Chapter 4 –Chapter 4 – Financial Forecasting,Financial Forecasting,

Planning, and BudgetingPlanning, and Budgeting

2005, Pearson Prentice Hall

Financial ForecastingFinancial Forecasting

1)1) Project sales revenues and expenses. Project sales revenues and expenses.

2)2) Estimate current assets and fixed Estimate current assets and fixed assets necessary to support projected assets necessary to support projected sales.sales. Percent of sales forecastPercent of sales forecast

Percent of Sales MethodPercent of Sales Method

Suppose this year’s sales will total Suppose this year’s sales will total $32 million$32 million..

Next year, we forecast sales of Next year, we forecast sales of $40 million$40 million..

Net income should be Net income should be 5%5% of sales. of sales. Dividends should be Dividends should be 50%50% of of

earnings.earnings.

This yearThis year % of % of $32m$32m

AssetsAssetsCurrent AssetsCurrent Assets $8m$8m 25%25%Fixed AssetsFixed Assets $16m$16m 50%50% Total AssetsTotal Assets $24m$24mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $4m$4m 12.5%12.5%Accrued ExpensesAccrued Expenses $4m$4m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $15m$15mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $2m$2m EquityEquity $9m$9m Total Liab. & EquityTotal Liab. & Equity $24m$24m

Next yearNext year % of % of $40m$40m

AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings EquityEquity Total Liab. & EquityTotal Liab. & Equity

Predicting Retained EarningsPredicting Retained Earnings

Next year’s projected retained earnings = last Next year’s projected retained earnings = last year’s year’s $2 million$2 million, plus:, plus:

projected net incomeprojected net income cash cash dividendsdividends

salessales sales sales net income net income

$40 million x .05 $40 million x .05 xx (1 - .50)(1 - .50)

= $2 million + $1 million = = $2 million + $1 million = $3 million$3 million

xx xx ( 1 - ) ( 1 - )

Next yearNext year % of % of $40m$40m

AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $3m$3m EquityEquity Total Liab. & EquityTotal Liab. & Equity

Next yearNext year % of % of $40m$40m

AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $3m$3m EquityEquity $10m$10m Total Liab. & EquityTotal Liab. & Equity

Next yearNext year % of % of $40m$40m

AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $3m$3m EquityEquity $10m$10m Total Liab. & EquityTotal Liab. & Equity $27m$27m

Next yearNext year % of % of $40m$40m

AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $3m$3m EquityEquity $10m$10m Total Liab. & EquityTotal Liab. & Equity $27m$27m

How muchDiscretionary

Financing will weNeed?

Next yearNext year % of % of $40m$40m

AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $3m$3m EquityEquity $10m$10m Total Liab. & EquityTotal Liab. & Equity $27m$27m

How muchDiscretionary

Financing will weNeed?

Next yearNext year % of % of $40m$40m

AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $3m$3m EquityEquity $10m$10m Total Liab. & EquityTotal Liab. & Equity $27m$27m

How muchDiscretionary

Financing will weNeed?

Predicting Discretionary Predicting Discretionary Financing NeedsFinancing Needs

Discretionary Financing Needed =Discretionary Financing Needed =

projectedprojected projectedprojected projectedprojected totaltotal -- total total -- owners’ owners’ assetsassets liabilitiesliabilities equity equity

$30 million - $17 million - $10 million$30 million - $17 million - $10 million

= = $3 million$3 million in discretionary financing in discretionary financing

Sustainable Rate of GrowthSustainable Rate of Growth

g* = ROE (1 - b)g* = ROE (1 - b) wherewhere

b =b = dividend payout ratio dividend payout ratio

(dividends / net income)(dividends / net income)

ROE =ROE = return on equity return on equity

(net income / common equity) or(net income / common equity) or

net income sales assetsnet income sales assets

sales assets common equitysales assets common equityROE = x xROE = x x

BudgetsBudgets

Budget:Budget: a forecast of future events. a forecast of future events.

BudgetsBudgets

Budgets indicate the Budgets indicate the amountamount and and timingtiming of of future financing needsfuture financing needs..

Budgets provide a basis for taking Budgets provide a basis for taking corrective actioncorrective action if budgeted and if budgeted and actual figures do not match.actual figures do not match.

Budgets provide the basis for Budgets provide the basis for performance evaluationperformance evaluation..