Chapter 5:

Financial Forecasting, Corporate Planning and Budgeting

Learning Objectives:
1.
2.
3.
4.

Know and explain the basic concepts involving financial forecasting, corporate planning and budgeting;
Know and explain what are pro-forma financial statements and percent-of-sales method;
Construct pro-forma statements in designing a financial forecast; and
Apply percent-of-sales method in the designing a financial forecast.

Learning Content:

Corporate Planning
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Defined as a formal, systematic , managerial process, that is organized by responsibility , time and information to assure the strategic planning, project planning and
operational planning are carried out irregularly to enable top management to direct and control the future of the company.

*Planning entails the creation of short term and long term objectives as well as seasonal financial targets.

Financial Plan
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guide company operations

serve as a control mechanism or barometer
guides in taking corrective measures

Three Forms of Corporate Planning

1.

Strategic Planning
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Involves the creation of strategies that are aimed in maximizing the entitys future position taking into consideration the various elements and factors that may pervade
the companys internal and external environment.

*Strategy is a design that integrates the corporate objectives, policies and programs in a well-developed unified whole.
Process of Strategic Planning (TOWS)

Threats
Opportunities
Weakness
Strength

2.

Project Planning
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3.

sometimes called as capex planning or capital expenditure planning

Entails detailed plans involving acquisition of new property, plant and equipment, creation of new products, modification or acquisition or adaptation of new system,
and acquisition of new entities.
Operational Planning

Concerned on how to efficiently and effectively utilize the entitys resources to achieve the companys short term and long terms objective set up during plan.

Budgeting

Budget
- is a formal statement of a plan presented in quantitative terms.
- serve as barometer to which the results of the daily operations of the company are matched, coordinated, evaluated and controlled.

Budgetary Controls Functions of Budgets

o
o
o
o

matched
coordinated
Evaluated
controlled

*accountabilities are pointed out as to who and/or what caused the favourable or unfavourable variances.
*rolling budget may also be done when a company makes a whole year budget then makes new budgets on a monthly and quarterly basis.

Reasons for Budgeting

1.
2.
3.

planning
coordination
control

Budget Manuals
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prepared by management to facilitate budgeting procedures

An average run of the mill budget manual may be composed of the following:

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2.
3.
4.
5.
6.
7.
8.
9.

objectives;
definition of authority;
responsibilities and duties of persons involved in preparing the budget;
procedures of budgetary control;
time schedule for preparing the budget;
forms and schedules;
procedures in obtaining budget approval;
form and nature of performance report; and
advantages of budgetary control.

Components of the Master Budget

1.
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Operations Budget/Profit Plan

Composed of a detailed presentation of revenues, expenses and a net profit.
Takes the form of the pro-forma invoice or budget income statement.
The formation of this budgeted income statement came about by the infusion of the different budgets on:
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.

2.
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3.
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4.

Sales
Production volume
Cost of raw materials
No. of raw materials units to be purchased
Cost of direct labor
Factory overhead
Inventory levels
Cost of goods sold
Selling expenses
Administrative expenses
Financing charges
Financial Resources Budget

Mainly made up of:

A.
Cash budget
B.
Pro-forma or budgeted statement of financial position (SFP)
C.
Projected funds flow statement

Capital Expenditures Budget

Involves plans on a material modification, acquisition and disposition of property plant and equipment or material modification, acquisition or renewal of a firms
computerized accounting information system.
Budgeted Financial Ratios

The ratios are taken from the pro-forma or budgeted financial statements prepared which figures are estimated and budgeted.

Process in preparing Master Budget

1.
2.
3.
4.
5.
6.

Formulation of corporate objectives, plans, policies and assumptions, which will give direction in the formulation of the budget estimates done by top management.
Establish or estimate sales projection or targeted sales.
The production scheduled and the associate new raw materials, direct labor, and overhead are done to compute cost of good sold.
Consolidations of individual budgets are done to create a draft master budget.
Revision of the preliminary drafted master budget is done to come up with the final draft subject to approval of a firm can do this.
Approval and dissemination of final master budget to department heads or supervisors.

Steps in the preparation of the Pro-forma statements

1.
2.
3.
4.
5.
6.

Establish or estimates sales projection or targeted sales.

Create the production budget schedule, which includes the raw materials costs, direct labor cost, and overhead.
Create the schedule for selling, administrative and other expenses.
Compute for the net income by preparing the pro-forma income statement.
Create the pro-forma cash budget scheduled where the estimated cash receipts and estimated cash disbursements are presented.
From the pro-forma income statement and cash budget schedule you can now create the pro-forma statement of financial position.
*Sale Budget is considered as the cornerstone of budgeting.

Estimating Sales

The following methods may be done in estimating or forecasting sales.

1.
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Sales Trends Analysis.

Product life cycle is used

Sales Force Composite Method

Each salesman estimates the sales in his particular territory

Executive Opinion Method

The views of a number of top executive are culled to arrive at a sales estimate.

Industry Trend Analysis Method

The relationship between expected industry sales and the company sales in terms of market share is determined.
When the trends are determined, a percentage of the expected total market for the budget period is estimated.

Correlation Analysis Method

Scientific means of forecasting sales by regression analysis.

Multiple Approach Method

Uses a combination of the various methods discussed.

2.
3.
4.

5.
6.

Cash Budget

Pro-forma Income Statement to Cash Flow

- Can be done by dividing the budgeted income statement in smaller time frames in order to appreciate the monthly trends of net cash flows.
*Net Cash Flow is the difference between cash inflow and cash outflow.
*Cash Outflow is concerned, the usual items that should be taken into consideration would be the payment made for the inventory acquisition, payment of labor and
overhead costs, selling and administrative expense, taxes and dividends.

Steps in Preparation of the Pro-forma Financial Statements:

1.
2.
3.
4.

Estimate Sales
Estimate Number of Units to be produced and Gross Profit
Create the Pro-forma Income Statement
Prepare the Cash Budget

Note: the total cash receipts is the sum of the total collections. Sales are NOT PART of the computation of the cash receipts. Sales were placed in the summary ONLY TO
SHOW the source in computing the collections.

Pro-forma Statement of Financial Position (SFP)

In creating SFP, the ff. statements are needed:
1.
2.
3.

Pro-forma income statement

Pro-forma cash budget
Prior period pro-forma statement of financial position

Percentage-of-Sales Method
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Another method of forecasting

The financial forecaster assumes that the accounts found in the SPF have a percentage relationship with the companys sales revenue account.
It is still important to project sales before all forecasting is done.

* Required New Funds (RNF) formula is RNF = Asset ratio (sales) Liability ratio (sales) NPR (new sales)*DPR