FINANCIAL PLANNING AND
FORECASTING
By Prof Sameer Lakhani
OUTLINE
• The Planning System
• What and Why of Financial Planning
• Sales Forecast
• Proforma Profit and Loss Account
• Proforma Balance Sheet
• Financial modeling using spreadsheets
• Growth and External Financing Requirement
• Key Growth Rates
THE PLANNING SYSTEM
Goals
Strategy
Research and
development
policy
Marketing
policy
Production
policy
Personnel
policy
Financial
policy
Research and
development
budget
Marketing
budget
Production
budget
Personnel
budget
Capital budget
and financing
plan
FINANCIAL PLAN
Profit and loss account
Balance sheet
Cash flow statement
COMPONENTS OF A FINANCIAL PLAN
• Economic Assumptions
• Sales Forecast
• Proforma Statements
• Asset Requirements
• Financing Plan
• Cash Budget
SALES FORECAST
• The sales forecast is typically the starting point of the
financial forecasting exercise.
• Sales forecasting techniques fall into three broad categories:
• Qualitative techniques : Based on Judgement
• Time series projection methods : Past behavior of time
series
• Causal models – Develop forecast based on Cause &
Effect relationship.
PROFORMA PROFIT & LOSS ACCOUNT
PERCENT OF SALES METHOD
Historical Data
20X1
percent
of Sales
Net sales
Cost of goods sold
Gross profit
Selling expenses
General and administration
expenses
Depreciation
Operating profit
Non-operating surplus/ deficit
Profit before interest and tax
Interest on bank borrowings
Interest on debentures
Profit before tax
Tax
Profit after tax
Dividends
20X2
Pro forma profit and
Average
loss account of 20X3
assuming sales of 1400
1200
775
425
25
1280
837
443
27
100 . 0
65 . 0
35 . 0
2.1
1400 . 0
910 . 0
490 . 0
29 . 4
53
75
272
30
302
60
58
184
82
102
60
54
80
282
32
314
65
60
189
90
99
63
4.3
6.3
22 . 3
2.5
24 . 8
5.0
4.8
15 . 0
6.9
8.1
60 . 2
88 . 2
312 . 2
35 . 0
347 . 2
70 . 0
67 . 2
210 . 0
96 . 6
113 . 4
PROFORMA PROFIT & LOSS ACCOUNT
COMBINATION METHOD
Historical Data
Net sales
Cost of goods sold
Gross profit
Selling expenses
General and administration
Depreciation
Operating profit
Non-operating surplus/ deficit
Profit before interest and tax
Interest on bank borrowings
Interest on debentures
Profit before tax
Tax
Profit after tax
Dividends
Retained earnings
20X1
20X2
Average
Percent
of sales
1200
775
425
25
53
75
272
30
302
60
58
184
82
102
60
42
1280
837
443
27
54
80
282
32
314
65
60
189
90
99
63
36
100.0
65.0
35.0
2.1
Budgeted
Budgeted
@
2.5
@
5.0
Budgeted
@
Budgeted
@
Budgeted
@
Proforma
Profit and loss
account of for
20X3
1400.0
910.0
490.0
29.4
56.0
85.0
319.6
35.0
354.6
70.0
65.0
219.6
90.0
129.6
70.0
59.6
PROFORMA BALANCE SHEET
Net sales
Assets
Fixed assets (net)
Investments
Current assets, loans and advances
• Cash and bank
• Receivables
• Inventories
• Pre-paid expenses
Miscellaneous expenditures and losses
Total
Liabilities
Share capital
• Equity
• Preference
Reserves and surplus
Secured loans
• Debentures
• Bank borrowings
Unsecured loans
• Bank borrowings
Current liabilities and provisions
• Trade creditors
• Provisions
External funds requirement
Total
Historical Data
March
March Average of Percent
31, 20X1 31, 20X1 of Sales or some other
basis
1200
1280
100.0
Projection for
March 31, 20X3
based on a fore-cast sales of 1400
1400.0
800
30
850
30
66.5
No change
931.0
30
25
200
375
50
20
1500
28
212
380
55
20
1575
2.1
16.6
30.4
4.2
No change
29.4
232.4
425.6
58.8
20
1727.2
250
50
250
250
50
286
No change
No change
Proforma income
statement
400
300
400
305
100
125
100
50
112
47
1500
1575
No change
24.4
9.1
8.5
3.9
Balancing figure
250.0
50.0
345.6
400
341.6
127.4
119.0
54.6
39.0
1727.2
Problem
Prepare the pro forma P&L & Balance sheet for the year 3 based on the following
assumptions.
Projected sales for the year 3 is 850
Forecast value for the following P&L accounts items may be derived using the percent of
sales method ( for this purpose assume that the average of the % for year 1 & 2 is
applicable)
COGS , Selling Expenses, General & Admin exp , Non Operating surplus / deficit , Interest
The forecast values for the other items of the P&L account are as follows
Depreciation 45
Tax @ 50 %
Dividends 21
Problem
Forecast values for Balance sheet:
Fixed assets : Budgeted at 300
Investments : No change over 2 years
Current assets : Percent of sales method wherein the percentages are based on the average
over 2 years
Mis expenditure & losses : Expected to be reduced to 5
Equity & preference capital : No change over year 2
Reserves & surplus : Proforma P & L
Bank borrowings & Current Liabilities & provision: Percent of sales method wherein the
percentages are based on the average over 2 years
Public deposit : No Change
External fund required : Balancing figure
GROWTH AND EXTERNAL FINANCING
REQUIREMENT
EFR = A/S (△S) – L/S (△S) – mS1 (1 – d) – (△IM + SR)
EFR = external funds requirement
A/S = current assets and fixed assets as a proportion of sales
△S = expected increase in sales
L/S = current liabilities and provisions as a proportion of sales
m = net profit margin
S1 = projected sales for next year
d = dividend payout ratio
△IM = Change in level of Investment & miscellaneous Expenditure &
GROWTH AND EXTERNAL FINANCING
REQUIREMENT
Manipulating Eq. a bit, we get
EFR
△S
A
=
S
–
L
S
m (1 + g) (1 – d)
–
g
Illustration
△S = Rs. 6 million,
A/S = 0.90,
M = 0.05,
L/S = 0.40,
S1 = Rs. 46 million,
and d = 0.6
EFR = (0.90) (6) – (0.4) (6) – (0.05) (46) (0.4)
= Rs. 2.08 million
EFR
△S
= 0.50 –
= 0.50 –
g (%)
EFR/△S
0.05 (1 + g) (1 – 0.60)
g
0.20 (1 + g)
g
5
10
15
20
25
0.08
0.28
0.35
0.38
0.42
FORECASTING WHEN THE BALANCE
SHEET RATIOS CHANGE
The assumption of constant ratios and identical growth
rates may be appropriate sometimes, but not always. In
particular its applicability is suspect in the following
situations:
•
Economies of scale
•
Lumpy assets
•
Forecasting errors and excess assets
INTERNAL GROWTH RATE
It is the maximum rate at which a firm can grow (in terms of sales or
assets) without external financing of any kind.
Assumptions:
1.Increase in asset of the firm in proportion of the sales.
2.PAT margin is in direct proportion to sales.
3.Firm has a target dividend payout ratio which is wants to maintain.
4.Firm wants to grow by retention it does not raise external funds
(neither equity or debt) to finance assets.
IGR = ROA * b
1 – (ROA * b)
SUSTAINABLE GROWTH RATE
It is the maximum rate at which the firm can grow by using both internal
sources (Retained Earnings) as well as additional external debt but without
increasing its financial leverage ( debt equity ratio).
Additional Assumptions:
1.The firm has a target capital structure (D/E ratio) which it wants to maintain.
2.The firm does not intend to sell new equity shares as it is costly source of
finance.
SGR = ROE * b
1 – (ROE * b)
Given the assumptions it enables the corporate to maintain the existing
ROE besides target D/E ratio and the target D/P ratio
SGR = P*A* A/E * b
1- (P*A* A/E * b)
SUSTAINABLE GROWTH RATE
SGR of the firm can increased by any one or more of the following factors:
1.Increase in Net profit Margin
2.Increase in Asset turnover ratio
3.Increase in financial leverage
4.Increase in retention ratio (or Decrease in the dividend payout ratio).
Concluding Remarks: When a company grows @ higher than its
SGR,it has better operating margin (Higher NPM or ATR) or it is prepared to
revise its financing policy (by Increasing its RR or its D/E financial leverage
ratio)
In case firm anticipates it is not possible to improve operating
performance nor it is willing to assume more risk it is prefer to grow at SGR or
a rate lower to conserve financial resources to avoid problem of liquidity &
solvency in future.
Thank You