Slide 1

Financial Forecasting, Planning, and Budgeting Financial Forecasting:

1. Project sales revenues and expenses

2. Estimate current assets and fixed assets necessary to support projected sales

Percent of sales forecast

Slide 2

Percent of Sales Method Suppose this year’s sales will total $32 million Next year, we forecast sales of $40 million Net income should be 5% of sales Dividends should be 50% of earnings

Slide 3

Construction of Forecast Balance Sheet All asset accounts are assumed to vary

proportionally with sales Accounts Payable and Accrued Expenses are the

Current Liability accounts that vary with sales directly – remember liabilities and equity are financing sources for a firm

Because of this Accounts Payable and Accrued Expenses are called spontaneous sources of financing

Slide 4

Percent of Sales Method (Continued) This year % of $32m

AssetsCurrent Assets $8m 25%Fixed Assets $16m 50% Total Assets $24mLiab. and EquityAccounts Payable $4m 12.5%Accrued Expenses $4m 12.5%Notes Payable $1m n/aLong Term Debt $6m n/a Total Liabilities $15mCommon Stock $7m n/aRetained Earnings $2m Equity $9m Total Liab. & Equity $24m

Slide 5

Percent of Sales Method (Continued) Next year % of $40m

AssetsCurrent Assets $10m 25%Fixed Assets $20m 50% Total Assets $30mLiab. and EquityAccounts Payable $5m 12.5%Accrued Expenses $5m 12.5%Notes Payable $1m n/aLong Term Debt $6m n/a Total Liabilities $17mCommon Stock $7m n/aRetained Earnings ??? Equity ??? Total Liab. & Equity

Slide 6

Predicting Retained Earnings Next year’s projected retained earnings = last

year’s $2 million, plus:

$40 million x 0.05 x (1 - 0.50) = $2 million + $1 million = $3million

IncomeNet

DividendsCash 1 x

Sales

IncomeNet x Sales

Slide 7

Predicting Discretionary Financing Needs Next year % of $40m

AssetsCurrent Assets $10m 25%Fixed Assets $20m 50% Total Assets $30mLiab. and EquityAccounts Payable $5m 12.5%Accrued Expenses $5m 12.5%Notes Payable $1m n/aLong Term Debt $6m n/a Total Liabilities $17mCommon Stock $7m n/aRetained Earnings $3m Equity $10m Total Liab. & Equity $27m

How muchDiscretionary

Financing will weNeed?

Slide 8

Predicting Discretionary Financing Needs (Continued)

Discretionary Financing Needed = [Projected Total Assets] – [Projected Total Liabilities] – [Projected Shareholders’ Equity]

Alternatively: DFN = [Projected Total Assets] – [Projected

Liabilities & Shareholders’ Equity] DFN = $30 million – $17 million – $10 million DFN = $3 million in discretionary financing

Slide 9

Predicting Discretionary Financing Needs (Continued)

At this point corporation has to decide how to finance the DFN

The Company can sell Bonds (Long-Term Debt) or Equity

This is why we call Long-Term Debt and Equity as sources of external capital

Note that paid-in capital is the difference between selling price of equity and face value times the number of shares sold

Slide 10

Sustainable Rate of Growth Sustainable rate of growth is the rate the sales can grow

without selling new equity and maintaining debt ratio (this means that if a firm retains earnings it would need to issue new debt to maintain debt ratio)

g* = ROE (1 – b) where

b = dividend payout ratio

(dividends / net income)

ROE = return on equity

(net income / common equity)

Slide 11

Budgets Budget: a forecast of future events Budgets indicate the amount and timing of future

financing needs Budgets provide a basis for taking corrective

action if budgeted and actual figures do not match Budgets provide the basis for performance

evaluation