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TRANSCRIPT
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Copyright 2002 by Harcourt, Inc. All rights reserved.
CHAPTER 4
Financial Planning and ForecastingFinancial Statements
Plans: strategic, operating, andfinancial
Pro forma financial statementsSales forecastsPercent of sales method
Additional Funds Needed (AFN)formula
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Pro Forma Financial Statements
Three important uses:
Forecast the amount of external
financing that will be required
Evaluate the impact that changesin the operating plan have on the
value of the firm
Set appropriate targets forcompensation plans
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Steps in Financial Forecasting
Forecast salesProject the assets needed to support
salesProject internally generated fundsProject outside funds neededDecide how to raise fundsSee effects of plan on ratios and
stock price
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2001 Balance Sheet
(Millions of $)
$1000Total claims$1000Total assets
200Earnings500Assets
RetainedNet fixed
500Common stk
100L-T debt$500Total CA
$200Total CL240Inventories100Notes payable240Accounts rec.
$100accruals
Accts. pay. &$20Cash & sec.
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2001 Income Statement
(Millions of $)
35.28Addn to RE
$15.12Dividends (30%)
$50.40Net income33.60Taxes (40%)
$84.00EBT
16.00Interest
$100.00EBIT
700.00SGA costs
1,200.00Less: COGS (60%)
$2,000.00Sales
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Key Ratios
O.K.30.00%30.00%Payout ratio
Poor3.00x2.50xCurrent ratio
Poor9.40x6.25xTIEGood36.00%30.00%Debt/assets
Poor2.50x2.00xT.A. turnover
Poor5.00x4.00xF.A. turnover
Poor11.00x8.33xInv. turnover
Poor32.00 days43.20 daysDSO
Poor15.60%7.20%ROE
Poor4.00%2.52%Profit Margin
Poor20.00%10.00%BEP
ConditionIndustryNWC
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Key Ratios (Continued)
(NOPAT/Net oper. capital)
Poor14.00%6.67%Return on invested capital
(Net oper. capital/Sales)
Poor35.00%45.00%Oper. capital requirement
(NOPAT/Sales)
Poor5.00%3.00%Net oper. prof. margin after taxes
Cond.Ind.NWC
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AFN (Additional Funds Needed):
Key AssumptionsOperating at full capacity in 2001.Each type of asset grows proportionally
with sales.Payables and accruals grow proportionally
with sales.
2001 profit margin (2.52%) and payout(30%) will be maintained.Sales are expected to increase by $500
million. (%S = 25%)
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Assets
Sales0
1,000
2,000
1,250
2,500
A*/S0 = $1,000/$2,000 = 0.5 = $1,250/$2,500.
Assets =(A*/S0)Sales= 0.5($500)= $250.
Assets = 0.5 sales
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Assets must increase by $250 million.
What is the AFN, based on the AFNequation?
AFN = (A*/S0
)S - (L*/S0
)S - M(S1
)(1 - d)
= ($1,000/$2,000)($500)
- ($100/$2,000)($500)
- 0.0252($2,500)(1 - 0.3)
= $180.9 million.
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Projecting Pro Forma Statements with
the Percent of Sales Method
Project sales based on forecastedgrowth rate in sales
Forecast some items as a percentof the forecasted sales
CostsCash
Accounts receivable (More...)
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Items as percent of sales (Continued...)
Inventories
Net fixed assets
Accounts payable and accrualsChoose other items
Debt (which determines interest)
Dividends (which determinesretained earnings)
Common stock
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Percent of Sales: Inputs
5%5%AP & accr./Sales
25%25%Net FA/Sales12%12%Inv./Sales
12%12%Acct. rec./Sales
1%1%Cash/Sales
35%35%SGA/Sales
60%60%COGS/Sales
Proj.Actual
20022001
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Other Inputs
30%Dividend payout rate
40%Tax rate
8%Interest rate on debt
1.25Growth factor in sales (g)
25%Percent growth in sales
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2002 1st Pass Income Statement
$46Add. to RE
$19Div. (30%)$65Net. Income
44Taxes (40%)$109EBT
1616Interest$125EBIT
875Pct=35%SGA1,500Pct=60%Less: COGS
$2,500g=1.25$2,000Sales1st PassFactor2001
2002
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2002 1st Pass Balance Sheet (Assets)
Forecasted assets are a percent of forecasted sales.
2002 Sales = $2,500
$1250Total assets$625Pct=25%Net FA$625Total CA
300Pct=12%Inventories300Pct=12%Accts. rec.$25Pct= 1%Cash
1st PassFactor
2002
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2002 1st Pass Balance Sheet (Claims)
*From 1st pass income statement.
2002 Sales = $2,500
$1,071Total claims246+46*200Ret. earnings500500Common stk.100100L-T debt
$225Total CL100100Notes payable
$125Pct=5%AP/accruals1st PassFactor2001
2002
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What are the additional funds
needed (AFN)?
Forecasted total assets = $1,250
Forecasted total claims = $1,071Forecast AFN = $ 179
NWC must have the assets to makeforecasted sales. The balance sheetsmust balance. So, we must raise $179externally.
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Assumptions about How AFN Will
Be Raised
No new common stock will beissued.
Any external funds needed will beraised as debt, 50% notes payable,and 50% L-T debt.
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How will the AFN be financed?
Additional notes payable =0.5 ($179) = $89.50 $90.
Additional L-T debt =0.5 ($179) = $89.50 $89.
But this financing will add 0.08($179) =$14.32 to interest expense, which willlower NI and retained earnings.
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$40$46Add. to RE
$17$19Div (30%)
$57$65Net income3844Taxes (40%)
$95$109EBT
30+1416Interest
$125$125EBIT 875875SGA
$1,500$1,500Less: COGS
$2,500$2,500Sales2nd PassFeedback1st Pass
2002 2nd Pass Income Statement
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2002 2nd Pass Balance Sheet (Assets)
No change in asset requirements.
$1,250$1,250Total assets
625625Net FA
$625$625Total CA
300300Inventories
300300Accts. rec.
$25$25Cash
2nd PassAFN1st Pass
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2002 2nd Pass Balance Sheet (Claims)
$1,244$1,071Total claims
240-6246Ret. earnings500500Common stk.
189+89100L-T debt
$315$225Total CL190+90100Notes payable
$125$125AP/accruals
2nd PassFeedback1st Pass
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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 the $6
reduction in retained earnings.Additional passes could be made untilassets exactly equal claims. $6(0.08) =$0.48 interest on 3rd pass.
Results After the Second Pass
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Equation method assumes aconstant profit margin.
Pro forma method is more flexible.More important, it allows differentitems to grow at different rates.
Equation AFN = $181
vs.Pro Forma AFN = $185.Why are they different?
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Ratios After 2nd Pass
30.00%
3.00x
9.40x
36.00%
2.50x
5.00x
11.00x
32.00
15.60%
4.00%
20.00%
Industry
OK30.00%30.00%Payout ratio
Poor1.99x2.50xCurrent ratio
Poor4.12x6.25xTIE
Good40.34%30.00%D/A ratio
Poor2.00x2.00xTA turnover
Poor4.00x4.00xFA turnover
Poor8.33x8.33xInv. turnover
Poor43.2043.20DSO (days)
Poor7.68%7.20%ROE
Poor2.27%2.52%Profit Margin
Poor10.00%10.00%BEP
Cond2002(E)2001
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Ratios after 2nd Pass (Continued)
NWC Ind. Cond.
Net oper. prof. margin after taxes 3.00% 5.00% Poor(NOPAT/Sales)
Oper. capital requirement 45.00% 35.00% Poor
(Net oper. capital/Sales)Return on invested capital 6.67% 14.00% Poor (NOPAT/Net oper. capital)
Note: These are the same as in 2001 (see slide 14-7),
because there have been no improvements in operations(i.e., all percent of sales items have same percentages in2001 and 2002). Also, there are no differences between 1stpass and 2nd pass because changes in financing do notaffect measures of operating performance.
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What is the forecasted free cash flow
for 2002?
-$150Free cash flow
$225Less Inv. in op. capital(EBITx(1-T))
$75$60NOPAT
(Net op. WC + net FA)
$1,125$900Total operating capital(CA - AP & accruals)
$500$400Net operating WC
2002(E)2001
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Suppose in 2001 fixed assets had been
operated at only 75% of capacity.
With the existing fixed assets, salescould be $2,667. Since sales areforecasted at only $2,500, no newfixed assets are needed.
Capacity sales =Actual sales
% of capacity
= = $2,667.$2,000
0.75
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How would the excess capacity
situation affect the 2002 AFN?
The projected increase in fixed assetswas $125, the AFN would decrease by$125.
Since no new fixed assets will beneeded, AFN will fall by $125, to
$179 - $125 = $54.
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Q. If sales went up to $3,000,
not $2,500, what would theF.A. requirement be?
A. Target ratio = FA/Capacity sales= $500/$2,667 = 18.75%.
Have enough F.A. for sales up to
$2,667, but need F.A. for another$333 of sales:
FA = 0.1875($333) = $62.4.
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How would excess capacity affect the
forecasted ratios?
1. Sales wouldnt change but assets
would be lower, so turnovers wouldbe better.
2. Less new debt, hence lower interest,
so higher profits, EPS, ROE (whenfinancing feedbacks considered).
3. Debt ratio, TIE would improve.
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2002 Forecasted Ratios: S02 = $2,500
% of 2001 Capacity
3.00x2.48x1.99xCurrent ratio
9.40x6.15x4.12xTIE
36.00%33.71%40.34%D/A ratio2.50x2.22x2.00xT.A. turnover
5.00x5.00x4.00xF.A. turnover
11.00x8.33x8.33xInv. Turnover
32.0043.2043.20DSO15.60%8.44%7.68%ROE
4.00%2.51%2.27%Profit Margin
20.00%11.11%10.00%BEP
Industry75%100%
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How is NWC performing with regard to
its receivables and inventories?
DSO is higherthan the industryaverage, and inventory turnover islowerthan the industry average.
Improvements here would lowercurrent assets, reduce capitalrequirements, and further improveprofitability and other ratios.
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Improvements in Working Capital
Management
9.09%12.00%Inventory/Sales
11.00x8.33xInventory turnover
8.89%12.00%Accts. rec./Sales
32.0043.20DSO (days)
AfterBefore
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Impact of Improvements in Working
Capital Management
8.59%7.7%ROE
7.7%6.7%ROIC (NOPAT/Capital)
$0.5-$150.0Free cash flow (1999)
AfterBefore
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Assets
Sales0
1,1001,000
2,000 2,500
Declining A/S Ratio
$1,000/$2,000 = 0.5; $1,000/$2,500 = 0.44. Decliningratio shows economies of scale. Going from S = $0to S = $2,000 requires $1,000 of assets. Next $500 ofsales requires only $100 of assets.
BaseStock
}
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Assets
Sales
1,000 2,000500A/S changes if assets are lumpy. Generally will haveexcess capacity, but eventually a small S leads to alarge A.
500
1,000
1,500
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Summary: How different factors affectthe AFN
forecast.Excess capacity:Existence lowers AFN.
Base stocks of assets:Leads to less-than-proportional asset
increases.Economies of scale:Also leads to less-than-proportional asset
increases. Lumpy assets:Leads to large periodic AFN requirements,
recurring excess capacity.
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Regression Analysis for Asset
Forecasting
Get historical data on a goodcompany, then fit a regression lineto see how much a given salesincrease will require in way of
asset increase.
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Example of Regression
Constant ratio overestimates inventory requiredto go from S1 = $2,000 to S2 = $2,500.
For a Well-Managed Co.Year Sales Inv.
1999 $1,280 $1182000 1,600 1382001 2,000 162
2002E 2,500E 192E
Inventory
Sales
(000)1.28 1.6 2.0 2.5
Regressionline
Constantratio forecast
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Regression with 10B for Our Example
Same as finding beta coefficients.Clear all
1280 Input 118+1600 Input 138+2000 Input 162+0 y, m 40.0 = Inventory at sales = 0.
SWAP 0.0611 = Slope coefficient.
Inventory = 40.0 + 0.0611 Sales.
LEAVE CALCULATOR ALONE!
^
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Equation is now in the calculator. Letsuse it by inputting new sales of $2,500and getting forecasted inventory:
2500 y, m 192.66.
The constant ratio forecast wasinventory = $300, so the regressionforecast is lower by $107. This wouldfree up $107 for use elsewhere, whichwould improve profitability and raise P0.
^
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How would increases in these items
affect the AFN?
Higher dividend payout ratio?
Increase AFN: Less retainedearnings.
Higher profit margin?Decrease AFN: Higher profits, moreretained earnings.
(More)
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Higher capital intensity ratio, A*/S0?
Increase AFN: Need more assets forgiven sales increase.
Pay suppliers in 60 days rather than30 days?
Decrease AFN: Trade creditorssupply more capital, i.e., L*/S0
increases.