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Chapter

McGraw-Hill/IrwinCopyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Financial

Forecasting4

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Chapter Outline

Financial forecasting in a firms strategicgrowth

Three financial statements

Percent-of-sales method

Methods to determine the amount of new

funds required in advance Factors that affect cash flow

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Financial Forecasting

Ability to plan ahead and make necessarychanges before actual events occur

Outcome of a firm through external events

might be a function of both: Risk-taking desires

Ability to hedge against risk with planning

No growth or a decline - not the primarycause of shortage of funds

A comprehensive financing plan must bedeveloped for a significant growth

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4-4

Constructing Pro Forma Statements

A systems approach to develop pro formastatements consists of:

Constructing it based on:

Sales projections

Production plans

Translating it into a cash budget

Assimilating all materials into a pro formabalance sheet

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Development of

Pro Forma Statements

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Pro Forma Income Statement

Provides a projection on the anticipation ofprofits over a subsequent period

Four important steps include: Establishing a sales projection

Determining production schedule and the associateduse of new material, direct labor, and overhead toarrive at gross profit

Computing other expenses

Determining profit by completing actual pro formastatement

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Establish a Sales Projection

Let us assume Goldman Corporation hastwo primary products: wheels and casters

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Stock of Beginning Inventory

Number of units produced will depend onbeginning inventory

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Determine a Production Schedule

and the Gross Profit

To determine the production requirements:

Units

+ Projected sales+ Desired ending inventory

Beginning inventory

= Production requirements

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Production Requirements

for Six Months

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Total Production Costs

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Cost of Goods Sold

Costs associated with units sold during thetime period

Assumptions for the illustration:

FIFO accounting is used

First allocates the cost of current sales to beginninginventory

Then to goods manufactured during the period

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Allocation of Manufacturing Cost

and Determination of Gross Profits

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Value of Ending Inventory

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Other Expense Items

Must be subtracted from gross profits toarrive at net profit

Earning before taxes

General and administrative expenses, and interestexpenses are subtracted from gross profit

Aftertax income

Taxes are deducted from the earning before taxes Contribution to retained earnings

Dividends are deducted from the aftertax income

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Actual Pro Forma Income Statement

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Exercises

Page: 112

Numbers: 8 and 13

4-18

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Cash Budget

Pro forma income statement must betranslated into cash flows

The long-term is divided into short-term pro

forma income statement

More precise time frames set to help anticipatepatterns of cash inflows and outflows

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Monthly Sales Pattern

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Cash Receipts

In the case of Goldman Corporation:

The pro forma income statement is taken for thefirst half year:

Sales are divided into monthly projections

A careful analysis of past sales and collectionrecords show:

20% of sales is collected in the month 80% in the following month

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Monthly Cash Receipts

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Cash Payments

Monthly costs associated with:

Inventory manufactured during the period

Material

Labor

Overhead

Disbursements for general and administrative

expenses Interest payments, taxes, and dividends

Cash payments for new plant and equipment

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Component Costs

of Manufactured Goods

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Cash Payments (contd)

Assumptions for the next two tables:

Costs are incurred on an equal monthly basisover a six-month period

Sales volume varies each month

Employment of level monthly production toensure maximum efficiency

Payment for material, once a month afterpurchases have been made

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Average Monthly

Manufacturing Costs

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Summary of All

Monthly Cash Payments

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Actual Budget

Difference between monthly receipts andpayments is the net cash flow for the month

Allows the firm to anticipate the need for funding

at the end of each month

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Cash Budget with Borrowing

and Repayment Provisions

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Pro Forma Balance Sheet

Represents the cumulative changes overtime

Important to examine the prior periods balance

sheet

Some accounts will remain unchanged, whileothers will take new values

Information is derived from the pro forma incomestatement and cash budget

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Development of a

Pro Forma Balance Sheet (contd)

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Explanation of

Pro Forma Balance Sheet

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Analysis of Pro Forma Statement

The growth ($25,640) was financed byaccounts payable, notes payable, and profit

As reflected by the increase in retained earnings

Total assets (June 30, 2005)$76,140

Total assets (Dec 31, 2004).$50,500

Increase...$25,640

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Percent-of-Sales Method

Based on the assumption that:

Accounts on the balance sheet will maintain agiven percentage relationship to sales

Notes payable, common stock, and retainedearnings do not maintain a direct relationshipwith sales volume

Hence percentages are not computed

l Sh

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Balance Sheet

of Howard Corporation

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Percent-of-Sales Method (contd)

Funds required is ascertained

Financing is planned based on:

Notes payable

Sale of common stock

Use of long-term debt

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Percent-of-Sales Method (contd)

Company operating at full capacity needs to buy newplant and equipment to produce more goods to sell: Required new funds:

(RNF) = A (S) L (S) PS2(1 D)

S S Where: A/S = Percentage relationship of variable assets to sales;

S = Change in sales; L/S = Percentage relationship of variableliabilities to sales; P = Profit margin; S2 = New sales level; D =Dividend payout ratio

RNF = 60% ($100,000) 25% ($100,000) 6% ($300,000) (1 .50)

= $60,000 - $25000 - $18,000 (.50)

= $35,000 - $9000

= $26,000 required sources of new funds

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Percent-of-Sales Method (contd)

Company not operating at full capacity - needs to add morecurrent assets to increase sales:

RNF = 35% ($100,000) 25% ($100,000) 6% ($300,000) (1 .50)

= $35,000 - $25,000 - $18,000 (.50)

= $35,000 - $25,000 - $9,000

= $1,000 required sources of new funds

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Activity

11th Edition Numbers 20, 22

13th Edition Numbers 23, 25

Comprehensive Problems