1. Financial Planning

2. How to get the “estimated” statements: The proforma financial statements Three important uses: –(1) Forecast the amount of external financing that will be required –(2) Evaluate the impact that changes in the operating plan have on the value of the firm  What if? –(3) Set appropriate targets for compensation plans Steps: Forecast sales Project the assets needed to support sales Project internally generated funds Project outside funds needed Decide how to raise funds See effects of plan on ratios and stock price

3. 2007 Income Statement (Millions of $) Sales $2,000.00 Less: COGS (60%) 1,200.00 SGA costs 700.00 EBIT$ 100.00 Interest 16.00 EBT$ 84.00 Taxes (40%) 33.60 Net income$ 50.40 Dividends (30%)$15.12 Add’n to RE$35.28

4. 2007 Balance Sheet (Millions of $) Cash & sec.$ 20Accts. pay. & accruals$ 100 Accounts rec.240Notes payable 100 Inventories 240 Total CL$ 200 Total CA$ 500L-T debt100 Common stk500 Net fixed assets Retained earnings 200 Total assets$1,000 Total claims$1,000 500

5. Projecting Pro Forma Statements: Percent of Sales Project sales based on forecasted growth rate in sales Forecast some items as a percent of the forecasted sales –Costs –Cash –Accounts receivable –Inventories –Net fixed assets –Accounts payable and accruals Look at the impact on financing items –Debt (which determines interest) –Dividends (which determines retained earnings) –Common stock

6. Percent of Sales: Inputs COGS/Sales60%60% SGA/Sales35%35% Cash/Sales1%1% Acct. rec./Sales12%12% Inv./Sales12%12% Net FA/Sales25%25% AP & accr./Sales5%5% 2007 (actual) 2008 (Proj.) Other data: Percent growth in sales25% Interest rate on debt8% Tax rate40% Dividend payout rate30%

7. 2008 1st Pass Income Statement 2007 Factor 2008 1st Pass Sales$2,000 x1.25$2,500 Less: COGSPct = 60%1,500 SGAPct = 35%875 EBIT$125 Interest16 EBT$109 Taxes (40%)44 Net. income$65 Div. (30%)$19 Add. to RE$46

8. 2008 1 st Pass Balance Sheet (Assets) Forecasted assets are a percent of forecasted sales. Factor 2008 1st Pass Cas h Pct= 1% $25 Accts. rec. Pct=12% 300 Pct=12% 300 Total CA$625 Net FA Pct=25% 625 Total assets$1,250 2008 Sales = $2,500 Inventories

9. 2008 1 st Pass Balance Sheet (Claims) * From 1st pass income statement. 2007Factor1st Pass AP/accrualsPct=5%$125 Notes payable100 Total CL$225 L-T debt100 Common stk.500 Ret. earnings200+46 *246 Total claims$1,071 2008 2002 Sales = $2,500

10. What are the additional funds needed (AFN)? Forecasted total assets= $1,250 Forecasted total claims= $1,071 Forecast AFN= $ 179 The balance sheets must balance. So, we must raise $179 externally. (OPM)

11. Assumptions about How AFN Will be Raised No new common stock will be issued. Any external funds needed will be raised as debt, 50% notes payable, and 50% L-T debt. Additional notes payable = 0.5 ($179)= $89.50  $90. Additional L-T debt = 0.5 ($179)= $89.50  $89. But this financing will add 0.08($179) = $14.32  $14 to interest expense, which will lower NI and retained earnings!!!

12. 1st PassFeedback2nd Pass Sales$2,500 $2,500 Less:COGS1,500 1,500 SGA 875 875 EBIT$ 125 $ 125 Interest 16 +14 30 EBT$ 109 $ 95 Taxes (40%) 44 38 Net income$ 65 $ 57 Div. (30%)$ 19 $ 17 Add. to RE$ 46 $ 40 2008 2nd Pass Income Statement

13. 2008 2 nd Pass Balance Sheet (Assets) 1st PassAFN2nd Pass Cash$25 Accts. rec.300 Inventories300 Total CA$625 Net FA625 Total assets$1,250 No change in asset requirements.

14. 2002 2nd Pass Balance Sheet (Claims) 1st PassFeedback2nd Pass AP/accruals$ 125 $ 125 Notes payable 100 +90 190 Total CL$ 225 $ 315 L-T debt 100 +89 189 Common stk.500 500 Ret. earnings 246 -6 240 Total claims$1,071 $1,244

15. Forecasted assets= $1,250 (no change) Forecasted claims= $1,244 (higher) 2nd pass AFN= $ 6 (short) Cumulative AFN= $179 + $6 = $185. The $6 shortfall came from the $6 reduction in retained earnings. Additional passes could be made until assets exactly equal claims. $6(0.08) = $0.48 interest on 3rd pass. Results After the Second Pass