Financial Planning and Control
4-1
 Financial Planning
The projection of sales, income, and assets based on alternative production and marketing strategies, as well as the determination of the resources needed to achieve these projections.
Forecasting also is important for production planning and human resource planning.
Financial Control
The phase in which financial plans are implemented; control deals with the feedback and adjustment process required to ensure adherence to plans and modification of plans because of unforeseen changes.

4-2
Financial Planning:
• Growth is a key theme behind financial forecasting. Remember that growth should not be the underlying goal of a corporation – creating shareholder value is the appropriate goal. In many cases, however, shareholder value creation is enabled through corporate growth.
•The sales forecast predicts a firm’s unit and dollar sales for some future period; generally based on recent sales trends plus forecasts of the economic prospects for the nation, region, industry, etc.
•We want to forecast if we need external funds – borrowing or a new stock issue

1.
2.
3.
4.
5.
6.
4-3
Percentage of Sales Method
Projected Balance sheet forecasting of AFN
Increased sales requires increased assets that must be financed. We will discuss the strategy for forecasting assets.
Increased sales automatically increases spontaneous liabilities.
Some financing will come from retained earnings.
Depending on the information, we formulate a strategy for determining RE.
If additional funds are needed we have to choose to finance with external funds -- debt or stock.
#5 affects #4 -- thus, we sometimes use an iterative approach to refine the estimate.

4-4
Projected balance sheet
 A = L + OE on a balance sheet
 If A = L + OE both at the beginning and end of an accounting period
– Then

A =

L +

OE
– Which is the fundamental basis for the sources and uses of funds statements
– In other words the accounting works right
 The concern is about acquiring outside capital
– Debt and Equity
• Bond issue or loans
• Stock Issue
 External sources take a lead time and planning

Steps to get AFN – simple one-pass
4-5 forecast balance sheet method
1.
2.
Calculate RE with the data given (method varies)
Increase CA and spontaneous liabilities proportionately with sales
3.
Increase FA if needed based on capacity information given
4.
Carry over bonds/bank-loans and stock
5.
Calculate TA - (TL+E) = AFN
 AFN = additional funds needed from external sources

Hand out simple example
4-6

$3,000
$2,500
$2,000
$1,500
$1,000
$500
$0
Two pass method example:
Northwest Chemical: 2001
Sales Projection
(millions of dollars)
1996 1997 1998 1999 2000 2001
4-7

Northwest Chemicals
Oregon producer of Ag Chemicals
4-8
 Prepare financial forecast, main assumption is a 25% increase in sales
 Want to know how performance/ratios changes.
 One of the hard items is Additional Funds
Needed
 We will use the percentage of sales method of forecasting financial statements. This will give you a thorough feel for the process of forecasting financial statements.

4-9
North West Chemical:
Key Ratios
Profit Margin
ROE
DSO
F.A. turnover
T.A. turnover
Debt/ assets
NWC
2.52%
7.20%
43.2 days
Inv. turnover 5.00x
4.00x
2.00x
30.00%
Industry Condition
4.00%
15.60%
32.0 days
8.00x
5.00x
2.50x
36.00%
Poor
“
“
“
“
“
Good
TIE 6.25x
Current ratio 2.50x
Payout ratio 30.00%
9.40x
3.00x
30.00%
Poor
“
O.K.

4-10
Projected Financial Statements
Step 1. Forecast the 2001
Income Statement
Key Assumptions
 Interest rate = 8% for any debt.
Implications for fixed assets and fixed cost?
 Operating at full capacity in 2000.
 Each type of asset grows proportionally with sales.
 Payables and accruals grow proportionally with sales.
 2000 payout (30%) will be maintained.
 No new common stock will be issued.
 Sales are expected to increase by $500 million.
(%

S = 25%)

NWC: Projected
2001 Income Statement:
Sales
Less: VC
FC
2000 Factor Initial Forecast
$2,000 x1.25
$2,500
1,200 x1.25
700 x1.25
1,500
875
EBIT
Interest
$ 100
16
EBT $ 84
Taxes (40%) 34
$ 125
16
$ 109
44
Net. income $ 50
Div. (30%) $ 15
Add. to RE $ 35
$ 65
$ 19
$ 46
4-11

4-12
Projected Financial Statements
Step 2. Forecast the 2001
Balance Sheet (Assets)
Cash/sec.
Accts. rec.
Inventories
Total CA
2000
$20
240
240
$500
Factor Initial Forecast x1.25
x1.25
x1.25
Net FA 500 x1.25
Total assets $1,000
$25
300
300
$625
625
$1,250
At full capacity, so all assets must increase in proportion to sales.

4-13
Projected Financial Statements
Step 2. Forecast the 2001
Balance Sheet (Liability & Equity)
AP/accruals
Notes payable
Total CL
2000 Factor Initial Forecast
$100 x1.25
$125
100
$200
100
$225
L-T debt
Common stk.
100
500
Ret. earnings 200 +46*
Total liab./eq.
$1,000
100
500
246
$1,071
*From projected income statement.

4-14
Projected Financial Statements
Step 3. Raising the
Additional Funds Needed
 Forecasted total assets
 Forecasted total claims
 Forecast AFN
1
= $1,250
= $1,071
= $ 179
NWC must have the assets to make forecasted sales. The balance sheet must balance. So, we must raise $179 externally.

How will the AFN be financed?
4-15
Additional notes payable =
0.5 ($179) = $89.50
Additional L-T debt =
0.5 ($179) = $89.50
But this financing will add 0.08 ($179) = $14.32 to interest expense, which will lower NI and retained earnings.

4-16
Projected Financial Statements
Step 4. Financing Feedbacks
The effects on the income statement and balance sheet of actions taken to finance forecasted increases in assets.

4-17
NWC: 2001 Adjusted Forecast of Income Statement
Sales
Less: VC
FC
EBIT
Interest
EBT
Taxes (40%)
Net. income
Div. (30%)
Add. to RE
1st Pass Feedback 2nd Pass
$2,500 $2,500
1,500
875
1,500
875
$125
16 +14
$109
44
$65
$19
$46
$125
30
$95
38
$57
$17
$40

4-18
NWC: 2001 Adjusted Forecast of Balance Sheet (Assets)
Cash/sec.
Accts. rec.
Inventories
1st Pass Feedback 2nd Pass
$25
300
300
$25
300
300
Total CA
Net FA
$625
625
Total assets $1,250
$625
625
$1,250
No change in asset requirements.

4-19
NWC: 2001 Adjusted Forecast of Balance Sheet
(Liabilities & Equity)
AP/accruals
Notes payable
Total CL
L-T debt
Common stk.
Ret. earnings
Total liab./eq.
1st Pass Feedback 2nd Pass
$125
100 +89.5
$125
190
$225
100 +89.5
$315
189
500
246
$1,071
-6
500
240
$1,244

4-20
Results of the
Adjusted Forecast:
 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 reduced net earnings. Additional passes could be made until assets exactly equal liabilities/equity. ex: $6 (0.08) = $0.48 interest 3rd pass.

4-21
Profit Margin
ROE
DSO (days)
Inv. turnover
F.A. turnover
T.A. turnover
D/A ratio
TIE
Current ratio
Payout ratio
North West Chemical:
Adjusted Key Ratios
2000
NWC
2001(E) Industry
2.52%
7.20%
43.2
5.00x
4.00x
2.00x
30.00%
6.25x
2.50x
2.27%
7.68%
4.00% Poor
15.60% “
43.2
5.00x
4.00x
32.0
11.00x
5.00x
“
“
“
2.00x
40.34%
4.12%
1.99x
2.50x
36.00%
9.40x
3.00x
“
“
“
“
30.00% 30.00% 30.00% O.K.

4-22
Analysis of the Forecast:
How does North West
Chemical Compare?
 Not very profitable relative to other companies in the industry.
 Carrying excess inventory and receivables.
 Debt ratio projected to move ahead of average.
 Overall, not in good shape and doesn’t appear to be improving.

 Sales last year $500
 Last year at 80% of capacity
 Sales will increase 50%
 What percentage will fixed cost and fixed assets increase?
4-23

4-24
Answer
 Sales last year were .8 times capacity
 Sales this year will be 1.5x.8 times capacity
 Which is 1.2 times capacity
 Therefore capacity needs to be increased by
20%.
 Multiply fixed cost and fixed assets by 1.2

Other Considerations in
Forecasting: Excess Capacity
4-25
Suppose in 2000 fixed assets had been operated at only 75% of capacity:
1.25 x .75 = .9375; will be at 93.75% of capacity
Full Capacity Sales
=
Actual sales
% of capacity usage
=
$2, 000
=
$2, 667 .

4-26
Does NWC need additional fixed assets?
With the existing fixed assets, sales could be $2,667. Since sales are forecasted at only $2,500, no new fixed assets are needed.
How would fixed costs change?
Fixed cost would not increase.

4-27
If NWC had been operating at full capacity, what would its fixed assets/sales ratio be?
Target FA / sales =
Actual fixed assets
Full capacity sales
=
$500
$2, 667
=
With the existing fixed assets, sales could be $2,667. Since sales are forecasted at only $2,500, no new fixed assets are needed.

4-28
Projected Financial Statements
Step 2. Forecast the 2001
Balance Sheet (Assets)
Cash/sec.
Accts. rec.
Inventories
Total CA
2000
$20
240
240
$500
Factor Initial Forecast x1.25
x1.25
x1.25
Net FA 500 x1.25
Total assets $1,000
$25
300
300
$625
625
$1,250
At full capacity, so all assets must increase in proportion to sales.

4-29
How would the excess capacity situation affect the 2001 AFN?

The projected increase in fixed assets was
$125, the AFN would decrease by $125.

Since no new fixed assets will be needed,
AFN will fall by $125.

NWC: Projected
2001 Income Statement:
Sales
Less: VC
FC
2000 Factor Initial Forecast
$2,000 x1.25
$2,500
1,200 x1.25
700 x1.25
1,500
875
EBIT
Interest
$ 100
16
EBT $ 84
Taxes (40%) 34
$ 125
16
$ 109
44
Net. income $ 50
Div. (30%) $ 15
Add. to RE $ 35
$ 65
$ 19
$ 46
4-30

4-31
How would the excess capacity situation affect the 2001 AFN?

Fixed cost would not increase, increasing
EBIT by $175

In turn net income and RE would increase, thus more internal financing and AFN would be smaller.

How would excess capacity affect the forecasted ratios?
4-32
 Sales wouldn’t change but assets would be lower, so turnovers would be better.
 Less new debt, hence lower interest, so higher profits, EPS,ROE.
 Debt ratio, TIE would improve.

4-33
2001 Forecasted Ratios:
Profit Margin
ROE
DSO (days)
Inv. turnover
F.A. turnover
T.A. turnover
D/A ratio
TIE
Current ratio
Payout ratio
% of Capacity in 2000
100%
2.27%
7.68%
43.2
5.00x
4.00x
2.00x
40.34%
4.12%
1.99x
30.00%
75% Industry
2.51% 4.00%
8.44% 15.60%
43.2
5.00x
32.0
8.00x
5.00x
2.22x
5.00x
2.50x
33.71% 36.00%
6.15x
9.40x
2.48x
3.00x
30.00% 30.00%

4-34
Summary: How different factors affect the AFN forecast.
 Dividend payout ratio changes.
If reduced, more RE, reduce AFN.
 Profit margin changes.
If increases, total and retained earnings increase, reduce AFN.
 Plant capacity changes.
Less capacity used, less need for AFN.
 AP Payment terms increased to 60 days from 30.
Accts. payable would double, increasing liabilities, reduce AFN.