Brooks 3e PPT 12

Chapter 12
Forecasting and
Short-Term
Financial
Planning
Learning Objectives
1. Understand the sources and uses of cash in building

a cash budget.
2.Explain how companies use sales forecasts to
predict cash inflow.
3. Understand how production costs vary in terms of
cash flow timing.
4. Explain possible ways to cover cash deficits and
invest cash surplus.
5. Prepare a pro forma income statement and a pro
forma balance sheet.
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12.1 Sources and Uses of Cash
Cash is considered to be the life-blood of a

business. Cash shortages can be stifling and
expensive while excesses can lead to poor returns.
Since most businesses do not function on a pure

cash basis, it is critical for them to forecast their
needs for cash in advance.
The cash budget is the analytical tool that

estimates the future timing of cash inflow and cash
outflow and projects potential shortfalls and
surpluses.

(continued)
Table 12.1 Bridge Water Pumps and Filters, Cash Budget for First Six
Months of 2014 ($ in thousands)
Despite setting up a cash reserve, the firm is projected to have

cash shortfalls in 3 months and surpluses in 2 after all cash
receipts and disbursements have been forecasted for the first
half of 2014.

(continued)
Figure 12.1
Cash inflows
and cash
outflows for a
company.
Identifying all
possible sources
and uses of cash is
essential for
preparing a useful
cash budget.
This list can serve

as a guide when
preparing a cash
budget.
12.2 Cash Budgeting and the
Sales Forecast
Sales revenue base variable driving almost all other
items in the cash budget, Must forecast sales as
objectively as possible.
There is usually a time lag between when a sale is
made and when the cash receipts come in Must
keep track of collections timeline.
Need internal data (information that is proprietary or
unique to the firm) as well as external data (publicly
available information) sources for objective sales
forecasts.

12.2 Cash Budgeting and the
Sales Forecast (continued)
Figure 12.2 Marketing data for Bridge Water

Pumps and Filters.

12.2 (A) Cash Inflow from Sales
Firms typically sell products and services

partially for cash and partially on credit.
An analysis of a firms collection policy can
help project cash inflow from sales.
It is quite common for firms to collect some
of their receivables in the 2 months
following the sale, i.e. November 2014s
credit sales will be partially collected in
December and January.

12.2 (A) Cash Inflow from Sales
(continued)
Table 12.3 Bridge Water Pumps and Filters Cash Flow from Sales:
January, February, and March 2014 Cash Flow Estimates
Managers often figure in a small percentage of the forecasted

sales as bad debts when preparing a cash budget.

12.2 (B) Other Cash Receipts
Besides sales, which are the main

contributor to a firms cash inflow, need to
forecast the timing and magnitude of other
occasional sources of cash such as
asset sales,
funds raised through issuance and sale of
securities, and
income earned on investments (dividends,
interest, etc.).

12.3 Cash Outflow from
Production
The magnitude and timing of the various cash disbursements
of a firm depends mainly on forecasted sales.
Payments for raw materials, labor costs, overheads such
as utilities and rent, shipping costs, etc.
Like sales, there is often a time lag between when the firm
receives and records the benefit, and when it actually makes
the payment for it.
The cash budget can be used as a handy planning document
to keep track of the projected disbursements.
Depreciation is merely a tax write-off, not a cash
disbursement, so should not be included in a cash budget.

12.4 The Cash Forecast: Short-Term
Deficits and Short-term Surpluses
The main objective of developing a cash budget Firm
has sufficient cash available from its revenues and other
receipts to cover its periodic cash disbursements such as:
1. Accounts payables for materials and supplies;
2. Salaries, wages, taxes, other operating expenses;
3. Capital expenditures for plant, equipment, and
machinery; and
4. Dividends, interest and floatation cost payments
related to raising and servicing of capital.
Over a short planning cycle, the total periodic cash inflow
rarely matches the total periodic outflow, seasonal
fluctuations and time lags.
Forecasted cash deficits and surpluses in certain periods

12.4 The Cash Forecast: Short-Term Deficits
and Short-term Surpluses (continued)
Table 12.4 Monthly Cash Budget for Bridge

Water Pumps and Filters

12.4 (A) Funding Cash
Deficits
Cash shortfalls can be handled in 4 ways:
1. Cash from savings
2. Unsecured loans (letters of credit)
3. Secured loans (using accounts receivable or
inventories)
4. Other sources (commercial paper, trade credit,
or bankers acceptance).

12.4 (B) Investing Cash
Surpluses
When a company has excess funds, it has 4 options:
1. Put the surplus in a savings account or invest it in
marketable securities.
2. Repay lenders and owners (retire debt early or pay
extra dividends).
3. Replace aging assets.
4. Invest in the company, accepting positive net
present value projects

12.5 Planning with Pro Forma
Financial Statements
Cash budgeting, is only one aspect of short-
term financial planning. Equally important for
firms to forecast their operating cash flow and
net income for the forthcoming period by
developing pro forma financial statements.
There are a variety of ways to produce pro
forma statements, but the statements usually
rely on two primary inputs:
The prior years financial statements and the
relationship of the account balances to each other,
and
The projected sales for the coming year.

12.5 Planning with Pro Forma
Financial Statements (continued)
The percentage of each item either to sales
(income statement) or to total assets (balance
sheet) is computed for the prior year and then
multiplied by the projected sales (income
statement) or total assets (balance sheet) for the
coming year to develop pro forma financial
statements.
For example, lets say that the cash balance for the prior
year is $2 million and the total assets is $100m. So cash
is 2% of total assets.
For the Pro Forma Balance Sheet, we would forecast cash
as 2% of the forecasted total assets as well, i.e. if total
assets are forecasted to increase by 20%$120mCash
would be forecasted to be .02*120m = $24m.
12.5 (A) Pro Forma Income
Statement (continued)
Figure 12.3

12.5 (A) Pro Forma Income
Statement (continued)
This approach, -- a good first

step, is often too simplistic in
reality because many
financial statement items do
not vary proportionately with
sales. In particular,
depreciation decreases over
time and cost of goods sold
often declines due to
economies of scale. The
manager would have to fine-
tune the forecasted values to
make them more in line with
reality.
Figure 12.4
12.5 (B) Pro Forma Balance
Sheet
Each prior years balance sheet item is expressed
as a percent of total assets, and then multiplied by
the forecasted total assets figure for the next
period.
Items which are obviously either constant each

period, or which vary at a different rate (for
whatever reason) are accordingly adjusted for by
the financial manager.
If total assets exceed total liabilities and owners

equity, external financing is allocated according to
some pre-determined ratio to serve as the plug
variable.

12.5 (B) Pro Forma Balance Sheet
(continued)
Figure 12.5

Sheet (continued)
Based on the following assumptions, a pro
forma balance sheet is developed

Sheet (continued)
Key calculations include:

Sheet (continued)

Sheet (continued)
Figure 12.6
Sheet (continued)
Pro Forma Cash Flow Statement

Finally, the pro forma cash flow statement
(Figure 12.7) is prepared to tie together all
the changes in operating, investment, and
financing cash flows.

Sheet (continued)
Figure 12.7

Additional Problems with Answers
Problem 1
Sales Forecast: You have been asked to forecast sales for
the coming year. Being convinced that the compound average
growth rate is the best way to forecast growth, you collect
data for the prior three years as listed below. Using the data
compute the compound growth rate for each of the years and
then forecast next years sales by using the two-year average
growth rate.
Year Sales
2012 $1,200,000
2013 $1,750,000
2014 $2,100,000
2015 ?

Problem 1 (Answer)
g = (ending value / beginning value)1 / number of years 1
2013 growth rate =[ (2010 Sales/2009 sales)] -1 =

(1.75m/1.2m) -1
2013 growth rate = 45.83%
2014 growth rate = =[ (2011 Sales/2010 sales)] -1 =

(2.1m/1.75m) -1
2014 growth rate 20%
2-year average growth rate = (2014 Sales/2012 Sales)1/2 =1=

(2.1m/1.2m)1/2 -1
2-year average growth rate =32.29%
2015 Sales Forecast =$ 2,100,000*(1.3229) = $2,778,090

Problem 2
Sales Receipts: The financial manager of Hearty Cereals is in the
process of preparing a cash budget for the first quarter of 2015. The
firm typically sells 1/3 of its monthly sales on cash terms and the
rest on credit. An analysis of the accounts receivables shows that on
average 40% of the sales are collected in the next month, 50% in 60
days, 7% in 90 days, with the rest ending up as bad debts. As the
managers assistant it is your job to project the sales receipts for the
first quarter of 2015, using the monthly sales figures listed below.
2014 Sales
October $1,750,000
November $2,000,000
December $2,450,000
2015 Forecasted Sales
January $1,850,000
February $1,650,000
March $1,900,000
Problem 2 (Answer)
Oct Nov Dec Jan Feb March
1,750,000 2,000,000 2,450,000 1,850,000 1,650,000 1,900,000
Cash 1/3 0.33 $583,333 $666,667 $816,667 $616,667 $550,000 $633,333
Credit 2/3 0.67 $388,889 $444,444 $544,444 $411,111 $366,667 $422,222
Bad debt
3% of
Credit sales 0.03 $11,666.67 $13,333 $16,333 $12,333 $11,000 $12,667
40% in 30
days =
.4*Prior
month's
credit sales 0.4 $155,556 $177,778 $217,778 $164,444 $146,667
50%in 60
days=.6* 2
month
earlier sales 0.5 $194,444 $222,222 $272,222 $205,556
7% in 90
days=.07 *
3 month
earlier sales 0.07 $27,222 $31,111 $38,111
1
Total
Receipts
from Sales $1,056,667 $986,667 $985,556

Problem 3
Production cash outflow. The Creative Products Corporation

produces its products two months in advance of anticipated sales
and ships to warehouse centers the month before sale.
The inventory safety stock is 15% of the anticipated months
sale.
Beginning inventory in October 2014 was 120,000 units. Each
unit costs $1.50 to make. The average selling price is $2.50 per
unit. The cost is made up of 60% labor, 30% materials, and 10%
shipping (to warehouse).
Labor is paid the month of production, shipping the month after
production, and raw materials the month prior to production.
What is the production cash outflow for the month of October
2014 production, and in what months does it occur?
Assume that the sales forecast for December 2014 is
$2,500,000

Problem 3 (Answer)
Unit Sales forecast for December 2014 = $2,500,000/$2.5
1 million units
Safety stock required = 15% of December sales = 150,000 units
Beginning Inventory (October 2014) = 120,000 units
Production needed in October = Dec. 14 Sales + Safety Stock

Beg. Inventory
Production needed in October = 1,000,000 + 150,000

120,000=1,030,000 units
Cost of Production (Oct. 2014) = 1,030,000*$1.50= $1,545,000
Labor cost = .60*$1,545,000 = $927,000 paid in October 2014
Shipping cost = .10*$1,545,000 = $154,500 paid in November 2014

Material cost = .30*$1,545,000 = $463,500 paid in September 2014

Problem 4
Pro forma income statement. Given the income statement below for
Imperial Products Corporation for 2014, and a 20% growth in sales for
2015, prepare a pro forma income statement.
Imperial Products Corp.
Income Statement for 2014
Sales Revenue $28,800,000

COGS 11,400,000
SG&A Expenses 6,800,000
Depreciation
Expenses 2,300,000
EBIT $8,300,000
Interest Expense 1,200,000
Taxable Income $7,100,000
Taxes $2,414,000.00
Net Income $4,686,000.00

Problem 4 (Answer)
First divide each item by sales
Then multiply each proportion by forecast sales for 2015
Forecast sales = 28,800,000*(1.2) = $34, 560,000
% of 2015
2014 sales Forecast
Sales Revenue $28,800,000 100.00% $34,560,000
COGS 11,400,000 39.58% $13,680,000
SG&A Expenses 6,800,000 23.61% $8,160,000
Depreciation
Expenses 2,300,000 7.99% $2,760,000
EBIT $8,300,000 28.82% $9,960,000
Interest Expense 1,200,000 4.17% $1,440,000
Taxable Income $7,100,000 24.65% $8,520,000
Taxes $2,414,000.00 8.38% $2,896,800
Net Income $4,686,000.00 16.27% $5,623,200

Problem 5
The Global Growth Corporation is planning for next year and wants you to help
them prepare a Pro Forma Balance Sheet for 2015. Their current Balance Sheet
is shown below along with some pre-determined changes in key balance sheet
accounts. How will you proceed?
Current Assets 2014
Cash $1,500,000
Marketable Securities 830,000

Accounts Receivable 3,450,000
Inventories 2,500,000
Total Current Assets $8,280,000
Long-term Assets
Plant, Property & Equip. $8,500,000

Goodwill 3,500,000
Intangible Assets 1,350,000
Total Long-term Assets $13,350,000

TOTAL ASSETS $21,630,000

Problem 5 (continued)
Current Liabilities
Accounts
Payable $5,125,000
Other Current
Liabilities $1,350,000
Total Current
Long-term Liabilities
Long-Term Debt $3,200,000
Other Long-term
Liab. $1,650,000
Total Long-Term
TOTAL LIABILITIES $11,325,000
Owners Equity
Common Stock $2,500,000
Retained
Earnings $7,805,000
TOTAL OWNERS EQUITY $10,305,000
TOTAL LIABILITIES & OWNERS EQUITY $21,630,000

Problem 5 (continued)
Next year, the firm will increase its Plant, Property, and
Equipment (PPE) by $7,000,000 with a plant expansion.
The inventories will grow by 70%, but accounts payables will
grow by 60%, and marketable securities will be reduced by
50% to help finance the expansion.
If all other asset accounts remain the same and long-term

debt will be used to finance the remaining costs of the
expansion (no change in common stock or retained earnings),
prepare a pro forma balance sheet for 2015. How much
additional debt will be estimated using this pro forma balance
sheet?

Problem 5 (Answer)
Start by changing the known asset accounts and then
total up assets. Then use the total assets for total
liabilities and owners equity balance. Finally, make the
required change in long-term debt to balance the
balance sheet.
i.e. PPE will be $8,500,000+$7,000,000 = $15,500,000
Inventories = 70% higher
(1.7)*2500000=4,250,000
Accounts payables = 60% higher
5,125,000*1.6=8,200,000
Marketable Securities = 50% lower = 830,000*.5
415,000

Problem 5 (Answer) (continued)
2014 2015 proforma
Cash $1,500,000 $1,500,000
Marketable Securities 830,000 415000
Accounts Receivable 3,450,000 3,450,000
Inventories 2,500,000 4250000
Total Current Assets $8,280,000 $9,615,000
Plant, Property & Equip. $8,500,000 $15,500,000

Goodwill 3,500,000 3,500,000
Intangible Assets 1,350,000 1,350,000
Total Long-term Assets $13,350,000 $20,350,000
Total Assets $21,630,000 $29,965,000

Problem 5 (Answer) (continued)
2014 2015 Pro Forma

Accounts Payable $5,125,000 $8,200,000.0
Other Current Liabilities $1,350,000 $1,350,000
Total Current Liabilities $6,475,000 $9,550,000
Long-Term Debt $3,200,000 $8,460,000

Other Long-term Liab. $1,650,000 $1,650,000
Total Long-Term
Liabilities $4,850,000 $10,110,000
$11,325,000 $16,585,000
Common Stock $2,500,000 $2,500,000

Retained Earnings $7,805,000 $7,805,000
Shareholders Equity $10,305,000 $10,305,000
Total Liab. And Sh.
Equity $21,630,000 $29,965,000

Table 12.2 McDonalds Sales
Revenues 2008 to 2013

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Chapter 12

1. Understand the sources and uses of cash in building

Copyright 2016 Pearson Education, Inc. All rights reserved. 12-2

Cash is considered to be the life-blood of a

Since most businesses do not function on a pure

The cash budget is the analytical tool that

Copyright 2016 Pearson Education, Inc. All rights reserved. 12-3

Despite setting up a cash reserve, the firm is projected to have

Copyright 2016 Pearson Education, Inc. All rights reserved. 12-4

This list can serve

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Figure 12.2 Marketing data for Bridge Water

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Firms typically sell products and services

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Managers often figure in a small percentage of the forecasted

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Besides sales, which are the main

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Table 12.4 Monthly Cash Budget for Bridge

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This approach, -- a good first

Items which are obviously either constant each

If total assets exceed total liabilities and owners

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Key calculations include:

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Pro Forma Cash Flow Statement

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2013 growth rate =[ (2010 Sales/2009 sales)] -1 =

2014 growth rate = =[ (2011 Sales/2010 sales)] -1 =

2-year average growth rate = (2014 Sales/2012 Sales)1/2 =1=

2015 Sales Forecast =$ 2,100,000*(1.3229) = $2,778,090

Copyright 2016 Pearson Education, Inc. All rights reserved. 12-29

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Production cash outflow. The Creative Products Corporation

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Beginning Inventory (October 2014) = 120,000 units

Production needed in October = Dec. 14 Sales + Safety Stock

Production needed in October = 1,000,000 + 150,000

Cost of Production (Oct. 2014) = 1,030,000*$1.50= $1,545,000

Labor cost = .60*$1,545,000 = $927,000 paid in October 2014

Shipping cost = .10*$1,545,000 = $154,500 paid in November 2014

Copyright 2016 Pearson Education, Inc. All rights reserved. 12-33

Sales Revenue $28,800,000

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Copyright 2016 Pearson Education, Inc. All rights reserved. 12-35

Marketable Securities 830,000

Plant, Property & Equip. $8,500,000

Total Long-term Assets $13,350,000

Copyright 2016 Pearson Education, Inc. All rights reserved. 12-36

Copyright 2016 Pearson Education, Inc. All rights reserved. 12-37