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CHAPTER 12

Financial Planning and Forecasting

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Topics in Chapter

Financial planning Additional funds needed (AFN)

equation Forecasted financial statements

Sales forecasts Operating input data Financial policy issues

Changing ratios

Free cash flow(FCF)

Weighted averagecost of capital

(WACC)

Projectedincome

statements

Projectedbalancesheets

Intrinsic Value: Financial Forecasting

Projectedadditionalfinancing

needed (AFN)

Forecasting:Operating

assumptions

Forecasting:Financial policy assumptions

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Elements of Strategic Plans

Mission statement Corporate scope Statement of corporate objectives Corporate strategies Operating plan Financial plan

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Financial Planning Process

Forecast financial statements under alternative operating plans.

Determine amount of capital needed to support the plan.

Forecast the funds that will be generated internally and identify sources from which required external capital can be raised.

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Financial Planning Process (Continued)

Establish a performance-based management compensation system that rewards employees for creating shareholder wealth.

Management must monitor operations after implementing the plan to spot any deviations and then take corrective actions.

Pro Forma Financial Statements

Three important uses: Forecast the amount of external

financing that will be required Evaluate the impact that changes in

the operating plan have on the value of the firm

Set appropriate targets for compensation plans

Steps in Financial Forecasting

Forecast sales Project the assets needed to support

sales Project internally generated funds Project outside funds needed Decide how to raise funds See effects of plan on ratios and

stock price

Comparison (Continued)

Profitability ratios lower because of higher interest expense.

Lower asset management ratios due to high levels of receivables and inventory.

Higher leverage than industry.

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AFN Key Factors (Continued)

Profit margin (Net income/Sales): The higher the profit margin, the smaller AFN will be other things held constant.

Payout ratio : The lower the payout ratio, the smaller AFN will be other things held constant.

Compensation and Forecasting

Forecasting models can be used to set targets for compensation plans.

The key is to rewards employees for creating shareholder intrinsic shareholder value.

The emphasis should be on the long run rather than short-run performance.

Financing Feedbacks Forecast does not include additional

interest from the line of credit because we assumed that the line was tapped only on the last day of the year.

It would be more realistic to assume that the line is drawn upon throughout the year.

Financing feedbacks occur when the additional financing costs of new external capital are included in the analysis.

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Modifying the Forecasting Model

Can maintain target capital structure each year by modifying model to issue/retire long term debt or issue/repurchase shares of stock.

THANK YOU

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