Financial Planning and Control Financial Planning and Control

Financial PlanningFinancial PlanningSales forecastsSales forecastsAFN formula methodAFN formula method

Set up a system of projected financial statements.

Determine the funds needed. Forecast funds available. Establish and maintain the system of controls. Develop procedures for adjusting the basic pl

an. - Establish the performance based managemen

t.

Financial plan

Financial PlanningThe 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.

Financial ControlThe 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

Financial Planning: The Sales Forecast

A forecast of a firm’s 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.

Sales Projection(millions of dollars)

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

2009 2010 2011 2012 2013 2014

Projected (Pro Forma) Financial Statements

A method of forecasting financial requirements based on forecasted financial statements.ADF = additional funds needed

to support the level of forecasted operations

2011 Balance Sheet (in millions of $)

Cash & sec. $ 20 Accts. pay & $ 100 accruals

Accounts rec. 240 Notes payable 100Inventories 240 Total CA $ 500 Total CL $ 200

L-T debt 100Common stk 500

Net fixed Retained assets 500 earnings 200 Total assets $1,000 Total claims $1,000

2011 Income Statement(in millions of $)

Sales $2,000.00Less: Var. costs (60%) 1,200.00

Fixed costs 700.00 EBIT $ 100.00Interest 16.00 EBT $ 84.00Taxes (30%) 25.20Net income $ 58.80Dividends (30%) $ 17.64Add’n to RE $ 41.16

Key Ratios

BEP 10.00% 20.00% PoorProfit Margin 2.52% 4.00% PoorROE 7.20% 15.60% PoorDSO (days) 43.2 32.0 PoorInv. turnover 8.33x 11.00x PoorFA turnover 4.00x 5.00x PoorTA turnover 2.00x 2.50x PoorD/A ratio 30.00% 36.00% GoodTIE 6.25x 9.40x PoorCurrent ratio 2.50x 3.00x PoorPayout ratio 30.00% 30.00% OK

NWC Industry Condition

Key Assumptions

Interest rate = 8% for any debt.Operating at full capacity in 2011.Each type of asset grows proportio

nally with sales.Payables and accruals grow propor

tionally with sales.2011 profit margin (2.52%) and pay

out (30%) will be maintained.Sales are expected to increase by $

500 million. (%S = 25%)

Assets

Sales0

1,000

2,000

A/S = 1,000/2,000 = 0.5 = 1,250/2,500.

1,250

2,500

Assets =(A/S) Sales= 0.5(500)= 250.

Assets = 0.5 sales

AFN= (A*/S)S - (L*/S)S - M(S1)(1 - d)

AFN formula

Additional funds needed

Required increase in assets

Spontaneous increase in liabilities

Increase in retained earnings

AFN formulaAFN= Additional funds needed A*= assets that tied directly to sales, so must i

ncrease if sales are to increaseS = sales during the last yearS = change in sales =S1 - S

L*= liabilities that increase spontaneously, normally include account payables and accruals, but not bank loans and bonds

M = profit margin = profit per $1 of sales

S1= total sales projected for next year

(1 - d)= Retention ratio = the percentage of net income that retained

(A*/S) = percentage of required assets to sales, showing the required dollar increase in asset per $1 increase in sales

(L*/S) = liabilities that increase spontaneously as a percentage of sales, or spontaneously generated financing per $1 increase in sales

AFN formula

What is the AFN based on the AFN equation?

AFN = (A*/S)S - (L*/S)S - M(S1)(1 - d)

= ($1,000/$2,000)($500) - ($100/$2,000)($500) - 0.0252($2,500)(1 - 0.3)

= $250 - $25 - $44.1

= $180.9 million.

Questions the Financial Planner Should Consider

Mark Twain once said “forecasting is very difficult, forecasting is very difficult, particularly if it concerns the particularly if it concerns the futurefuture”. The process of financial planning involves the use of mathematical models which provide the illusion of great accuracy.

Questions the Financial Planner Should Consider

In assessing a financial forecast, the planner should ask the following questions: Are the results generated by the model reasonable? Have I considered all possible outcomes? How reasonable were the economic assumptions which

were used to generate the forecast? Which assumptions have the greatest impact on the

outcome? Which variables are of the greatest importance in

determining the outcome? Have I forgotten anything important?