chapter 12 financial planning and control
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Chapter 12 Financial Planning and Control. Profit Planning: Pro Forma Statements. Pro forma financial statements are projected, or forecast, financial statements - income statements and balance sheets. - PowerPoint PPT PresentationTRANSCRIPT
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 1 of 19
Chapter Chapter 1212
Financial Planning and
Control
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 2 of 19
• Pro forma financial statements are projected, or
forecast, financial statements - income statements and
balance sheets.
• The inputs required to develop pro forma statements
using the most common approaches include:
– financial statements from the preceding year
– the sales forecast for the coming year
– key assumptions about a number of factors
• The development of pro forma financial statements will
be demonstrated using the financial statements for
Vectra Manufacturing.
Profit Planning: Pro Forma Statements
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 3 of 19
FINANCIAL PLANNING—FORECASTING
• Sales Forecast– most important part of financial planning– generally based on the trend in sales in recent periods– inaccurate sales forecasts can have serious
repercussions—if the firm is too optimistic, such assets as inventory will be built up too much; if the firm is too conservative, it might miss valuable opportunities because existing production capabilities might not be sufficient to meet new demand
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 4 of 19
Trend in Sales for Vectra Manufacturing
0
100
200
300
400
500
600
1999 2000 2001 2002 2003 2004
Sales($ millions)
Average growth = 12%
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 5 of 19
• Estimate the percentage growth (increase or decrease) in sales, cost of goods sold, and other variable revenues and expenses
• Change the current values by the estimates– An easy way to approach this task is to apply a single growth
rate to all revenue and expense categories that change when production changes
– To be more accurate, each category should be examined individually to determine what the effect of any forecasted change is
Profit Planning: Pro Forma Financial Statements
Step 1: Preparing the Pro Forma Income Statement
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 6 of 19
Assumptions• Vectra Manufacturing operated at full capacity in 2004.• Sales are expected to grow by 12 percent.• The variable cost ratio remains at 80 percent (same as 2004)• 2005 dividend payout will be maintained at 60 percent of net
income.
Profit Planning: Pro Forma Financial Statements
Step 1: Preparing the Pro Forma Income Statement
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 7 of 19
Profit Planning: Pro Forma Financial Statements
Step 1: Preparing the Pro Forma Income Statement
(*1,12)Dollars Initial forecast
Sales Revenue 500,00 560,00
Variable costs 400,00 448,00
Result 100,00 112,00
Fixed costs 55,00 61,60
Net Operating Income 45,00 50,40
Less: Interest Expense 10,00 10,00
Taxable income 35,00 40,40
Less: Taxes (40%) 14,00 16,16
Net Profits After Taxes 21,00 24,24
Less: Common Stock Dividends 12,60 14,54
To Retained Earnings 8,40 9,70
Vectra Manufacturing Income StatementFor the Year Ended December 31, 2004
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 8 of 19
Assumptions• Vectra Manufacturing operated at full capacity in 2004.• Sales are expected to grow by 12 percent.• The variable cost ratio remains at 80 percent (same as 2004)• 2005 dividend payout will be maintained at 60 percent of net
income.
Profit Planning: Pro Forma Financial Statements
Step 2: Preparing the Pro Forma Balance Sheet
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 9 of 19
Profit Planning: Pro Forma Financial Statements
Step 2: Preparing the Pro Forma Balance Sheet 2004
•Current assets $155.00•Fixed assets 120.00• Total assets $275.00
•Payables & accruals 30.00•Notes Payable 13.00•Current liabilities 43.00•Long-term debt 100.00• Total liabilities 143.00•Common stock 44.00•Retained earnings 88.00• Total equity 132.00• Total liabilities & equity $275.00
x (1 + g) Initial Forecastx 1.12 $176.60x 1.12 134.40
$308.00
x 1.12 $ 33.60 13.00
46.60 100.00
146.6044.00 97.70141.70
$288.30
+9.70 RE
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 10 of 19
Spontaneously generated funds• Spontaneously generated funds are those that increase with
the same rate as sales, i.e. higher sales increase taxable income but also higher wages
• However, notes payable, long-term bonds and common stock are not spontaneously generated sales, they do not increase with the same rate as sales.
Profit Planning: Pro Forma Financial Statements
Spontaneously generated funds
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 11 of 19
Profit Planning: Pro Forma Financial Statements
Step 3: Raising the additional funds needed
•If Vectra Manufacturing does not raise additional capital by borrowing from the bank or issuing new stocks or bonds, then, based on the pro forma balance sheet, the following exists:
• Total assets $308.00
• Total liabilities and equity $288.30
• Additional funds needed $19.7
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 12 of 19
Profit Planning: Pro Forma Financial Statements
Step 3: Raising the additional funds needed
Vectra Manufacturing plans to raise the additional funds needed (AFN) as follows:
Proportion
Notes payable 15.0%
New long-term debt 20.0
New common stock 65.0
100.0
Amount$2,953,94
$12,8119,70
Cost7.0%
10.0 dividend
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 13 of 19
Profit Planning: Pro Forma Financial StatementsStep 4: Financing Feedbacks
• If Vectra Manufacturing issues new debt and common stock, the total amount of interest and dividends paid will increase.
• Because interest and dividends must be paid with cash, any increase in these costs will decrease the funds the firm has to invest—that is, the amount of income added to retained earnings will be less than originally forecasted.
• When we consider the effects of the increased interest and dividend payments, we find that the AFN is actually greater than originally expected.
• Financing feedbacks—that is, the effects on the financial statements of actions taken to finance forecasted increases in assets—must be considered to determine the exact amount of AFN.
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 14 of 19
Evaluation of Pro Forma StatementsWeaknesses of Simplified Approaches
• The major weaknesses of the approaches to pro forma
statement development outlined above lie in two
assumptions:
– that the firm’s past financial performance will be
replicated in the future
– that certain accounts can be forced to take on desired
values
• For these reasons, it is imperative to first develop a
forecast of the overall economy and make adjustments
to accommodate other facts or events.
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 15 of 19
Financial Breakeven Analysis• Financial breakeven point is defined as the level of
operating income (NOI or EBIT) that covers all fixed financing charges.
• At the financial breakeven point, EPS = 0.• For the most part, fixed financial charges include
interest paid on debt and preferred stock dividends.• For firms that do not have preferred stock, the
financial breakeven point, EBITFinBE, is simply interest on debt.
• Most firms do not have preferred stock.
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 16 of 19
Financial Breakeven Analysis—Example
•Worldwide Widgets, Inc. is financed with the following sources of long-term funds:
• Bonds @ 8% interest $ 50,000• Preferred stock 0
Common stock (5,000 shares outstanding) 50,000
Total capital $100,000
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 17 of 19
Financial Breakeven Analysis—Graph
Financial breakeven point
-2.00
-1.50
-1.00
-0.50
0
0.50
1.00
1.50
2.00
-8,000 -4,000 0 4,000 8,000 12,000 16,000
EPS ($)
EBIT ($)
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 18 of 19
Financial Breakeven Analysis—Computation
• The financial breakeven point is computed as follows:
rateTax - 1
payments dividend Preferred + costsInterest = EBITFinBE
If Worldwide Widgets’ marginal tax rate is 40 percent, its financial breakeven point is:
000,4$4.0 - 1
0$ + )08.0(000,50$ = EBITFinBE
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 19 of 19
Financial Breakeven Analysis—Uses
• Financial breakeven analysis gives an indication as to how the firm’s mix of debt and preferred stock (fixed financing) affects EPS (net income).