Financial Forecasting, Planning, and Budgeting
Financial Forecasting:

1.
2.

Project sales revenues and expenses
Estimate current assets and fixed assets necessary to
support projected sales
Percent of sales forecast
Slide 1
Percent of Sales Method




Suppose this year’s sales will total $32 million
Next year, we forecast sales of $40 million
Net income should be 5% of sales
Dividends should be 50% of earnings
Slide 2
Construction of Forecast Balance Sheet



All asset accounts are assumed to vary
proportionally with sales
Accounts Payable and Accrued Expenses are the
Current Liability accounts that vary with sales
directly – remember liabilities and equity are
financing sources for a firm
Because of this Accounts Payable and Accrued
Expenses are called spontaneous sources of
financing
Slide 3
Percent of Sales Method (Continued)
This year
Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity
% of $32m
$8m
$16m
$24m
25%
50%
$4m
$4m
$1m
$6m
$15m
$7m
$2m
$9m
$24m
12.5%
12.5%
n/a
n/a
n/a
Slide 4
Percent of Sales Method (Continued)
Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity
Next year
% of $40m
$10m
$20m
$30m
25%
50%
$5m
$5m
$1m
$6m
$17m
$7m
???
???
12.5%
12.5%
n/a
n/a
n/a
Slide 5
Predicting Retained Earnings

Next year’s projected retained earnings = last
year’s $2 million, plus:
Net Income  Cash Dividends 
Sales x
x 1 

Sales
Net Income 



$40 million x 0.05 x (1 - 0.50)
= $2 million + $1 million = $3million
Slide 6
Predicting Discretionary Financing Needs
Assets
Current Assets
Fixed Assets
Total Assets
Liab. and Equity
Accounts Payable
Accrued Expenses
Notes Payable
Long Term Debt
Total Liabilities
Common Stock
Retained Earnings
Equity
Total Liab. & Equity
Next year
% of $40m
$10m
$20m
$30m
25%
50%
$5m
$5m
$1m
$6m
$17m
$7m
$3m
$10m
$27m
12.5%
12.5%
n/a much
How
n/a
Discretionary
Financing
n/a
will we
Need?
Slide 7
Predicting Discretionary Financing Needs
(Continued)





Discretionary Financing Needed = [Projected
Total Assets] – [Projected Total Liabilities] –
[Projected Shareholders’ Equity]
Alternatively:
DFN = [Projected Total Assets] – [Projected
Liabilities & Shareholders’ Equity]
DFN = $30 million – $17 million – $10 million
DFN = $3 million in discretionary financing
Slide 8
Predicting Discretionary Financing Needs
(Continued)




At this point corporation has to decide how to
finance the DFN
The Company can sell Bonds (Long-Term Debt)
or Equity
This is why we call Long-Term Debt and Equity
as sources of external capital
Note that paid-in capital is the difference between
selling price of equity and face value times the
number of shares sold
Slide 9
Sustainable Rate of Growth


Sustainable rate of growth is the rate the sales can grow
without selling new equity and maintaining debt ratio
(this means that if a firm retains earnings it would need to
issue new debt to maintain debt ratio)
g* = ROE (1 – b) where
b
= dividend payout ratio
(dividends / net income)
ROE = return on equity
(net income / common equity)
Slide 10
Budgets




Budget: a forecast of future events
Budgets indicate the amount and timing of future
financing needs
Budgets provide a basis for taking corrective
action if budgeted and actual figures do not match
Budgets provide the basis for performance
evaluation
Slide 11