Financial Forecasting,
Planning and Control
Prof. Maricel R. Dizon, CPA, MPA, DipPM
September 18, 2021
What and Why Financial Planning
• A long-term financial plan represents a blueprint of what a
firm proposes to do in the future.
• Typically it covers a period of three to ten years. Naturally,
planning over such an extended time horizon tends to be
in fairly aggregative terms.
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Planning System
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What and Why Financial Planning
While there is considerable variation in the scope, degree of formality,
and level of sophistication in financial planning across firms, most
corporate financial plans have certain common elements. These are:
1. Economic assumptions: The financial plan is based on certain
assumptions about the economic environment (interest rate, tax rate,
inflation rate, growth rate, exchange rate, and so on).
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What and Why Financial Planning?
Common Elements. These are:
2. Sales forecast: The sales forecast is typically the starting point of
the financial forecasting exercise. Most financial variables are related to
the sales figure.
3. Pro forma statements. The heart of a financial plan are the pro
forma (forecast) statement of profit and loss and balance sheet.
4. Asset requirements. Firms need to invest in plant and equipment
and working capital. The financial plan spells out the projected capital
investments and working capital requirements over time.
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What and Why Financial Planning?
Common Elements. These are:
4. Asset requirements. Firms need to invest in plant and equipment
and working capital. The financial plan spells out the projected capital
investments and working capital requirements over time.
5. Financing plan. Suitable sources of financing have to be thought of
for supporting the investment in capital expenditure and working
capital. The financing plan delineates the proposed means of
financing.
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What and Why Financial Planning?
Thus, the capital budgeting decision, working capital decision,
capital structure decision, and dividend decision have to be
established for developing an explicit financial plan.
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What and Why Financial Planning?
Companies spend considerable time and resources in financial
planning. Hence, it is reasonable to ask: What are the benefits of
financial planning?
Recitation:
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What and Why Financial Planning?
Benefits of financial planning:
1. Identifies advance actions to be taken in various areas.
2. Seeks to develop a number of options in various areas that can
be exercised under different conditions.
3. Facilitates a systematic exploration of interaction between
investment and financing decisions.
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What and Why Financial Planning?
Benefits of financial planning:
4. Clarifies the links between present and future decisions.
5. Forecasts what is likely to happen in future and hence helps in
avoiding surprises.
6. Ensures that the strategic plan of the firm is financially viable.
7. Provides benchmarks against which future performance may
be measured.
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Financial Forecasting:
• Financial Forecasting is the basis for budgeting
activities and estimating future financing needs. Financial
forecasts begin with forecasting sales and their related
expenses.
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What and Why Financial Planning?
A company’s annual financial plan is called a budget. The budget
is a set of formal (written) statements of management’s
expectations regarding sales, expenses, production volume, and
various financial transactions of the firm for the coming period.
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BUDGET
Simply put, a budget is a set of pro forma statements about the
company’s finances and operations. A budget is a tool for both
planning and control. At the beginning of the period, the budget
is a plan or standard; at the end of the period, it serves as a
control device to help management measure the firm’s
performance against the plan so that future performance may be
improved.
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THE COMPONENTS OF THE MASTER BUDGET
1. Operations Budget/Profit Plan. Composed of a detailed
presentation of revenues, expenses, and net profit. This takes the
form of the pro-forma or budgeted income statement.
The operating budget consists of:
a. Sales budget
b. Production volume
c. Cost of Raw Materials
d. Number of Raw Materials units to be produced (next slide)
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THE COMPONENTS OF THE MASTER BUDGET
The operating budget consists of (con’t):
e. Cost of direct labor
f. Factory overhead
g. Inventory levels
h. Cost of good sold
i. Selling Expenses
j. Administrative Expenses
k. Financing Charges
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THE COMPONENTS OF THE MASTER BUDGET
1. Operations Budget/Profit Plan.
2. Financial Resources Budget. This is mainly made up of:
a. Cash Budget
b. Pro-forma or budgeted Statement of Financial Position
c. Projected funds flow statement
3. Capital Expenditures Budget. This involves plans on material modification
acquisition, and disposal of PPE or material Modification, and acquisition or renewal of a
firm’s computerized accounting information system
4. Budget Financial Ratio. The ratios are taken from the pro-forma or budgeted
financial statement prepared. Figures are estimated and budgeted.
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PROCESS IN PREPARING THE MASTER BUDGET
1. Top management formulates the corporate objectives, plans,
policies, and assumptions, which will give direction in the
formulation of the budget estimates.
2. Establish or estimate sales projection or targeted sales. This will
serve as a basis in determining the targeted number of units
(volume) to be sold.
3. Heads or supervisors of different functional areas prepare individual
budgets for their respective areas as well as sub-units or
responsibility centers (production, marketing, research, finance)
based on the planned volume of units to sold.
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PROCESS IN PREPARING THE MASTER BUDGET
4. The corporate planning department of a firm consolidates the
individual budgets to create a draft master budget.
5. Revision of the preliminary drafted master budget is done to come-up
with the final draft subject to the approval of the top management.
6. Department heads or supervisors approve the final master budget.
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CONSTRUCTION OF THE PRO-FORMA STATEMENTS
One of the most thorough ways in preparing a budget or doing financial
forecasting is by creating a series of pro-forma or projected or budgeted
financial statements.
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CONSTRUCTION OF THE PRO-FORMA STATEMENTS
One of the most thorough ways in preparing a budget or doing financial
forecasting is by creating a series of pro-forma or projected or budgeted
financial statements.
1. Establish or estimates sales projection or targeted sales. This will
serve as a basis in determining the targeted number of units
(volume) to be sold. The sales budgets is considered as the
cornerstone of budgeting.
2. Create the production budget schedule, which includes the raw
materials costs, direct labor costs, and overhead. This will help in
determining the gross profit.
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CONSTRUCTION OF THE PRO-FORMA STATEMENTS
One of the most thorough ways in preparing a budget or doing financial
forecasting is by creating a series of pro-forma or projected or budgeted
financial statements.
3. Create the schedule for selling, administrative and other expenses
4. Compute for the net income by preparing the pro-forma income
statement
5. Create the pro-forma cash budget schedule where the estimated cash
receipts and estimated cash disbursements are presented.
6. From the pro-forma income statement and cash budget schedule,
create a pro-forma statement of financial position.
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THE SALES BUDGET
The sales budget is the starting point in preparing the
operating budget, since estimated sales volume
influences almost all other items appearing throughout
the annual budget. The sales budget gives the quantity
of each product expected to be sold.
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Estimating Sales
The following methods may be done in estimating or forecasting sales:
1. Sales Trend Analysis – Product life cycle is used in making the
forecast. The growth commences at the introduction of the product and
accelerates during its middle year and then plateaus then it declines.
2. Sales Force Composite Method – each salesman estimates the
sales in his particular territory.
3. Executive Opinion Method – views of a number of top executives
are culled to arrive at a sales estimate.
(cont.)
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Estimating Sales
The following methods may be done in estimating or forecasting sales:
4. Industry Trend Analysis Method – relationship between expected
industry sales and the company sales in terms of market share is
determined.
5. Correlation Analysis Method – Uses regression analysis
6. Multiple Approach Method – Combination of the various methods
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THE SALES BUDGET
Basically, there are three ways of making estimates for the sales
budget:
1. Make a statistical forecast on the basis of an analysis of general
business conditions, market conditions, product growth curves, etc.
2. Make an internal estimate by collecting the opinions of executives
and sales staff.
3. Analyze the various factors that affect sales revenue and then
predict the future behavior of each of those factors
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THE SALES BUDGET
After sales volume has been estimated, the sales budget
is constructed by multiplying the estimated number of
units by the expected unit price. Generally, the sales
budget includes a computation of cash collections
anticipated from credit sales.
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THE SALES BUDGET
Assume that of each quarter’s sales, 70% is collected in the first quarter of
the sale; 28% is collected in the following quarter; and 2% is uncollectible
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THE SALES BUDGET
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The Production Budget
• After sales are budgeted, the production budget can be
determined. The number of units expected to be manufactured to
meet budgeted sales and inventory is set forth.
• The expected volume of production is determined by subtracting
the estimated inventory at the beginning of the period from the
sum of units to be sold plus desired ending inventory.
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The Production Budget
Assume that ending inventory is 10% of the next quarter’s sales and that the ending
inventory for the fourth quarter is 100 units
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The Direct Materials Budget
• When the level of production has been computed, a direct
materials budget is constructed to show how much
material will be required and how much of it must be
purchased to meet production requirements.
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The Direct Materials Budget
• The purchase will depend on both expected usage of materials
and inventory levels. The formula for computing the purchase is:
• The direct materials budget is usually accompanied by a
computation of expected cash payments for the purchased
materials.
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The Direct Labor Budget
• The production budget also provides the starting point for
the preparation of the direct labor cost budget. The direct
labor hours necessary to meet production requirements
multiplied by the estimated hourly rate yields the total
direct labor cost.
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The Direct Labor Budget: Example
• Assume that 5 hours of labor are required per unit of product and that
the hourly rate is P5.
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The Factory Overhead Budget
• The factory overhead budget is a schedule of all
manufacturing costs other than direct materials and direct
labor.
• In developing the cash budget, remember that
depreciation does not entail a cash outlay and therefore
must be deducted from the total factory overhead in
computing cash disbursements for factory overhead
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The Factory Overhead Budget: Example
• For the following factory overhead budget, assume
that:
1. Total factory overhead is budgeted at P6,000 per quarter plus P2 per
hour of direct labor.
2. Depreciation expenses are P3,250 per quarter.
3. All overhead costs involving cash outlays are paid in the quarter in
which they are incurred
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The Factory Overhead Budget: Example
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The Ending Inventory Budget
• The ending inventory budget provides the information
required for constructing budgeted financial
statements.
• First, it is useful for computing the cost of goods sold
on the budgeted income statement.
• Second, it gives the value of the ending materials and
finished goods inventory that will appear on the
budgeted FS
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The Ending Inventory Budget: Example
• For the ending inventory budget, we first need to compute the unit
variable cost for finished goods, as follows.
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The Selling and Administrative Expense Budget
• The selling and administrative expense budget lists the
operating expenses involved in selling the products and
in managing the business
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The Selling and Administrative Expense Budget
•
The variable selling and administrative expenses amount of P4 per unit of sale, including
commissions, shipping, and supplies; expenses are paid in the same quarter in which they
are incurred, with the exception of P1,200 in income tax, which is paid in the third quarter
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The Cash Budget
• The cash budget is prepared in order to forecast the firm’s
future financial needs.
• It is also a tool for cash planning and control. Because the cash
budget details the expected cash receipts and disbursements
for a designated time period, it helps avoid the problem of
either having idle cash on hand or suffering a cash shortage.
However, if a cash shortage is experienced, the cash budget
indicates whether the shortage is temporary or permanent,
that is, whether short-term or long-term borrowing is needed.
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The Cash Budget
The cash budget typically consists of four major sections:
1. The receipts section, which gives the beginning cash balance, cash
collections from customers, and other receipts
2. The disbursements section, which shows all cash payments made,
listed by purpose
3. The cash surplus or deficit section, which simply shows the
difference between the cash receipts section and the cash disbursements
section
4. The financing section, which provides a detailed account of the
borrowings and repayments expected during the budget period
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The Cash Budget: Example
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The
Cash
Budget:
Example
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The Budgeted Income Statement (Pro-forma)
The budgeted income statement summarizes the various component
projections of revenue and expenses for the budgeting period. For
control purposes, the budget can be divided into quarters, for example,
depending on the need.
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The Budgeted Income Statement: Example
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The Budgeted(Pro-Forma) Statement of FP
The budgeted balance sheet is developed by beginning with the balance
sheet for the year just ended and adjusting it, using all the activities that
are expected to take place during the budget period. Some of the
reasons why the budgeted balance sheet must be prepared are:
1. To disclose any potentially unfavorable financial conditions
2. To serve as a final check on the mathematical accuracy of all the
other budgets
3. To help management perform a variety of ratio calculations
4. To highlight future resources and obligations
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The Budgeted(Pro-Forma) Statement of FP: Example
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The Budgeted(Pro-Forma) Statement of FP: Example
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The Budgeted(Pro-Forma) Statement of FP: Example
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PERCENT OF SALES METHOD
• The percent of sales method for preparing the pro
forma statement of profit and loss is simple. Basically, this
method assumes that the future relationship between
various elements of costs to sales will be similar to their
historical relationship.
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The Jawhead Corporation
Income Statement and Vertical Analysis
For the Years Ended December 31, 2020 and 2021
In thousand Pesos
Particulars
Sales
Sales return and allowances
Net sales
Cost of good sold
Gross Profit
Operating Expenses (Other)
Selling Expenses
General Expenses
Total Operating Expenses
Earnings before interest, taxes and depreciation (EBITD)
Depreciation
Earnings before interest and taxes (EBIT) = operating income
Interest Expense
Earnings before taxes
Income taxes (40%)
Net Income
% over sales
2021
2020
%
%2
Amount
Amount
100,000.00 100.00% 110,000.00 100.00%
20,000.00 20.00%
8,000.00
7.27%
80,000.00 80.00% 102,000.00 92.73%
50,000.00 50.00% 60,000.00
0.55
30,000.00 30.00% 42,000.00 38.18%
5,000.00
4,000.00
9,000.00
5.00%
4.00%
9.00%
12,000.00
7,000.00
19,000.00
10.91%
6.36%
17.27%
21,000.00
3,000.00
18,000.00
2,000.00
16,000.00
6,400.00
9,600.00
21.00%
3.00%
18.00%
2.00%
16.00%
6.40%
9.60%
23,000.00
1,000.00
22,000.00
2,000.00
20,000.00
8,000.00
12,000.00
20.91%
0.91%
20.00%
1.82%
18.18%
7.27%
10.91%
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PERCENT-OF-SALES METHOD OF FINANCIAL
FORECASTING
The calculations for a pro forma FS are as follows:
1. Express balance sheet items that vary directly with sales as a
percentage of sales. Any item that does not vary directly with sales
(such as long-term debt) is designated not applicable (n.a.).
2. Multiply the percentages determined in step 1 by the sales
projected to obtain the amounts for the future period.
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PERCENT-OF-SALES METHOD OF FINANCIAL
FORECASTING
The calculations for a pro forma balance sheet are as follows:
3. Where no percentage applies (such as for long-term debt, common
stock, and capital surplus), simply insert the figures from the present
balance sheet in the column for the future period.
4. Compute the projected retained earnings as follows:
Projected retained earnings = present retained earnings + projected
net income - cash dividends paid
(You will need to know the % of sales that constitutes net income
and the dividend payout ratio)
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PERCENT-OF-SALES METHOD OF FINANCIAL
FORECASTING
The calculations for a pro forma balance sheet are as follows:
5. Sum the asset accounts to obtain a total projected assets figure.
Then add the projected liabilities and equity accounts to determine
the total financing provided. Since liability plus equity must balance
the assets when totaled, any difference is a shortfall, which is the
amount of external financing needed.
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PERCENT-OF-SALES METHOD OF FINANCIAL
FORECASTING
When constructing a financial forecast, the sales forecast is used
traditionally to estimate various expenses, assets, and liabilities. The
most widely used method for making these projections is the percent
of-sales method, in which the various expenses, assets, and liabilities
for a future period are estimated as a percentage of sales. These
percentages, together with the projected sales, are then used to
construct pro forma (planned or projected) SFS.
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PERCENT-OFSALES METHOD
OF FINANCIAL
FORECASTING
For the following pro forma FS, net income is assumed to
be 5% of sales and the dividend payout ratio is 4%.
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PERCENT-OFSALES METHOD
OF FINANCIAL
FORECASTING
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PERCENT-OF-SALES METHOD OF FINANCIAL
FORECASTING
• One important limitation of the percent-of-sales method is
that the firm is assumed to be operating at full capacity. On
the basis of this assumption, the firm does not have sufficient
productive capacity to absorb projected increases in sales and
thus requires an additional investment in assets.
• The major advantage of the percent-of-sales method of
financial forecasting is that it is simple and inexpensive to use
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Next meeting
Working Capital Management
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