Financial Planning Part 2

Financial Management I
ACFINA 1
Financial Forecasting
and Planning
Copyright 2018, 2014, 2011 Pearson

Copyright Education, Inc. Education,
2018, 2014, 2011 Pearson All Rights
Inc. All Reserved
Rights Reserved
An Overview of Financial Planning (1 of 4)
The primary objective of financial planning is the
estimation of the firms future financing needs.
Having a prior knowledge of financial needs
allows the firms management to seek out
financing with the most advantageous terms
possible. Also, financial planning process forces
managers to think systematically about the future
and to develop contingency plans to respond to
uncertainties of future.
Copyright 2018, 2014, 2011 Pearson Education, Inc. All Rights Reserved
Most firms engage in three types of planning:
Strategic planning,
Long-term financial planning, and
Short-term financial planning
Strategic plan defines, in very general terms,
how the firm plans to make money in the future. It
serves as a guide to the preparation of long- and
short-term financial plans.
The long-term financial plan generally
encompasses a period of three to five years and
incorporates estimates of the firms income
statements and balance sheets for each year of
the planning horizon.
The short-term financial plan spans a period of
one year or less and is a very detailed description of
the firms anticipated cash flows. The format
typically used for short-term financial plan is a cash
budget.
17.2 DEVELOPING A LONGTERM FINANCIAL
PLAN
Developing a LongTerm Financial Plan
Three basic steps:
1. Construct a Revenue Forecast
2. Prepare Pro Forma Financial Statements
3. Estimate the Firms Financing Needs
(1 of 3)
Step 1: Construct a Revenue Forecast

Revenue forecast is generally made using:
1. past trend in sales; and
2. Information about the influence of any
anticipated events that might materially affect the
sales trend.
(2 of 3)
Step 2: Prepare Pro Forma Financial Statements

These statements forecast the assets the firm needs to
support the forecast of revenues (step 1).
The most common technique is percent of sales
method, which expresses expenses, assets, and
liabilities for a future period as percentage of sales.
(3 of 3)
Step 3: Estimate the Firms Financing Needs

Using the pro forma financial statements, we can
extract the cash flow requirements of the firm.
Financial Forecasting Example: Ziegen,
Inc. (3 of 4)
Step 2: Prepare Pro Forma Financial Statements
The firms need for assets to support firm sales is
forecasted using the percent-of-sales method, where
each item in the balance sheet is assumed to vary in
accordance with its percent of sales for 2016.
Note, only if Zeigen, Inc. currently operates at full
capacity, then an increase in fixed assets will be
required to increase sales.
Financial Forecasting Example: Ziegen,
Inc. (4 of 4)
Step 3: Estimate the Firms Financing
Requirements
Financing needs are determined by comparing the
projected level of assets needed to support the sales
forecast to the available sources of financing. In
essence, we now forecast the liabilities and owners
equity section of the pro forma balance sheet.
Sources of Spontaneous Financing:
Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses, referred
to as spontaneous financing sources are typically
the only liabilities that vary directly with sales. The
percent of sales method can be used to forecast the
levels of both these sources of financing.
Sources of Discretionary Financing
Raising financing with notes payable, long-term
debt and common stock requires managerial
discretion. For this reason, these sources of
financing are called discretionary sources of
financing.
The retention of some or all of the firms earnings
is also a discretionary source because retention is
the result of firms managements discretionary
dividend policy.
Summarizing Ziegens Financial Forecast
(1 of 3)
Discretionary
Pro Forma Accounts Accrued Notes Long-term Common
Financing
Total Assets Payable Expenses Payable Debt Equity
Needs (DFN ) Projected Spontaneous Existing Discretionary
Sources of Financing Sources of Financing
Total
Financing less Projected Sources of Financing
Needs
Discretionary Financing Needs (DFN )
Analyzing the Effects of Profitability and Dividend Policy
on the Firms DFN (Discretionary Financing Needs)
(1 of 2)
The table (on next slide) shows that as dividend

payout ratios and net profit margin vary, DFN also
changes significantly from a negative $40,000 to
$764,000.
Analyzing the Effects of Profitability and Dividend Policy
on the Firms DFN (Discretionary Financing Needs)
(2 of 2)
DFN for Various Net Profit Margins and

Dividend Payout Ratio (DPR)
Net Profit Margin DPR = 30% DPR = 50% DPR = 70%

1%
5%
10%
Figure 17.1 Sales Growth and the Discretionary Financing
Needs of the Firm
CHECKPOINT 17.1: CHECK YOURSELF
Estimating DFN
The Problem
Pendletons management estimates that under the
most optimistic circumstances it might experience a
25% rate of growth of sales in 2017. Assuming that
net income is 5% of firm sales and that both current
and fixed assets are equal to a fixed percent of
sales (as found in the above forecast), what do you
estimate the firms DFN to be under these optimistic
circumstances?
Step 1: Picture the Problem
The firms DFN is equal to the financing the firm
requires for the year that is not provided by
spontaneous sources such as accounts payable
and accrued expenses plus retained earnings for
the period.
Step 2: Decide on a Solution Strategy
We can calculate the DFN using the following
equation:
Discretionary
Pro Forma Accounts Accrued Notes Long-term Common
Financing
Total Assets Payable Expenses Payable Debt Equity
Needs (DFN ) Projected Spontaneous Existing Discretionary
Sources of Financing Sources of Financing
Total
Financing less Projected Sources of Financing
Needs
Discretionary Financing Needs (DFN )
Step 3: Solve (1 of 2)
Line Blank Performa Income Statement for 2017 Blan Blank
k
1 Growth Rate 25% Blan Blank
k
2 Sales Blank Blan $6,250,000.00
k
3 Net Income 5% Blan 312,500.00
k
Blank Blank Performa Balance Sheet for 2011 Blan Blank
k
Blank Blank Multiple Computation Blan Blank
k
4 Current Assets 0.20 Blan $1,250,000.00
k
5 Net Fixed Assets 0.6 Blan $3,750,000.00
k
6 Total Blank 4+5 $5,000,000.00
7 Accounts Payable 0.2 Blan $1,250,000.00
k
8 Accrued Expenses 0.1 Blan $625,000.00
k
Step 3: Solve (2 of 2)
Line Blank Performa Income Statement for Blank Blank
2017
9 Notes Payable Blank Blank $500,000.00
10 Current Liabilities Blank 7+8+9 $2,375,000.00
11 Long-term Debt Blank Blank $1,000,000.00
12 Common Stock Blank Blank $100,000.00

(par)
13 Paid-in-capital Blank Blank $200,000.00
14 Retained Earnings Blank Blank $1,012,500.00
15 Common Equity Blank 12+13+14 $1,312,500.00
$700,000 + $312,500
Step 4: Analyze (1 of 2)
Projected Sources of Financing
= Total Liabilities + Total Common Equity
= $3,375,000 + $1,312,500 = $4,687,500
Total Financing Needs = Pro Forma total assets =
$5,000,000
DFN = Total Financing Needs Projected Sources
of Financing
= $5,000,000 $4,687,500
= $312,500
Step 4: Analyze (2 of 2)
USING EQUATION 17-1
DFN = $5,000,000 $1,250,000 $625,000
$500,000
$1,000,000 $1,312,500
= $312,500
If the firm experiences a 25% growth rate in sales,
Pendleton can expect to raise $312,500 during the
coming year.
17.3 DEVELOPING A SHORTTERM FINANCIAL
PLAN
Developing a ShortTerm Financial Plan
A short-term financial plan is typically presented in
the form of a cash budget that contains details
concerning the firms cash receipts and
disbursements. It includes the following main
elements:
Cash receipts,
Cash disbursements,
Net change in cash,
Ending cash balance and
New financing needed.
Uses of the Cash Budget
1. It is a useful tool for predicting the amount and
timing of the firms future financing requirements.
2. It is a useful tool to monitor and control the firms
operations.
Table 17.3 Melco Furniture, Inc., Cash Budget for the Six
Months Ended June 30, 2017 (1 of 4)
Blank Octob Novem Dece Janu Febr Marc April May June July Aug
er ber mber ary uary h ust
Worksheet Blank Blank Blank Blank Blank Blank Blank Blank Blank Blank Blank
Sales (forecast) $55,00 $62,000 $50, $60, $75, $88, $100 $110, $100 $80, $75,
0 000 000 000 000 ,000 000 ,000 000 000
Purchases (75% of Blank Blank 56,2 66,0 75,0 82,5 75,0 60,0 56,2 Blank Blank
sales in 2 months) 50 00 00 00 00 00 50
Cash receipts Blank Blank Blank Blank Blank Blank Blank Blank Blank Blank Blank
Collections: Blank Blank Blank Blank Blank Blank Blank Blank Blank Blank Blank
First month after Blank Blank Blank Blank Blank Blank Blank Blank Blank Blank Blank
sale (30%)
First month after Blank Blank Blank 15,0 18,0 22,5 26,4 30,0 33,0 Blank Blank
sale (30%) 00 00 00 00 00 00
Second month Blank Blank Blank 31,0 25,0 30,0 37,5 44,0 50,0 Blank Blank
after sale (50%) 00 00 00 00 00 00
Third month after Blank Blank Blank 11,00 12,4 10,0 12,0 15,0 17,6 Blank Blank
sale (20%) 0 00 00 00 00 00
Blank Octob Nove Dece Janu Febr Marc Apr May June July Aug
er mber mber ary uary h il ust
Total cash receipts Blank Blank Blank 57,0 55,4 62,50 75,9 89,0 100,6 Blank Blank
00 00 0 00 00 00
Cash Blank Blank Blank Blank Blank Blank Blan Blank Blank Blank Blank
disbursements k
Payments (1-month Blank Blank Blank 56,2 66,0 75,00 82,5 75,0 60,00 Blank Blank
lag of purchases 50 00 0 00 00 0
made the previous
month)
Wages and salaries Blank Blank Blank 3,00 10,0 7,000 8,00 6,00 4,000 Blank Blank
0 00 0 0
Rent Blank Blank Blank 4,00 4,00 4,000 4,00 4,00 4,000 Blank Blank
0 0 0 0
Other expenses Blank Blank Blank 1,00 500 1,200 1,50 1,50 1,200 Blank Blank
0 0 0
Interest expense on Blank Blank Blank Blank Blank Blank Blank 600 7,500 Blank Blank
existing debta
Taxes Blank Blank Blank Blank Blank 4,460 Blank Blank 5,200 Blank Blank
Blank Octo Nove Dece Janu Febru Marc April May June Jul Aug
ber mber mber ary ary h y ust
Blank Blank Blank Blank Blank Blank Blank
Purchases and Blank Blank Blank 14,000
equipment
Blank
Loan repaymentb Blank Blank Blank Blank Blank Blank Blank 12,0 Blank Blank
00
Blank Blank Blank Blank Blank
Total cash 64,25 94,500 91,66 96,00 99,1 81,9
disbursements 0 0 0 00 00
Net change in cash (7,250 (39,10 (29,16 (20,10 (10,1 18,7
for the period ) 0) 0) 0) 00) 00

Plus: Beginning 20,00 12,750 10,00 10,00 10,0 10,0
cash balance 0 0 0 00 00
Less: Interest on 0 0 (364) (659) (866) (976)
short-term
borrowing
Equals: Ending 12,75 (26,35 (19,52 (10,75 (966) 27,7
cash balance before 0 0) 4) 9) 24
short-term
Blank Octo Nove Dece Janu Febru Marc April May June Jul Aug
ber mber mber ary ary h y ust
Blank Blank Blank Blank Blank Blank Blank Blank Blank Blank Blank
borrowing

New financing 0 36,350 29,52 20,75 10,9 (17,7
neededc 4 9 66 24)d
Ending cash 12,75 10,000 10,00 10,00 10,0 10,0
balance 0 0 0 00 00
Cumulative 0 36,350 65,87 86,63 97,5 79,8
borrowing 4 3 99 75
aAn interest payment of $600 on the $12,000 loan is due in May, and an interest payment of $7,500 on the $150,000 long-
term debt is due in June.
bThe principal amount of the $12,000 loan is also due in May.
cThe amount of financing that is required to raise the firms ending cash balance up to its $10,000 desired cash balance.
dNegative financing needed simply means the firm has excess cash that can be used to retire a part of its short-term
borrowing from prior months.

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Financial Planning Part 2

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Financial Management I

Copyright 2018, 2014, 2011 Pearson

Step 1: Construct a Revenue Forecast

Step 2: Prepare Pro Forma Financial Statements

Step 3: Estimate the Firms Financing Needs

The table (on next slide) shows that as dividend

DFN for Various Net Profit Margins and

Net Profit Margin DPR = 30% DPR = 50% DPR = 70%

10 Current Liabilities Blank 7+8+9 $2,375,000.00

11 Long-term Debt Blank Blank $1,000,000.00

12 Common Stock Blank Blank $100,000.00

14 Retained Earnings Blank Blank $1,012,500.00

15 Common Equity Blank 12+13+14 $1,312,500.00

Blank Blank Blank Blank Blank

Blank Blank Blank Blank Blank

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