1 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Financial Planning,
Forecasting,
and Cash Budgets

Copyright © 2002 Pearson Education

2 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Chapter Objectives
 Make sales forecasts
 Prepare cash budgets
 Prepare pro forma statements
 Estimate external funds needed
 Estimate maximum sustainable
growth rate
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3 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Financial Planning Is
Difficult Because...
 Information must be gathered
from a variety of sources, both
internal and external
 Estimates must be made about
the unforeseeable future

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4 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

 The future of the firm often

depends on the accuracy of the
projections

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5 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

The First Step:

 Develop long-term
strategic goals
– Use capital budgeting
methods to evaluate
investment objective

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6 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

– Develop an investment
strategy that lets the firm
utilize its advantages over
other firms
– Then convert long-term
goals into short-term
operating plans

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7 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Financial Planning

 The allocation of a firm’s

resources to achieve its
investment plans

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8 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

The Sales Forecast Is:

 The beginning point for financial

planning, where sales depend on:
– The economy and
business cycles
– The condition of industry
– The behavior of competitors
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9 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Estimating Sales

 Using the Historical Average

Growth Rate
– Compute historical
compounded average
growth rate.

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10 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

– Apply this growth rate to the

most recent year’s sales to
estimate future period sales.

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11 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Example
 Compute the average compounded
growth rate for the following sales:
1998 $100
1999 $110
2000 $120
2001 $140

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12 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Solution
PV = $100
FV = $140
N = 3 (periods of growth)
FV = PV (1 + i)N
140 = 100(1 + i) 3
1.4 = (1 + i) 3

1.4  1  i
3 11.87% = growth rate
i = .1187 =

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13 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Choosing Which
Periods to Use
 A critical choice to the
accuracy of this method. In
the following figure picking
periods 2 and 4 results in a
much different projection than
picking periods 1 and 3.
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14 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

FIGURE 15.1 Projecting Sales Growth

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15 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Estimating Sales with

Regression Analysis
 Every observation is used to
compute a best fitting line,
 Which can be then projected
into the future.

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16 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Example

1998 $77
1999 $97
2000 $132
2001 $140.30

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17 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Solution

150

100

50

1997 98 99 00 01 02

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18 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Future Sales

 Can also be estimated using

management opinions
 This is often the only way to
estimate sales for new products
where no historical information is
available
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19 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Percentage of Sales
Forecasting Method
 Estimate future sales using one of
the methods discussed earlier.
 Divide each balance sheet
item that varies with sales by
current sales to get percent of
current sales.
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20 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Percentage of Sales
(continued)
(continued)

 Multiply percent of current sales by

estimated future sales.
 Compute additions to equity due to
current year income.
 Use additional funds as a plug
figure to balance.
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21 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

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22 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Additional Funds
Needed (AFN)
 Equation Approach
AFN =  sales  A* -  sales L* – [PM  s  (1 – d)]
sales sales

A* = Assets which increase proportionately to sales

L* = Liabilities which increase proportionately to sales
PM = Profit margin
d = Divident payout ratio

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23 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Example

 Using the data from the

previous example:

AFN = $5($5 / 20) – $5($3 / 20) – [$25 – .06(1 – .7)] = $.05

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24 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Solution

 AFN calculations show that

because firms must acquire assets
to support their growth, it is
possible to grow so fast that they
outgrow their ability to raise
funds.
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25 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

 In the following figure no

additional funds are required as
long as sales are below $24.

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26 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

FIGURE 15.3 AFN with Different Sales Growth Projections

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27 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

The Maximum
Internal Growth Rate
 How much a firm can grow using only
internally generated funds
Internal Growth Rate = ROA(1 – d)
1 – ROA(1 – d)
ROA = Return on Assets
d = dividend payout ratio

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28 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Example

 ROA = 16.43% and the firm

pays out 20.91% of its income
as dividends. What is its
maximum internal growth rate?

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29 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Solution

g = ROA(1 – d)
1 – ROA(1 – d)

g = .1643(1 – .2091)
1 – [.1643(1 – .2091)]

g = 14.93%
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30 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Maximum
Sustainable Growth Rate
The rate of growth a firm can maintain
while keeping its financial leverage
constant and not issuing additional
equity (it may increase its debt)

MSG = ROE  (1–d)

1-ROE  (1-d)
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31 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Example

 ROE = 24.32% and the dividend

payout is 20.91%. What is the
firm’s maximum sustainable
growth rate?

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32 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Solution

MSG = .2432(1 – .2091)

1 – [.2432(1 – .2091)]

MSG = 23.81%

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33 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

What if . . .

 You determine your projected

growth rate to be greater than
your maximum sustainable
growth rate?

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34 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

– Profit Margin: increasing

margin will provide more cash.
– Total Asset Turnover:
increasing turnover will reduce
the need for new assets.

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35 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

IfIf Projected
Projected Growth
Growth Rate
Rate is
is
determined
determined to to be
be greater
greater than
than
MSG…
MSG…
 Financial Leverage: More debt in
optimal capital structure reduces the
need for equity.
 Dividend Payout Ratio: Reducing
payout provides additional funds for
growth.

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36 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Cash Budget

 A detailed statement of cash

inflows and outflows
 Can be daily, weekly,
or monthly
 Used to ensure that funds will
be available when needed
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37 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Cash Budget

 General Format:
Cash Receipts
– Cash Disbursements
Net Cash Flow
+ Beginning Cash Balance
– Required Cash Balance
Required External Funds Needed/Excess Cash Balance

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38 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Example

 Sales Increase = 10% per month

 November and December sales
are $9,500 and $10,000
 COGS = 60% of sales and is
paid the following month
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39 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Example (continued)

 All sales for credit, 80%

collected the following month
and 20% collected during the
second month

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40 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Example (continued)

Wages = $1000, Rent = $1500, Taxes = $500

Loan payment due in February = $1000
Interest Expense = $200
Cash Balance in December = $3000
(the minimum desired)

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41 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

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42 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Multiple Spreadsheets

 Can be prepared for different

sales growth estimates.
 The resulting projection of
external funds needed can be
summarized graphically.

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43 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

FIGURE 15.4 Sensitivity of Cash Flow to Sales Growth

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44 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Pro-Forma
Financial Statements
 Project 1, 2 or more years into
the future
 A valuable management tool for
assessing the effects of various
management decisions
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45 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

 Virtually all firms prepare these

statements as a part of their
strategic planning process.

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46 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Example
Income statement
Explanation
Sales $100 47% of sales
Cost of goods sold 47
EBIT 53
Interest 3 10% of debt
Earnings before taxes 50
Taxes 20 40% of EBT
Net income $ 30
Dividends $ 10
Addition to retained earnings $ 20

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47 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Example (continued)
Balance Sheet
Assets
  Net working capital $  40 40% of sales
  Fixed assets 160 Reflects excess capacity
Net assets $200
Liabilities and owners’ equity
  Current liabilities 20 20% of sales
  Long-term debt 30 Interest at 10%
  Shareholder equity 150 Includes $20
retained earnings
from current year
Total liabilities and equity $200

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48 Chapter 15: Financial Planning, Forecasting, and Cash Budgets

Solution

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