1. Financial Forecasting

2. Forecasting and Pro Forma Analysis Timing of financial needs Amount of financial needs Flow of funds Check the covenants

3. Pro forma Income Statement Pro forma Balance Sheet Plug FigureFinancing Options Depreciation Capital Expenditures Change in Net Plant & Equipment Sales Forecast Net Income Dividend Policy Change in Retained Earnings Working Capital Accounts External Financing Required Short-Term Debt Long-Term Debt

4. Steps in Financial Forecasting 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

5. Sales Forecast Seasonal changes Business cycle Recession Expansion Market segment High growth Contraction Inflation

6. 2001 Balance Sheet (Millions of $) Cash & sec.$20Accts. pay. & accruals$100 Accounts rec.240Notes payable100 Inventories240 Total CL$200 Total CA$500L-T debt100 Common stk500 Net fixed Retained Assets500Earnings200 Total assets$1000 Total claims$1000

7. 2001 Income Statement (Millions of $) Sales$2,000.00 Less: COGS (60%)1,200.00 SGA costs700.00 EBIT$100.00 Interest16.00 EBT$84.00 Taxes (40%)33.60 Net income$50.40 Dividends (30%)$15.12 Add ’ n to RE 35.28

8. AFN (Additional Funds Needed) Key Assumptions Operating at full capacity in 2001. Each type of asset grows proportionally with sales. Payables and accruals grow proportionally with sales. 2001 profit margin (2.52%) and payout (30%) will be maintained. Sales are expected to increase by $500 million. (%ΔS = 25%)

9. AFN (Additional Funds Needed) AFN= (A*/S0) ΔS - (L*/S0) ΔS - M(S1)(1 - d) = ($1,000/$2,000)($500) - ($100/$2,000)($500) - 0.0252($2,500)(1 - 0.3) = $180.9 million.

10. Projecting Pro Forma Statements with the Percent of Sales Method: Project sales based on forecasted growth rate in sales Forecast some items as a percent of the forecasted sales Costs Cash Accounts receivable Items as percent of sales Inventories Net fixed assets Accounts payable and accruals Choose other items Debt (which determines interest) Dividends (which determines retained earnings) Common stock

11. Percent of Sales: Inputs 20012002 ActualProj. COGS/Sales60% SGA/Sales35% Cash/Sales1% Acct. rec./Sales12% Inv./Sales12% Net FA/Sales25% AP & accr./Sales5%

12. Other Inputs Percent growth in sales25% Growth factor in sales (g)1.25 Interest rate on debt8% Tax rate40% Dividend payout rate30%

13. 2002 1st Pass Income Statement 2002 2001Factor1st Pass Sales$2,000g=1.25$2,500 Less: COGS Pct=60%1,500 SGA Pct=35%875 EBIT $125 Interest16 EBT $109 Taxes (40%) 44 Net. Income $65 Div. (30%) $19 Add. to RE $46

14. 2002 1st Pass Balance Sheet (Assets) Forecasted assets are a percent of sales. 2002 Sales = $2,500 2002 Factor1st Pass Cash Pct= 1%$25 Accts. rec. Pct=12%300 Inventories Pct=12%300 Total CA $625 Net FA Pct=25%$625 Total assets $1250

15. 2002 1st Pass Balance Sheet (Claims) 2002 Sales = $2,500 2002 2001Factor1st Pass AP/accruals Pct=5%$125 Notes payable100 Total CL $225 L-T debt100 Common stk.500 Ret. earnings200+46*246 Total claims $1,071

16. What are the additional funds needed (AFN)? Forecasted total assets= $1,250 Forecasted total claims= $1,071 Forecast AFN = $ 179 NWC must have the assets to make forecasted sales. The balance sheets must balance. So, we must raise $179 externally

17. How will the AFN be financed? 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 to interest expense, which will lower NI and retained earnings.

18. 2002 2nd Pass Income Statement 1st PassFeedback2nd Pass Sales$2,500 Less: COGS$1,500 SGA875 EBIT$125 Interest16+1430 EBT$109 $95 Taxes (40%)44 38 Net income$65 $57 Div (30%)$19 $17 Add. to RE$46 $40

19. 2002 2nd Pass Balance Sheet (Assets) 1st PassAFN2nd Pass Cash$25 Accts. rec.300 Inventories300 Total CA$625 Net FA625 Total assets$1,250

20. 2002 2nd Pass Balance Sheet (Claims) 1st PassFeedback2nd Pass AP/accruals$125 Notes payable100+90190 Total CL$225 $315 L-T debt100+89189 Common stk.500 Ret. earnings246-6240 Total claims$1,071 $1,244

21. Results After the Second Pass 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.

22. Financial Forecasting and Firm Capacity Balance Sheet ($ in Millions) Assets1999Liabilities and Owners' Equity 1999 Current Assets Current Liabilities Cash200Accounts Payable400 Accounts Receivable400Notes Payable400 Inventory600Total Current Liabilities800 Total Current Assets1200Long-Term Liabilities Long-Term Debt500 Fixed Assets Total Long-Term Liabilities500 Net Fixed Assets800Owners' Equity Common Stock ($1 Par)300 Retained Earnings400 Total Owners' Equity700 Total Assets2000Liab. and Owners' Equity 2000

23. Income Statement ($ in Millions), 1999 Sales1200 Cost of Goods Sold900 Taxable Income300 Taxes90 Net Income210 Dividends70 Addition to Retained Earnings140

24. Full Capacity The equation used to calculate EFN when fixed assets are being utilized at full capacity is given below.

25. S 0 = Current Sales, S 1 = Forecasted Sales = S 0 (1 + g), g = the forecasted growth rate is Sales, A* 0 = Assets (at time 0) which vary directly with Sales, L* 0 = Liabilities (at time 0) which vary directly with Sales, PM = Profit Margin = (Net Income)/(Sales), and b = Retention Ratio = (Addition to Retained Earnings)/(Net Income).

26. Full Capacity Example Given that Fixed Assets are being utilized at full capacity and the forecasted growth rate in Sales is 25%. Forecasted Sales: S 1 = 1200(1 +.25) = $1500

27. Excess Capacity If the firm has excess capacity in its Fixed Assets then the Fixed Assets may not have to increase in order to support the forecasted sales level. Moreover, if the Fixed Assets do need to increase in order to support the forecasted sales level, then they will not have to increase by as much as would be required if they were being used at full capacity. If Forecasted Sales are less than Full Capacity Sales, then fixed assets do not need to increase to support the forecasted sales level. On the other hand, if Forecasted Sales are greater than Full Capacity Sales, then Fixed Assets will have to increase.

28. Case 1: S 1 Less Than S FC Given that Fixed Assets are currently being utilized at 60% of capacity and the forecasted growth rate in Sales is 25%. S 1 = 1200(1 +.25) = $1500 S FC = 1200/.60 = $2000 Forecasted Sales are less than Full Capacity Sales the EFN can be found in one step. Here A* 0 is equal to Total Current Assets which equals $1200.

29. Case 2: S 1 Greater Than S FC When the Forecasted Sales are greater than Full Capacity Sales, EFN can be determined in two steps. The first step, EFN 1, finds the EFN needed to get to Full Capacity Sales. The second step, EFN 2, finds the additional EFN to get from Full Capacity Sales to the Forecasted Sales. The total EFN is simply EFN 1 plus EFN 2.

30. Excess Capacity Example: S 1 > S FC Given that Fixed Assets are currently being utilized at 90% of capacity and the forecasted growth rate in Sales is 25%. S 1 = 1200(1 +.25) = $1500 S FC = 1200/.90 = $1333.33