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FINANCIAL PLANNING
AND CONTROL
Sales forecasts
Projected financial statements
Additional Funds Needed
Also called External Funds Needed (EFN)
Financial control
Hypothetical Data for Northwest
Chemical Company
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Financial Planning
The projection of sales, income, and assets
based on alternative production and marketing
strategies, as well as the determination of the
resources needed to achieve these projections.
Forecasting also is important for production
planning and human resource planning.

Financial Control
The phase in which financial plans are
implemented; control deals with the feedback and
adjustment process required to ensure adherence
to plans and modification of plans because of
unforeseen changes.
Financial Planning and Control

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Financial Planning:

Growth is a key theme behind financial
forecasting. Remember that growth should not be
the underlying goal of a corporation creating
shareholder value is the appropriate goal. In many
cases, however, shareholder value creation is
enabled through corporate growth.
The sales forecast predicts a firms unit and dollar
sales for some future period; generally based on
recent sales trends plus forecasts of the economic
prospects for the nation, region, industry, etc.
We want to forecast if we need external funds
borrowing or a new stock issue
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Percentage of Sales Method
1. Projected Balance sheet forecasting of AFN
2. Increased sales requires increased assets that must be
financed. We will discuss the strategy for forecasting
assets.
3. Increased sales automatically increases spontaneous
liabilities.
4. Some financing will come from retained earnings.
Depending on the information, we formulate a strategy
for determining RE.
5. If additional funds are needed we have to choose to
finance with external funds -- debt or stock.
6. #5 affects #4 -- thus, we sometimes use an iterative
approach.
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Steps to get AFN simple one-pass
forecast balance sheet method
1. Calculate RE with the data given (method
varies)
2. Increase CA and spontaneous liabilities
proportionately with sales
3. Increase FA if needed based on capacity
information given
4. Carry over bonds/bank-loans and stock
5. Calculate TA - (TL+E) = AFN
AFN = additional funds needed from
external sources

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Hand out simple example
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Two pass method example:
Northwest Chemical: 2001
Sales Projection
(millions of dollars)
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
1996 1997 1998 1999 2000 2001
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Northwest Chemicals
Oregon producer of Ag Chemicals
Prepare financial forecast, main
assumption is a 25% increase in sales
Want to know how performance/ratios
changes.
One of the hard items is Additional Funds
Needed
We will use the percentage of sales method
of forecasting financial statements. This
will give you a thorough feel for the
process of forecasting financial
statements.
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NWC Industry Condition
Profit Margin 2.52% 4.00% Poor
ROE 7.20% 15.60%
DSO 43.2 days 32.0 days
Inv. turnover 5.00x 8.00x
F.A. turnover 4.00x 5.00x
T.A. turnover 2.00x 2.50x
Debt/ assets 30.00% 36.00% Good
TIE 6.25x 9.40x Poor
Current ratio 2.50x 3.00x
Payout ratio 30.00% 30.00% O.K.
North West Chemical:
Key Ratios
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Key Assumptions
Interest rate = 8% for any debt.
Operating at full capacity in 2000.
Each type of asset grows proportionally with
sales.
Payables and accruals grow proportionally with
sales.
2000 payout (30%) will be maintained.
No new common stock will be issued.
Sales are expected to increase by $500 million.
(%S = 25%)
Projected Financial Statements
Step 1. Forecast the 2001
Income Statement


Implications for
fixed assets
and fixed cost?
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There will be simpler problems than this in
lab
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NWC: Projected
2001 Income Statement:
2000 Factor Initial Forecast
Sales $2,000 x1.25 $2,500
Less: VC 1,200 x1.25 1,500
FC 700 x1.25 875
EBIT $ 100 $ 125
Interest 16 16
EBT $ 84 $ 109
Taxes (40%) 34 44
Net. income $ 50 $ 65
Div. (30%) $ 15 $ 19
Add. to RE $ 35 $ 46
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2000 Factor Initial Forecast
Cash/sec. $20 x1.25 $25
Accts. rec. 240 x1.25 300
Inventories 240 x1.25 300
Total CA $500 $625
Net FA 500 x1.25 625
Total assets $1,000 $1,250


Projected Financial Statements
Step 2. Forecast the 2001
Balance Sheet (Assets)
At full capacity, so all assets must
increase in proportion to sales.
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2000 Factor Initial Forecast
AP/accruals $100 x1.25 $125
Notes payable 100 100
Total CL $200 $225
L-T debt 100 100
Common stk. 500 500
Ret. earnings 200 +46* 246
Total liab./eq. $1,000 $1,071
Projected Financial Statements
Step 2. Forecast the 2001
Balance Sheet (Liability & Equity)
*From projected income statement.
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Forecasted total assets = $1,250
Forecasted total claims = $1,071
Forecast AFN
1
= $ 179
NWC must have the assets to make
forecasted sales. The balance sheet must
balance. So, we must raise $179 externally.
Projected Financial Statements
Step 3. Raising the
Additional Funds Needed
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Additional notes payable =
0.5 ($179) = $89.50

Additional L-T debt =
0.5 ($179) = $89.50
But this financing will add 0.08 ($179) = $14.32
to interest expense, which will lower NI and
retained earnings.
How will the AFN be financed?
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Projected Financial Statements
Step 4. Financing Feedbacks
The effects on the income statement and
balance sheet of actions taken to finance
forecasted increases in assets.
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1st Pass Feedback 2nd Pass
Sales $2,500 $2,500
Less: VC 1,500 1,500
FC 875 875
EBIT $125 $125
Interest 16 +14 30
EBT $109 $95
Taxes (40%) 44 38
Net. income $65 $57
Div. (30%) $19 $17
Add. to RE $46 $40
NWC: 2001 Adjusted Forecast
of Income Statement
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1st Pass Feedback 2nd Pass
Cash/sec. $25 $25
Accts. rec. 300 300
Inventories 300 300
Total CA $625 $625
Net FA 625 625
Total assets $1,250 $1,250
NWC: 2001 Adjusted Forecast
of Balance Sheet (Assets)
No change in asset requirements.
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1st Pass Feedback 2nd Pass
AP/accruals $125 $125
Notes payable 100 +89.5 190
Total CL $225 $315
L-T debt 100 +89.5 189
Common stk. 500 500
Ret. earnings 246 -6 240
Total liab./eq. $1,071 $1,244
NWC: 2001 Adjusted Forecast
of Balance Sheet
(Liabilities & Equity)
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Forecasted assets = $1,250 (no change)
Forecasted claims = $1,244 (higher)
2nd pass AFN = $ 6 (short)
Cumulative AFN = $179 + $6 = $185.
The $6 shortfall came from reduced net
earnings. Additional passes could be
made until assets exactly equal
liabilities/equity. ex: $6 (0.08) = $0.48
interest 3rd pass.
Results of the
Adjusted Forecast:
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NWC
2000 2001(E) Industry
Profit Margin 2.52% 2.27% 4.00% Poor
ROE 7.20% 7.68% 15.60%
DSO (days) 43.2 43.2 32.0
Inv. turnover 5.00x 5.00x 11.00x
F.A. turnover 4.00x 4.00x 5.00x
T.A. turnover 2.00x 2.00x 2.50x
D/A ratio 30.00% 40.34% 36.00%
TIE 6.25x 4.12% 9.40x
Current ratio 2.50x 1.99x 3.00x
Payout ratio 30.00% 30.00% 30.00% O.K.
North West Chemical:
Adjusted Key Ratios
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Not very profitable relative to other
companies in the industry.
Carrying excess inventory and receivables.
Debt ratio projected to move ahead of
average.
Overall, not in good shape and doesnt
appear to be improving.
Analysis of the Forecast:
How does North West
Chemical Compare?
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Capacity Issues
Sales last year $500
Last year at 80% of capacity
Sales will increase 50%
What percentage will fixed cost and fixed
assets increase?
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Suppose in 2000 fixed assets had been
operated at only 75% of capacity:
Full Capacity Sales
Actual sales
=
% of capacity usage
= =
$2,
.
$2, .
000
0 75
667
Other Considerations in
Forecasting: Excess Capacity
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With the existing fixed assets, sales could
be $2,667. Since sales are forecasted at
only $2,500, no new fixed assets are needed.
Does NWC need additional
fixed assets?
How would fixed costs change?
Fixed cost would not increase.
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With the existing fixed assets, sales could
be $2,667. Since sales are forecasted at
only $2,500, no new fixed assets are needed.
If NWC had been operating at full
capacity, what would its fixed
assets/sales ratio be?
Target FA / sales =
Actual fixed assets
Full capacity sales
= =
$500
$2,
.
667
18 75%
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2000 Factor Initial Forecast
Cash/sec. $20 x1.25 $25
Accts. rec. 240 x1.25 300
Inventories 240 x1.25 300
Total CA $500 $625
Net FA 500 x1.25 625
Total assets $1,000 $1,250


Projected Financial Statements
Step 2. Forecast the 2001
Balance Sheet (Assets)
At full capacity, so all assets must
increase in proportion to sales.
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The projected increase in fixed assets was
$125, the AFN would decrease by $125.
Since no new fixed assets will be needed,
AFN will fall by $125.

How would the excess capacity
situation affect the 2001 AFN?
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NWC: Projected
2001 Income Statement:
2000 Factor Initial Forecast
Sales $2,000 x1.25 $2,500
Less: VC 1,200 x1.25 1,500
FC 700 x1.25 875
EBIT $ 100 $ 125
Interest 16 16
EBT $ 84 $ 109
Taxes (40%) 34 44
Net. income $ 50 $ 65
Div. (30%) $ 15 $ 19
Add. to RE $ 35 $ 46
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Fixed cost would not increase, increasing
EBIT by $175
In turn net income and RE would increase,
thus more internal financing and AFN
would be smaller.
How would the excess capacity
situation affect the 2001 AFN?
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Sales wouldnt change but assets
would be lower, so turnovers would be
better.

Less new debt, hence lower interest, so
higher profits, EPS,ROE.

Debt ratio, TIE would improve.

How would excess capacity
affect the forecasted ratios?


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% of Capacity in 2000
100% 75% Industry
Profit Margin 2.27% 2.51% 4.00%
ROE 7.68% 8.44% 15.60%
DSO (days) 43.2 43.2 32.0
Inv. turnover 5.00x 5.00x 8.00x
F.A. turnover 4.00x 5.00x 5.00x
T.A. turnover 2.00x 2.22x 2.50x
D/A ratio 40.34% 33.71% 36.00%
TIE 4.12% 6.15x 9.40x
Current ratio 1.99x 2.48x 3.00x
Payout ratio 30.00% 30.00% 30.00%
2001 Forecasted Ratios:
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Summary: How different factors
affect the AFN forecast.
Dividend payout ratio changes.
If reduced, more RE, reduce AFN.
Profit margin changes.
If increases, total and retained earnings increase,
reduce AFN.
Plant capacity changes.
Less capacity used, less need for AFN.
AP Payment terms increased to 60 days from 30.
Accts. payable would double, increasing
liabilities, reduce AFN.