Financial Planning and Forecasting

Chapter 17

Forecasting Sales Projecting the Assets and

Internally Generated Funds Projecting Outside Funds Needed Deciding How to Raise Funds

17-1

Preliminary Financial Forecast:Balance Sheets (Assets)

2008 2009E

Cash and equivalents $ 20 $ 25Accounts receivable 240 300Inventories 240 300Total current assets $ 500 $ 625Net fixed assets 500 625Total assets $1,000 $1,250

17-2

Preliminary Financial Forecast: Balance Sheets (Liabilities and Equity)

2008 2009E

Accts payable & accrued liab.

$ 100 $ 125

Notes payable 100 190

Total current liabilities 200 315

Long-term debt 100 190

Common stock 500 500

Retained earnings 200 245

Total liabilities & equity $1,000 $1,25017-3

Preliminary Financial Forecast: Income Statements

2008 2009ESales $2,000.0$2,500.0Less: Variable costs 1,200.0 1,500.0 Fixed costs 700.0 875.0EBIT $ 100.0$ 125.0Interest 16.0 16.0EBT $ 84.0$ 109.0Taxes (40%) 33.6 43.6Net income $ 50.4$ 65.40Dividends (30% of NI) $15.12 $19.62Addition to retained earnings

$35.28 $45.7817-4

Key Financial Ratios

2008 2009E Ind Avg Comment

Basic earning power 10.00% 10.00% 20.00% PoorProfit margin 2.52% 2.62% 4.00% PoorReturn on equity 7.20% 8.77% 15.60% PoorDays sales outstanding

43.8 days

43.8 days

32.0 days

Poor

Inventory turnover 8.33x 8.33x 11.00x PoorFixed assets turnover

4.00x 4.00x 5.00x Poor

Total assets turnover

2.00x 2.00x 2.50x Poor

Debt/assets 30.00% 40.40% 36.00% OKTimes interest earned

6.25x 7.81x 9.40x Poor

Current ratio 2.50x 1.99x 3.00x PoorPayout ratio 30.00% 30.00% 30.00% OK

17-5

Key Assumptions in Preliminary Financial Forecast for NWC

Operating at full capacity in 2008.

Each type of asset grows proportionally with sales.

Payables and accruals grow proportionally with sales.

2008 profit margin (2.52%) and payout (30%) will be maintained.

Sales are expected to increase by $500 million. (%S = 25%)

17-6

Determining Additional Funds Needed Using the AFN Equation

AFN = (A0*/S0)S – (L0*/S0)S – M(S1)(RR)

= ($1,000/$2,000)($500)

– ($100/$2,000)($500)

– 0.0252($2,500)(0.7)

= $180.9 million

17-7

Management’s Review of the Financial Forecast

17-8

Consultation with some key managers has yielded the following revisions: Firm expects customers to pay quicker

next year, thus reducing DSO to 34 days without affecting sales.

A new facility will boost the firm’s net fixed assets to $700 million.

New inventory system to increase the firm’s inventory turnover to 10x, without affecting sales.

17-9

Management’s Review of the Financial Forecast

These changes will lead to adjustments in the firm’s assets and will have no effect on the firm’s liabilities and equity section of the balance sheet or its income statement.

Revised (Final) Financial Forecast:Balance Sheets (Assets)

2008 2009F

Cash and equivalents $ 20 $ 67

Accounts receivable 240 233

Inventories 240 250

Total current assets $ 500 $ 550

Net fixed assets 500 700

Total assets $1,000 $1,250

17-10

Key Financial Ratios – Final Forecast

2008 2009F Ind Avg Comment

Basic earning power 10.00% 10.00% 20.00% PoorProfit margin 2.52% 2.62% 4.00% PoorReturn on equity 7.20% 8.77% 15.60% PoorDays sales outstanding

43.8 days

34.0 days

32.0 days

OK

Inventory turnover 8.33x 10.00x 11.00x OKFixed assets turnover

4.00x 3.57x 5.00x Poor

Total assets turnover

2.00x 2.00x 2.50x Poor

Debt/assets 30.00% 40.40% 36.00% OKTimes interest earned

6.25x 7.81x 9.40x Poor

Current ratio 2.50x 1.98x 3.00x PoorPayout ratio 30.00% 30.00% 30.00% OK

17-11

What was the net investment in capital?

17-12

$1,125

625$125$$625

FANet NWC Capital2009

900$ Capital2008

225$

900$$1,125 capital in investmentNet

How much free cash flow is expected to be generated in 2009?

FCF = EBIT(1 – T) – Net investment in capital

= $125(0.6) – $225

= $75 – $225

= -$150

17-13

Suppose Fixed Assets Had Been Operating at Only 85% of Capacity in 2008 The maximum amount of sales that can be supported by the 2008 level

of assets is:

17-14

$2,3535$2,000/0.8

capacity of %sales/ ActualsalesCapacity

2009 forecast sales exceed the capacity sales, so new fixed assets are required to support 2009 sales.

How can excess capacity affect the forecasted ratios?

Sales wouldn’t change but assets would be lower, so turnovers would improve.

Less new debt, hence lower interest and higher profits EPS, ROE, debt ratio, and TIE would

improve.

17-15

How would the following items affect the AFN?

Higher dividend payout ratio? Increase AFN: Less retained earnings.

Higher profit margin? Decrease AFN: Higher profits, more retained

earnings. Higher capital intensity ratio?

Increase AFN: Need more assets for given sales. Pay suppliers in 60 days, rather than 30

days? Decrease AFN: Trade creditors supply more

capital (i.e., L0*/S0 increases).

17-16