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Chapter 4

Financial Forecasting

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Chapter 4 - Outline LT 4-1

What is Financial Forecasting?

2 Methods of Financial Forecasting

3 Financial Statements for Forecasting

Steps in a Pro Forma Income Statement

(I/S)Determining Production Requirements

Percent-of-Sales Method

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What is Financial Forecasting? LT 4-2

Financial forecasting is looking ahead to

develop a financial plan for the future

Very important for the strategic growth of a

firm

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2 Methods of Financial Forecasting: LT 4-3

Using Pro Forma, or Projected, Financial

Statements (more exact, time consuming)

Percent-of-Sales Method (less precise, easier

to calculate)

Often times these statements are required

by lenders

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4-24.Cambridge Prep Shops

Cambridge Prep Shops, a national clothing chain, had sales of $200 million last year. The businesshas a steady net profit margin of 12 percent and a dividend payout ratio of 40 percent.

Balance Sheet End of Year ($ millions)

Cambridges marketing staff tells the president that in the coming year there will be a largeincrease in the demand for tweed sport coats and various shoes. A sales increase of 15 percent isforecast for the Prep Shop. All balance sheet items are expected to maintain the same percent-of-sales relationships as last year, except for common stock and retained earnings. No change is

scheduled in the number of common stock shares outstanding, and retained earnings will change asdictated by the profits and dividend policy of the firm. (Remember the net profit margin is 12percent.)

a. Will external financing be required for the company during the coming year?

b. What would be the need for external financing if the net profit margin went up to 14 percentand the dividend payout ratio was increased to 70 percent? Explain.

Assets Liabilities and Stockholders Equity

Cash 10$ Accounts Payable 15$

Accounts Receivable 15$ Accrued Expenses 5$

Inventory 50$ Other Payables 40$

Plant and Equipment 75$ Common Stock 30$Total Liabilities and Stockholders Equity 60$

150$ 150$

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4-24.Cambridge Prep Shops (cont.)

A negative figure for required new fundsindicates that an excess of funds ($3.06

mil.) is available for new investment. No

external funds are needed.

Note:

The Problem states All balance sheetitems are expected to maintain the same

percent-of-sales relationships as last year,

except for common stock and retained

earnings. This means that Assets (A)

include Plant and Equipment. (emphasis

added)

$3,060,000RNF

000,560,16$000,000,9$000,500,22$

6.000,000,230$

12.000,000,30$30.000,000,30$75.

4.1000,000,230$

12.000,000,30$200

60000,000,30$

200

150RNF

0$30,000,0000$200,000,015%S

D1PSSSLS

SFundsNewRequired 2

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3 Financial Statements for

Forecasting LT 4-4

Pro Forma Income Statement (I/S)

Cash Budget

Pro Forma Balance Sheet (B/S)

The first step is to develop a sales projection

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Steps in a Pro Forma

Income Statement (I/S)

Establish a sales projection

Determine a production schedule (or

production requirements)

Compute other expenses

Determine profit by completing an actualpro forma income statement (I/S)

LT 4-5

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PPT 4-1

FIGURE 4-1

Development

of pro formastatements

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PPT 4-2

TABLE 4-1

Projected wheel andcaster sales (first six

months, 2005)

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Determining Production

Requirements LT 4-6

Projected Units Sales PLUS

Desired Ending Inventory (EI) MINUS

Beginning Inventory (BI) EQUALS

Production Requirements(or Units to be Produced)

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PPT 4-3

TABLE 4-2Stock of beginning

inventory

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PPT 4-3

TABLE 4-3

Production

requirements for six

months

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PPT 4-3

TABLE 4-4

Unit costs

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PPT 4-3

TABLE 4-5

Total production costs

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PPT 4-3TABLE 4-6

Allocation of manufacturing cost

and determination of gross profits

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PPT 4-3

TABLE 4-7Value of ending

inventory

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PPT 4-4

TABLE 4-8

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PPT 4-5

TABLE 4-9Monthly sales pattern

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PPT 4-5

TABLE 4-10

Monthly cast receipts

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PPT 4-5

TABLE 4-11

Component costs of

manufactured goods

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PPT 4-6

TABLE 4-12

Average monthly

manufacturing costs

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PPT 4-7

TABLE 4-14Monthly cash flow

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PPT 4-7

TABLE 4-15Cash budget with borrowing and

repayment provisions

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PPT 4-8TABLE 4-16

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PPT 4-9

FIGURE 4-2Development

of a pro forma

balance sheet

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PPT 4-10TABLE 4-17

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PPT 4-6

TABLE 4-13

Summary of all monthly

cash payments

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PPT 4-11TABLE 4-18

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Percent-of-Sales Method LT 4-7

A short-cut, less exact, easier method of

determining financing needs (The quick and

dirty approach)

Assumes that B/S accounts will maintain a

constant percentage relationship to salesAssets / Current Sales = % of Sales