Financial Planning and Forecasting
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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
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2006 Sales 10,000,000
2006 Total Assets 8,000,000
Want to project 2007 financial statements based
on a 30% increase in sales.
Projected 2007 Sales 10,000,000(1.30) =
$13,000,000
Assets
Cash
Receivables
Inventory
2006
$ 500
$ 2,000
$ 1,500
Liabilities and Equity
Accounts payable
Accruals
Notes payable
Total Current Assets $ 4,000 Total Current Liabilities
Long-term debt
Net fixed assets
$ 4,000 Common stock
Retained earnings
Total Assets
$ 8,000 Total Liabilities and Equity
2006
$ 1,000
$ 500
$ 900
$ 2,400
$ 1,600
$ 1,700
$ 2,300
$ 8,000
Income Statement
2006
Sales
10000
Operating Expenses(72.5%)
7250
Operating Income
2750
Interest Expense
250
Income before taxes
2500
Taxes (40%)
1000
Net Income
1500
Dividends (30%)
450
Addition to Retained Earnings 1050
Known as percentage of sales approach.
 Zippy is operating at full capacity in 2006.
 Each type of asset grows proportionally with
sales.
 Accounts payable and accruals grow
proportionally with sales.
 2006 profit margin (15%) and payout (30%) will
be maintained.
 Sales are expected to increase by $3 million.
(%S = 30%)
Income Statement
2006 times = 2007 Proj
Sales
10000
1.3
13000
Operating Expenses(72.5%)
7250
1.3
9425
Operating Income
2750
3575
Interest Expense
250
1.3
325
Income before taxes
2500
1.3
3250
Taxes (40%)
1000
1.3
1300
Net Income
1500
1.3
1950
Dividends (30%)
450
585
Addition to Retained Earnings 1050
1365
Assets
Cash
Receivables
Inventory
Total Current Assets
Net fixed assets
Total Assets
2006 times = 2007 Proj
500
1.3
650
2000
1.3
2600
1500
1.3
1950
4000
5200
4000
1.3
5200
8000
10400
Liabilities and Equity
Accounts payable
Accruals
Notes payable
Total Current Liabilities
Long-term debt
Common stock
Retained earnings
Total Liabilities and Equity
2006
1000
500
900
2400
1600
1700
2300
8000
times = 2007 Proj
1.3
1300
1.3
650
same
900
2850
same
1600
same
1700
+1365
3665
9815
Projected 2007 Assets
10,400
Projected 2007 Liab&Eq
9,815
Additional Financing Needed
585
 Assume Zippy will raise 40% of additional
financing needed through Notes Payable and
the rest (60%) through Long-term Debt.
 Addition to Notes Payable
234
 Addition to Long-term Debt
351
Liabilities and Equity
Accounts payable
Accruals
Notes payable
Total Current Liabilities
Long-term debt
Common stock
Retained earnings
Total Liabilities and Equity
2006
1000
500
900
2400
1600
1700
2300
8000
times = Proj2007
1.3
1300
1.3
650
+ 234 =
1134
3084
+ 351 =
1951
same
1700
+ 1365 =
3665
10400
AFN = (A*/S)S - (L*/S)S - M(S1) (RR)
RR = retention ratio = 1 – dividend payout
AFN = ($8,000 / $10,000) ($3,000)
- ($1,500 / $10,000) ($3,000)
- 0.15($13,000) (1- 0.3)
= $585.
2006
Current
1.67
Quick
1.04
DSO
73.00
InvTurn
debt/assets
6.67
50.0%
Proj2007
Current
1.69
Quick
1.05
DSO
73.00
InvTurn
debt/assets
6.67
48.4%
FAT
2.50
FAT
2.50
TAT
1.25
TAT
1.25
ROA
18.8%
ROA
18.8%
ROE
37.5%
ROE
36.3%
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Sales growth: higher growth leads to more AFN
Capital Intensity Ratio (A/S): higher A/S leads to
more AFN
Spontaneous liabilities to sales ratio (L/S): higher
ratio means more internal financing and less AFN
Profit Margin (M): higher profit margin means
higher net income and less AFN
Retention Ratio: higher ratio means more retained
earnings and less AFN
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Assume Zippy’s net fixed assets were
operating at 80% capacity and current assets at
100% capacity in 2006.
How would Zippy’s additional financing
needed change?
Need to know what level of sales Zippy’s
existing net fixed assets can support or produce
= Full Capacity Sales
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Full Capacity Sales (FCS)
= Current Sales/% of Capacity
Zippy’s 2006 Sales = 10,000
80% Capacity
Full Capacity Sales = 10,000/0.8 = 12,500
Target FA Ratio = 2006 FA/ FCS
4000/12,500 = 0.32 = 32%
Proj FA = 0.32(proj sales) = 0.32(13,000)
= 4,160
Assets
Cash
Receivables
Inventory
Total Current Assets
Net fixed assets
Total Assets
2006 % of Sales Pro.Sales
500
5%
13000
2000
20%
13000
1500
15%
13000
4000
40%
13000
4000
32%
13000
8000
Proj2007
650
2600
1950
5200
4160
9360
Liabilities and Equity
Accounts payable
Accruals
Notes payable
Total Current Liabilities
Long-term debt
Common stock
Retained earnings
Total Liabilities and Equity
2006
1000
500
900
2400
1600
1700
2300
8000
Proj2007
1300
650
900
2850
1600
1700
3665
9815
-455
9360
% of Sales
10%
5%
same
13000
13000
same
same
+ 1365 =
AFN
Total
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New AFN is -455
This means Zippy can reduce debt to make the
projected balance sheet balance or just add the
surplus financing to the cash account.
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We have assumed a constant profit margin
which means interest expense is assumed to
increase proportionally with sales.
A company’s financing decision may cause the
actual interest expense to be higher or lower
than this projection.
If the additional financing decision causes
interest expense to be higher, then even more
financing will be needed.
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Instead of assuming individual assets will
remain a constant percentage of sales, a
company can modify their forecast by:
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using regression analysis to project individual asset
accounts.
using target financial ratios to project individual
asset accounts.
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Zippy’s 2006 DSO is 73 days, they plan to
improve their collection policy and lower their
DSO to 60 days in 2007. What is their projected
2007 receivables (projected sales 13,000,000)
and reduction in AFN vs. their current DSO?
DSO = Receivables/(sales/365)
Receivables = DSOx(sales/365)
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New Receivables projection = 60 x
(13,000,000/365) = 2,136,986
Our “original” projection = 73 x
(13,000,000/365) = 2,600,000
Reduction in projected receivables = 2,600,000 –
2,136,986 = 463,014
463,014 is also the reduction in AFN.
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Unless stated otherwise, all expenses are
assumed to increase proportionally with sales,
yielding the same profit margin
At full capacity, all assets increase
proportionally with sales
Only accounts payable and accrued taxes and
wages(accruals) increase proportionally with
sales
Forecasted Retained Earnings are added to the
previous year’s b/s acct.
1
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With financial statement forecast, AFN =
projected total assets - projected liab&eq
Proj. spontaneous assets and liabilities = last
year’s ratio of each account to sales times
forecasted sales
AFN is plug amount that makes the balance
sheet balance
With AFN equation, AFN = projected change
in assets - proj. change in liabilities - projected
new retained earnings
2
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If fixed assets are operating at less than 100%
capacity, determine full capacity sales
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Full capacity sales = old sales/ % of capacity
If projected sales < full capacity sales, no
increase in fixed assets is needed
If projected sales > full capacity sales, then proj.
FA = old FA/Full capacity sales times
projected sales
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