Chapter 4

Financial Forecasting

Chapter 4 - Outline
What

LT 4-1

is Financial Forecasting? 2 Methods of Financial Forecasting 3 Financial Statements for Forecasting Steps in a Pro Forma Income Statement (I/S) Determining Production Requirements Percent-of-Sales Method
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What is Financial Forecasting?

Financial

LT 4-2

forecasting is looking ahead to develop a financial plan for the future

important for the strategic growth of a

Very

firm

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2 Methods of Financial Forecasting:

Using Pro Forma, or Projected, Financial Statements (more exact, time consuming)

LT 4-3

Percent-of-Sales Method (less precise, easier to calculate)

Often times these statements are required by lenders

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4-24.Cambridge Prep Shops

Cambridge Prep Shops, a national clothing chain, had sales of $200 million last year. The business has a steady net profit margin of 12 percent and a dividend payout ratio of 40 percent. Balance Sheet End of Year ($ millions)
Assets Cash Accounts Receivable Inventory Plant and Equipment $ $ $ $ $ 10 15 50 75 150 Liabilities and Stockholders Equity Accounts Payable Accrued Expenses Other Payables Common Stock Total Liabilities and Stockholders Equity $ $ $ $ $ $ 15 5 40 30 60 150

Cambridges marketing staff tells the president that in the coming year there will be a large increase in the demand for tweed sport coats and various shoes. A sales increase of 15 percent is forecast for the Prep Shop. All balance sheet items are expected to maintain the same percent-ofsales relationships as last year, except for common stock and retained earnings. No change is scheduled in the number of common stock shares outstanding, and retained earnings will change as dictated by the profits and dividend policy of the firm. (Remember the net profit margin is 12 percent.) a. Will external financing be required for the company during the coming year? b. What would be the need for external financing if the net profit margin went up to 14 percent and the dividend payout ratio was increased to 70 percent? Explain.

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4-24.Cambridge Prep Shops (cont.)

A negative figure for required new funds indicates that an excess of funds ($3.06 mil.) is available for new investment. No external funds are needed. Note: The Problem states All balance sheet items are expected to maintain the same percent-of-sales relationships as last year, except for common stock and retained earnings. This means that Assets (A) include Plant and Equipment. (emphasis added)

Required New Funds

S L S PS2 1 D S S S 15% $200,000,0 $30,000,00 00 0 150 $30,000,000 60 $30,000,000 .12 200 200 $230,000,0001 .4

RNF

$230,000,000.6
RNF $3,060,000

.75$30,000,000 .30$30,000,000 .12 $22,500,000 $9,000,000 $16,560,000

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3 Financial Statements for Forecasting

Pro

LT 4-4

Forma Income Statement (I/S) Cash Budget Pro Forma Balance Sheet (B/S)
The first step is to develop a sales projection

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Steps in a Pro Forma Income Statement (I/S)

Establish

LT 4-5

a sales projection Determine a production schedule (or production requirements) Compute other expenses Determine profit by completing an actual pro forma income statement (I/S)
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PPT 4-1 FIGURE 4-1 Development of pro forma statements

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PPT 4-2

TABLE 4-1 Projected wheel and caster sales (first six months, 2005)

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Determining Production Requirements

Projected Units Sales Desired Ending Inventory (EI) Beginning Inventory (BI)
PLUS MINUS

LT 4-6

EQUALS

Production Requirements (or Units to be Produced)

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PPT 4-3

TABLE 4-2 Stock of beginning inventory

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PPT 4-3

TABLE 4-3 Production requirements for six months

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PPT 4-3

TABLE 4-4 Unit costs

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PPT 4-3

TABLE 4-5 Total production costs

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PPT 4-3 TABLE 4-6 Allocation of manufacturing cost and determination of gross profits

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PPT 4-3

TABLE 4-7 Value of ending inventory

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PPT 4-4 TABLE 4-8

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PPT 4-5

TABLE 4-9 Monthly sales pattern

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PPT 4-5

TABLE 4-10 Monthly cast receipts

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PPT 4-5

TABLE 4-11 Component costs of manufactured goods

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PPT 4-6

TABLE 4-12 Average monthly manufacturing costs

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PPT 4-7

TABLE 4-14 Monthly cash flow

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PPT 4-7

TABLE 4-15 Cash budget with borrowing and repayment provisions

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TABLE 4-16

PPT 4-8

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PPT 4-9

FIGURE 4-2 Development of a pro forma balance sheet

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TABLE 4-17

PPT 4-10

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PPT 4-6 TABLE 4-13 Summary of all monthly cash payments

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TABLE 4-18

PPT 4-11

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Percent-of-Sales Method

LT 4-7

A short-cut, less exact, easier method of determining financing needs (The quick and dirty approach)
Assumes that B/S accounts will maintain a constant percentage relationship to sales
Assets / Current Sales = % of Sales

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