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4

Chapter

Financial

Forecasting

McGraw-Hill/Irwin

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

 

Chapter Outline

Financial forecasting in a firm’s strategic growth

Three financial statements Percent-of-sales method

Methods to determine the amount of new funds required in advance

Factors that affect cash flow

   
   
   

Financial Forecasting

 

Ability to plan ahead and make necessary changes 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 primary cause of shortage of funds

A comprehensive financing plan must be developed for a significant growth

 
   
     
Constructing Pro Forma Statements • A systems approach to develop pro forma statements consists of: –
Constructing Pro Forma Statements
• A systems approach to develop pro forma
statements consists of:
– Constructing it based on:
• Sales projections
• Production plans
– Translating it into a cash budget
– Assimilating all materials into a pro forma
balance sheet
Development of Pro Forma Statements
Development of
Pro Forma Statements
Pro Forma Income Statement • Provides a projection on the anticipation of profits over a subsequent
Pro Forma Income Statement
• Provides a projection on the anticipation of
profits over a subsequent period
• Four important steps include:
• Establishing a sales projection
• Determining production schedule and the associated
use of new material, direct labor, and overhead to
arrive at gross profit
• Computing other expenses
• Determining profit by completing actual pro forma
statement

Establish a Sales Projection

Let us assume Goldman Corporation has two primary products: wheels and casters

Establish a Sales Projection • Let us assume Goldman Corporation has two primary products: wheels and
   
   

Stock of Beginning Inventory

Number of units produced will depend on beginning inventory

Stock of Beginning Inventory • Number of units produced will depend on beginning inventory
   
   
 

Determine a Production Schedule and the Gross Profit

To determine the production requirements:

Units

+ Projected sales + Desired ending inventory Beginning inventory = Production requirements

   
   

Production Requirements for Six Months

Production Requirements for Six Months
   
   

Unit Costs

Cost to produce each unit:

Unit Costs • Cost to produce each unit:
   
   

Total Production Costs

Total Production Costs
   
   
Cost of Goods Sold • Costs associated with units sold during the time period – Assumptions
Cost of Goods Sold
• Costs associated with units sold during the
time period
– Assumptions for the illustration:
• FIFO accounting is used
• First allocates the cost of current sales to beginning
inventory
• Then to goods manufactured during the period
Allocation of Manufacturing Cost and Determination of Gross Profits
Allocation of Manufacturing Cost
and Determination of Gross Profits

Value of Ending Inventory

Value of Ending Inventory
   
   
Other Expense Items • Must be subtracted from gross profits to arrive at net profit –
Other Expense Items
• Must be subtracted from gross profits to
arrive at net profit
– Earning before taxes
• General and administrative expenses, and interest
expenses 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
Actual Pro Forma Income Statement
Actual Pro Forma Income Statement

Exercises

Page: 112

Numbers: 8 and 13

   
   
Cash Budget • Pro forma income statement must be translated into cash flows – The long-term
Cash Budget
• Pro forma income statement must be
translated into cash flows
– The long-term is divided into short-term pro
forma income statement
– More precise time frames set to help anticipate
patterns of cash inflows and outflows

Monthly Sales Pattern

Monthly Sales Pattern
   
   
Cash Receipts • In the case of Goldman Corporation: – The pro forma income statement is
Cash Receipts
• In the case of Goldman Corporation:
– The pro forma income statement is taken for the
first half year:
• Sales are divided into monthly projections
– A careful analysis of past sales and collection
records show:
• 20% of sales is collected in the month
• 80% in the following month
Monthly Cash Receipts
Monthly Cash Receipts
Cash Payments • Monthly costs associated with: – Inventory manufactured during the period • Material •
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

Component Costs of Manufactured Goods

Component Costs of Manufactured Goods
   
   
   

Cash Payments (cont’d)

 

Assumptions for the next two tables:

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

Sales volume varies each month

Employment of level monthly production to ensure maximum efficiency

Payment for material, once a month after purchases have been made

     
     

Average Monthly Manufacturing Costs

Average Monthly Manufacturing Costs
   
   
Summary of All Monthly Cash Payments
Summary of All
Monthly Cash Payments
 

Actual Budget

Difference between monthly receipts and payments is the net cash flow for the month

Allows the firm to anticipate the need for funding at the end of each month

   
   

Monthly Cash Budget

Monthly Cash Budget
   
   
Cash Budget with Borrowing and Repayment Provisions
Cash Budget with Borrowing
and Repayment Provisions
Pro Forma Balance Sheet • Represents the cumulative changes over time – Important to examine the
Pro Forma Balance Sheet
• Represents the cumulative changes over
time
– Important to examine the prior period’s balance
sheet
– Some accounts will remain unchanged, while
others will take new values
• Information is derived from the pro forma income
statement and cash budget
Development of a Pro Forma Balance Sheet
Development of a
Pro Forma Balance Sheet
Development of a Pro Forma Balance Sheet (cont’d)
Development of a
Pro Forma Balance Sheet (cont’d)
Explanation of Pro Forma Balance Sheet
Explanation of
Pro Forma Balance Sheet
 

Analysis of Pro Forma Statement

The growth ($25,640) was financed by accounts 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 ...

   
   
Percent-of-Sales Method • Based on the assumption that: – Accounts on the balance sheet will maintain
Percent-of-Sales Method
• Based on the assumption that:
– Accounts on the balance sheet will maintain a
given percentage relationship to sales
– Notes payable, common stock, and retained
earnings do not maintain a direct relationship
with sales volume
• Hence percentages are not computed
Balance Sheet of Howard Corporation
Balance Sheet
of Howard Corporation
Percent-of-Sales Method (cont’d) • Funds required is ascertained • Financing is planned based on: – Notes
Percent-of-Sales Method (cont’d)
• Funds required is ascertained
• Financing is planned based on:
– Notes payable
– Sale of common stock
– Use of long-term debt
Percent-of-Sales Method (cont’d) • Company operating at full capacity – needs to buy new plant and
Percent-of-Sales Method (cont’d)
Company operating at full capacity – needs to buy new
plant and equipment to produce more goods to sell:
– Required new funds:
(RNF) =
A (ΔS) – L (ΔS) – PS 2 (1 – D)
S
S
Where: A/S = Percentage relationship of variable assets to sales;
ΔS = Change in sales; L/S = Percentage relationship of variable
liabilities to sales; P = Profit margin; S 2 = 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
Percent-of-Sales Method (cont’d) • Company not operating at full capacity - needs to add more current
Percent-of-Sales Method (cont’d)
Company not operating at full capacity - needs to add more
current 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
 

Activity

11 th Edition Numbers 20, 22 13 th Edition Numbers 23, 25

Comprehensive Problems