investors by an already public company.
Shelf Registration - A procedure that allows
firms to file one registration statement for
several issues of the same security.
Private Placement - Sale of securities to a
limited number of investors without a public
offering.