1. Financial Forecasting and Short-term Financing

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. 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

6. 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

7. 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%)

8. 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.

9. 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

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

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

12. 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

13. 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

14. 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

15. 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

16. 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.

17. 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

18. 2002 2nd Pass Balance Sheet (Assets) 1st PassAFN2nd Pass Cash$25 Accts. rec.300 Inventories300 Total CA$625 Net FA625 Total assets$1,250

19. 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

20. 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.

21. The Operating Cycle and the Cash Cycle Time Accounts payable period Cash cycle Operating cycle Cash received Accounts receivable periodInventory period Finished goods sold Firm receives invoiceCash paid for materials Order Placed Stock Arrives Raw material purchased

22. Operating Cycle, Inventory turnover, and A/R turnover Inventory turnover = Sales / Average Inventory, or COGS / Average Inventory [Inventory Conversion = 365 / Inventory turnover] Accounts Receivable turnover = Sales / AR [Days A/R outstanding = 360 / Accounts Receivable turnover] Payable turnover = Purchase (or COGS) / AP [Days A/P outstanding = 360 / Payable turnover] Operating Cycle = Inventory Conversion + Days A/R outstanding

23. The Operating Cycle and the Cash Cycle In practice, the inventory period, the accounts receivable period, and the accounts payable period are measured by days in inventory, days in receivables and days in payables. Cash cycle=Operating cycle– Accounts payable period

24. You find the following information from a firm’s financial statements, please calculate its cash (conversion) period? Beginning Inventory$ 400,000 Purchase$2,600,000 Ending Inventory$ 600,000 Accounts Receivable$ 800,000 Sales$3,600,000 Accounts Payable$ 600,000

26. Operating Cycle = Inventory Conversion + A/R Days Cash Cycle = Operating cycle – A/P days Operating Cycle = 75 + 80 = 155 days Cash Cycle = 155 days – 83 days = 72 days