Presentation on theme: "$424$ Financial Planning and Control Financial Planning"— Presentation transcript:
1 $424$ Financial Planning and Control Financial Planning The projection of sales, income, and assets based on alternative production and marketing strategies, as well as the determination of the resources needed to achieve these projections.Forecasting also is important for production planning and human resource planning.Financial ControlThe phase in which financial plans are implemented; control deals with the feedback and adjustment process required to ensure adherence to plans and modification of plans because of unforeseen changes.
2 $424$ Financial Planning: Growth is a key theme behind financial forecasting. Remember that growth should not be the underlying goal of a corporation – creating shareholder value is the appropriate goal. In many cases, however, shareholder value creation is enabled through corporate growth.The sales forecast predicts a firm’s unit and dollar sales for some future period; generally based on recent sales trends plus forecasts of the economic prospects for the nation, region, industry, etc.We want to forecast if we need external funds – borrowing or a new stock issue
3 Percentage of Sales Method $424$Projected Balance sheet forecasting of AFNIncreased sales requires increased assets that must be financed. We will discuss the strategy for forecasting assets.Increased sales automatically increases spontaneous liabilities.Some financing will come from retained earnings. Depending on the information, we formulate a strategy for determining RE.If additional funds are needed we have to choose to finance with external funds -- debt or stock.#5 affects #4 -- thus, we sometimes use an iterative approach to refine the estimate.
4 Projected balance sheet A = L + OE on a balance sheetIf A = L + OE both at the beginning and end of an accounting periodThen A = L + OEWhich is the fundamental basis for the sources and uses of funds statementsIn other words the accounting works rightThe concern is about acquiring outside capitalDebt and EquityBond issue or loansStock IssueExternal sources take a lead time and planning
5 Steps to get AFN – simple one-pass forecast balance sheet method Calculate RE with the data given (method varies)Increase CA and spontaneous liabilities proportionately with salesIncrease FA if needed based on capacity information givenCarry over bonds/bank-loans and stockCalculate TA - (TL+E) = AFNAFN = additional funds needed from external sources
7 Two pass method example: Northwest Chemical: 2001 Sales Projection (millions of dollars) $424$
8 Northwest Chemicals Oregon producer of Ag Chemicals $424$Northwest Chemicals Oregon producer of Ag ChemicalsPrepare financial forecast, main assumption is a 25% increase in salesWant to know how performance/ratios changes.One of the hard items is Additional Funds NeededWe will use the percentage of sales method of forecasting financial statements. This will give you a thorough feel for the process of forecasting financial statements.
10 Projected Financial Statements Step 1 Projected Financial Statements Step 1. Forecast the Income Statement$424$Key AssumptionsInterest rate = 8% for any debt.Operating at full capacity in 2000.Each type of asset grows proportionally with sales.Payables and accruals grow proportionally with sales.2000 payout (30%) will be maintained.No new common stock will be issued.Sales are expected to increase by $500 million. (%S = 25%)Implications for fixed assets and fixed cost?
14 Projected Financial Statements Step 3 Projected Financial Statements Step 3. Raising the Additional Funds Needed$424$Forecasted total assets = $1,250Forecasted total claims = $1,071Forecast AFN1 = $ 179NWC must have the assets to makeforecasted sales. The balance sheet must balance. So, we must raise $179 externally.
15 How will the AFN be financed? $424$Additional notes payable =0.5 ($179) = $89.50Additional L-T debt =But this financing will add 0.08 ($179) = $14.32 to interest expense, which will lower NI and retained earnings.
16 $424$ Projected Financial Statements Step 4. Financing Feedbacks The effects on the income statement and balance sheet of actions taken to finance forecasted increases in assets.
17 NWC: 2001 Adjusted Forecast of Income Statement $424$
18 $424$ NWC: 2001 Adjusted Forecast of Balance Sheet (Assets) No change in asset requirements.
22 $424$ Analysis of the Forecast: How does North West Chemical Compare? Not very profitable relative to other companies in the industry.Carrying excess inventory and receivables.Debt ratio projected to move ahead of average.Overall, not in good shape and doesn’t appear to be improving.
23 Capacity Issues Sales last year $500 Last year at 80% of capacity Sales will increase 50%What percentage will fixed cost and fixed assets increase?
24 Answer Sales last year were .8 times capacity Sales this year will be 1.5x.8 times capacityWhich is 1.2 times capacityTherefore capacity needs to be increased by 20%.Multiply fixed cost and fixed assets by 1.2
25 $424$ Other Considerations in Forecasting: Excess Capacity Suppose in 2000 fixed assets had been operated at only 75% of capacity: 1.25 x .75 = .9375; will be at 93.75% of capacityFull Capacity SalesActual sales=% of capacity usage
26 Does NWC need additional fixed assets? $424$With the existing fixed assets, sales couldbe $2,667. Since sales are forecasted atonly $2,500, no new fixed assets are needed.How would fixed costs change?Fixed cost would not increase.
27 If NWC had been operating at full capacity, what would its fixed assets/sales ratio be? $424$With the existing fixed assets, sales couldbe $2,667. Since sales are forecasted atonly $2,500, no new fixed assets are needed.
28 Projected Financial Statements Step 2 Projected Financial Statements Step 2. Forecast the Balance Sheet (Assets)$424$At full capacity, so all assets mustincrease in proportion to sales.
29 How would the excess capacity situation affect the 2001 AFN? $424$The projected increase in fixed assets was $125, the AFN would decrease by $125.Since no new fixed assets will be needed, AFN will fall by $125.
31 How would the excess capacity situation affect the 2001 AFN? $424$Fixed cost would not increase, increasing EBIT by $175In turn net income and RE would increase, thus more internal financing and AFN would be smaller.
32 How would excess capacity affect the forecasted ratios? $424$Sales wouldn’t change but assets would be lower, so turnovers would be better.Less new debt, hence lower interest, so higher profits, EPS,ROE.Debt ratio, TIE would improve.
34 Summary: How different factors affect the AFN forecast. $424$Dividend payout ratio changes.If reduced, more RE, reduce AFN.Profit margin changes.If increases, total and retained earnings increase, reduce AFN.Plant capacity changes.Less capacity used, less need for AFN.AP Payment terms increased to 60 days from 30.Accts. payable would double, increasing liabilities, reduce AFN.