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Financial Forecasting, Planning, and Budgeting Financial Forecasting: Project sales revenues and expenses Estimate current assets and fixed assets necessary to support projected sales Percent of sales forecast Percent of Sales Method Suppose this year’s sales will total $32 million

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financial forecasting planning and budgeting
Financial Forecasting, Planning, and Budgeting
  • Financial Forecasting:
    • Project sales revenues and expenses
    • Estimate current assets and fixed assets necessary to support projected sales
  • Percent of sales forecast
percent of sales method
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
construction of forecast balance sheet
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
percent of sales method continued
Percent of Sales Method (Continued)

This year% of $32m

Assets

Current Assets $8m 25%

Fixed Assets $16m 50%

Total Assets $24m

Liab. and Equity

Accounts Payable $4m 12.5%

Accrued Expenses $4m 12.5%

Notes Payable $1m n/a

Long Term Debt $6m n/a

Total Liabilities $15m

Common Stock $7m n/a

Retained Earnings $2m

Equity $9m

Total Liab. & Equity $24m

slide5

Percent of Sales Method (Continued)

Next year% of $40m

Assets

Current Assets $10m 25%

Fixed Assets $20m 50%

Total Assets $30m

Liab. and Equity

Accounts Payable $5m 12.5%

Accrued Expenses $5m 12.5%

Notes Payable $1m n/a

Long Term Debt $6m n/a

Total Liabilities $17m

Common Stock $7m n/a

Retained Earnings ???

Equity ???

Total Liab. & Equity

predicting retained earnings
Predicting Retained Earnings
  • Next year’s projected retained earnings = last year’s $2 million, plus:
  • $40 million x 0.05 x (1 - 0.50)
  • = $2 million + $1 million = $3million
predicting discretionary financing needs
Predicting Discretionary Financing Needs

Next year% of $40m

Assets

Current Assets $10m 25%

Fixed Assets $20m 50%

Total Assets $30m

Liab. and Equity

Accounts Payable $5m 12.5%

Accrued Expenses $5m 12.5%

Notes Payable $1m n/a

Long Term Debt $6m n/a

Total Liabilities $17m

Common Stock $7m n/a

Retained Earnings $3m

Equity $10m

Total Liab. & Equity $27m

How much

Discretionary

Financing

will we

Need?

predicting discretionary financing needs continued
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
predicting discretionary financing needs continued9
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
sustainable rate of growth
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)

budgets
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