Chapter17
Financial Planning and
Control
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Learning Outcomes
Chapter 17
Construct simple pro forma financial statements that can
be used to forecast financing and investment needs.
Discuss some of the complications that management
should consider when constructing pro forma financial
statements.
Describe and compute (a) operating breakeven and
operating leverage, (b) financial breakeven and financial
leverage, and (c) total leverage.
Discuss how knowledge of leverage is used in the
financial forecasting and control process and why financial
planning is critical to firm survival.
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Financial Planning and Control
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
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Financial Planning and Control
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.
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Financial Planning: The Sales Forecast
A forecast of 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.
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Projected (Pro Forma)
Financial Statements
A method of forecasting financial
requirements based on forecasted financial
statements
AFN = additional funds needed to support the
level of forecasted operations
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Projected Financial Statements
Determine how much money the firm will
need in a given period.
Determine how much money the firm will
generate internally during the same period.
Subtract the funds generated internally from
the funds required to determine the external
financial requirements.
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Step 1. Forecast the 2011 Income
Statement: Unilate Textiles
Assumptions:
Unilate operated at full capacity in 2010.
Sales are expected to grow by 10 percent.
The variable cost ratio remains at 82 percent
(same as 2010).
2011 dividend per share will be the same as
in 2010.
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Step 1. Forecast the 2011 Income Statement
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Step 2. Forecast the 2011 Balance Sheet
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Step 3. Raising the
Additional Funds Needed (AFN)
Higher sales must be supported by higher
assets.
Asset increase can be financed by
spontaneous increases in accounts payable
and accruals and by retained earnings.
Any short fall must be financed from external
sources--by borrowing or by selling new
stock.
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Step 4. Financing Feedbacks
The effects on the income statement and
balance sheet of actions taken to finance
forecasted increases in assets
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2011 Adjusted Forecast of Income Statement
a
b
The upper portion of the income statement is not affected by financing feedbacks.
The adjustment to RE shows up in the balance sheet as well.
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2011 Adjusted Forecast of Balance Sheet
b
c
The adjustment to RE shows up in the balance sheet as well.
Total AFN = $45.0 million, which equals $42.7 million plus the $2.3 million decrease in RE.
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Unilate Textiles: Adjusted Key Ratios
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Other Considerations in Forecasting:
Excess Capacity
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Other Considerations in Forecasting:
Economies of Scale
Unilate’svariable cost ratio is 82% of sales.
Ratio might decrease to 80% if operations
increase significantly.
Changes in variable cost ratio affect the
addition to retained earnings which affects the
amount of AFN.
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Other Considerations in Forecasting:
Lumpy Assets
Assets that cannot be acquired in small
increments, but must be obtained in large,
discrete amounts
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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.
Payment terms increased to 60 days.
 Accounts payable would double, increasing liabilities, reduce
AFN.
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Financial Control Budgeting and Leverage
The phase in which financial plans are
implemented; control deals with the feedback
and adjustment processes required to
ensure the firm is following the right financial
path to accomplish its goals, and, if not, to
make necessary corrections.
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Operating Breakeven Analysis
An analytical technique for studying the
relationship between sales revenues, operating
costs, and profits
Operating breakeven analysis deals only with the
upper portion of the income statement—the
portion from sales to NOI
At the operating breakeven point, EBIT = 0
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Unilate’s 2011 Forecasted Operating
Income
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Operating Breakeven Chart
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Breakeven Computation
For the proposal to break even, Unilate must sell 57
million units or $855.6 million of product.
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Operating Leverage
The existence of fixed operating costs, such
that a change in sales will produce a larger
change in operating income (EBIT)
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Degree of Operating Leverage
The percentage change in NOI
(or EBIT) associated with a given percentage
change in sales
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Calculating the Degree of Operating
Leverage
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Operating Income/Leverage at Sales
Levels of 110 and 121 Million Units
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Financial Breakeven Analysis
Determining the operating income (EBIT) the
firm needs to just cover all of its fixed
financing costs and produce earnings per
share equal to zero
At the financial breakeven point, EPS = 0
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Financial Breakeven Graph
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Financial Breakeven Computation
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Financial Breakeven Computation
The financial breakeven point for Unilate
Textiles in 2011 is:
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Financial Leverage
The existence of fixed financial costs such as
interest and preferred dividends when a
change in EBIT results in a larger change in
EPS
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Degree of Financial Leverage
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Degree of Financial Leverage
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EPS/Financial Leverage at Sales Levels of
110 and 121 Million Units
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Degree of Total Leverage
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Importance of Forecasting and Control
Functions
If projected operating results are not satisfactory,
management can reformulate its plans.
If funds required to meet sales forecast cannot be
obtained, management can sale back projected levels
of operations.
If required funds can be raised, it is best to plan for
their acquisition in advance.
Any deviation from projections needs to be handled
to improve future forecasts.
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