Chapter 15 McGraw-Hill/Irwin Financial Planning and Forecasting Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. 1 Financial Planning • Strategic planning for a firm – Formulating, implementing, and evaluating crossfunctional decisions to achieve long-term objectives 15-2 Financial Planning • Firm’s financial plan – Base case is underlying set of assumptions – Base case projections • Set internal goals • Provide information to shareholders and external stakeholders 15-3 Forecasting Sales • Naïve approach – Assume future period’s sales will be equal to last observed period 15-4 Target Historic Sales vs. Average Annual Sales 2006 and 2007 – Conclusion? 15-5 Forecasting Sales • Need to examine how much error exists in using the naïve approach • Measure forecast error with Mean Absolute Percentage Error (MAPE) 15-6 MAPE Approach • Measures efficiency of forecasting technique – Uses one set of historic data to forecast a later set of “testing data” 15-7 MAPE Approach Calculated across n forecasts of a testing period 15-8 Average Approach • Better than naïve approach • Uses larger sample • Takes mean of multiple historic observations 15-9 Average Approach • Average approach reduces MAPE compared to naïve forecasts 15-10 Estimating Sales with Systematic Variations • Accurate future sales predictions must make adjustments for strong patterns • De-seasonalize – divide each month’s actual sales by the seasonal index 15-11 External Financing • Simple approach: Additional Funds Needed (AFN) 15-12 Additional Funds Needed (AFN) Capital intensity ratio – Divide amount of assets tied to sales by amount of current sales – Multiply capital intensity ratio by projected sales delta 15-13 Necessary Increase in Assets Calculation 15-14 Additional Funds Needed • Spontaneous liabilities ratio – Divide the amount of liabilities tied directly to sales by amount of current sales – Multiply by the Retention Ratio (RR) to get projected increase in retained earnings 15-15 Spontaneous Increase in Liabilities Calculation 15-16 AFN with Unused Capacity Assets • Firms often do not fully use fixed assets • Unused capacity can support increases in sales 15-17 AFN with “Lumpy” Assets • Fixed assets are not infinitely divisible • Fixed assets are bought in discrete, nondivisible, integer-based quantities 15-18 AFN Using Pro Forma Statements • Identify and compute balance sheet and income statements items that change • Adjust amounts for change in sales impact 15-19 AFN Using Pro Forma Statements • Strategize changing items that do not vary proportionally with sales • Solve for variable that allows the balance sheet to balance 15-20