Chapter 14 :

Financial
Forecasting
 Financial
Management
✘ Financial Management is
concerned with the proper
specifications of the financial
goals of the firm as well as
the measurement of
performance relative to the
achievement of these
objectives.

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 Financial
Management
✘ Responsibilities:
 To allocate funds to current and fixed
assets.
 To obtain the best mix of financing
alternatives.
 To develop an appropriate dividend
policy within the context of the
firm’s objectives.

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Role oF Financial
Management Less routine
function
✘ Daily activities include: includes:
 Credit Management • Sale of
 Inventory Control stocks
 Receipt and
and
Disbursement of
funds bonds
• Establish
ment of
capital
budgeting
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• Dividend
 Objectives of the
Firm
Financial Goals Social and Community
which refer to Goals
shareholder wealth which pertain to providing
maximization vis-à-vis benefits to its community
through profit through pollution control,
maximization. equitable hiring practices and
fair trade and pricing
standards.

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 Objectives of the
Firm
A certified public Financial Financial
accountant who is Analysis Forecasting
engaged in management
consultancy services may Working
be in the forefront or best Capital
Capital
position to providing Budgeting
Management
advisory services relative and
and
to financial management Financing
particularly in the ff. Financing
Dividend
Decisions
areas: Decisions
Policy and
External
Growth
through
6 Mergers and
 NATURE OF
FINANCIAL
FORECASTING
Financial forecasting allows the firm to anticipate
events before they occur, particularly the need
for raising funds externally.
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 Steps in Financial
Forecasting
1. 2. 3.
How much How much How much
money will the money will the additional
firm need firm generate funds or
during a given internally or external
period? through financing will
operations be required?
during the
same period?

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 * To estimate the external
financing required, the projected or
pro forma financial statement method
or the formula method may be used
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Projected
Financial
Statement
Method
Step 1. Forecast the Statement of
Comprehensive Income.
a. Establish a sales projection.

b. Prepare the production schedule and

project the corresponding production
costs; direct materials, direct labor and
overhead.

c. Estimate selling and administrative

expenses.

d. Consider financial expenses, if any.

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tep 2. Forecast the Statement of
Financial Position.
a. Project the assets that will be
needed to support projected
sales.
b. Project funds that will be
spontaneously generated
(through accounts payable and
accruals) and by retained
earnings.
c. Project liability and shareholders’ equity
accounts that will not rise spontaneously with
sales (e.g., notes payable, long-term bonds,
preference shares and ordinary shares) but may
change due to financing decisions that will be
made later.
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tep 2. Forecast the Statement of
Financial Position.
d. Determine if
additional funds will
be needed by using
Additional Funds Needed (AFN) =
the following formula
Required Increase in Assets
– Spontaneous Increase in
Liabilities – Increase in Retained
Earnings

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aising the additional funds needed.
The financing decision will consider the
following factors:
1. Target capital structure
2. Effect of short-term borrowing on its
current ratio
3. Conditions in the debt and equity
markets, or
4. Restrictions imposed by existing debt
agreements.

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4. Consider financing feedbacks.
Depending on whether additional funds will be
borrowed or will be raised through ordinary shares,
consideration should be given on additional
interest expense in the income statement or
dividends, thus decreasing the retained earnings.

Apply the iteration process using the available

financing mix until the AFN would become so small
that the forecast can be considered complete.

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Illustrative Case I:
Financial Forecasting (Percent of Sales Method)

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The
The firm
firm is
is expecting 20 percent increase in sales
expecting aa
next
next year
year and
and management
management is
is concerned
concerned about
about thethe company's
company's
need for external funds.. The The increase
increase in
in sales
sales is
is expected
expected to
to be
be
carried
carried out
out without
without any
any expansion
expansion ofof fixed
fixed assets
assets butbut rather
rather
through more efficient asset utilization in
through more in the
the existing
existing store.
store.
Among,
Among, liabilities only current liabilities vary directly with
liabilities only
sales..

Using
Using the
the percent-of-sales
percent-of-sales method,
method, determine
determine whether
whether the
the company
company
has
has external
external financing
financing needs
needs or
or aa surplus
surplus of
of funds.
funds.
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Solution:

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Step 2. Project
the Statement
of Financial
Position

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Illustrative Case I:
Financial Forecasting (Percent of Sales Method)

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Formula method:
`Additional financing needed (AFN) may also be computed as follows:

Additional funds needed = Required increase in assets

- Spontaneous increase in liabilities
- Increase in retained earnings

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22
* Illustration 2 in excel

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Chapter 15 :
Working
Capital
and
the
financing
decision
25
Working capital 1. Working capital represents a
management margin of safety for short-term
involves the
creditors.
financing and
management of
2.The amount of working capital
the current
represents the extent to which
assets of the
firm. current assets are financed from
long-term sources.

The amount by
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WORKIN
G
CAPITAL Working capital

POLICY policy involves

two basic
questions:

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Factors Affecting Level of
Current Assets

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 Adequate
Working Capital
1. The company can settle its debts
promptly.
2. Credit may be extended to customers.
3. Inventories can be readily replenished.
4. Current operating expenses are paid
promptly.
5. Management and employee morale is
enhanced.
6. Profitable opportunities can be taken
advantage of.

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 Disadvantages
of Inadequate
Working Capital
1. Business failure.
2. The company may not able to pursue
its objectives because of lack of funds.

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 Disadvantages
of Excessive
Working Capital
1. Management may become inefficient
and complacent.
2. Management may be tempted to
speculate.
3. Unnecessary expenses and
extravagance may result.
4. Resources are not optimally employed.

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 CURRENT
ASSET
INVESTMENT
POLICIES
32
 Aggressiv Modera
Conservati
e Or te
ve
Restricted Current
Approach
Current Assets
or Relaxed
Asset Investm
Current
Investmen ent
Investmen
t Policy
t Policy
Policy

A policy where In this policy, A policy

a large amount the firm has between
of cash, fewer liquid the relaxed
marketable assets with and
securities, and which to restricted
inventories are prevent a policies
carried and possible
under which financial
sales are failure. 33
CURRENT
ASSET
Financing
POLICIES
34
1. Maturity
Matching or
“Self-
A moderate approach to current
asset financing involves matching to
liquidating”
the extent possible the maturities of
assets and liabilities, so that
APPROACH
temporary current assets are
financed with short term
nonspontaneous debt, and
permanent current assets and fixed
assets are financed with long term
debt or equity, plus spontaneous
det.

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2. Aggressive
APPROACH
Firm finances all of its fixed assets
with long term capital but part of its
permanent current assets is financed
with short tem, nonspontaneous
debt.

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THANKS!
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