ATENEO - J.G.

SCHOOL OF M ANAGEMENT FINANCE 103: PRINCIPLES OF FINANCE

Finance & Accounting Department V – Financial Planning & Forecasting
Instructor : Alice Parlan SY 2016 – 2017 Intersession

FINANCIAL PLANNING & FORECASTING

 Forecasting Sales
 Projecting the Assets and Internally Generated Funds
 Projecting Outside Funds Needed
 Deciding How to Raise Funds

 6 Key Elements of a Strategic Plan

 Mission Statement - a condensed version of a firm’s strategic plan

 Corporate Scope - defines a firm’s lines of business and geographic areas of operation, which
should be logical and consistent with the firm’s capabilities

 Statement of Corporate Objectives - sets specific goals that operating managers are expected
to meet, which includes qualitative and quantitative objectives

 Corporate Strategies - broad approaches developed for achieving firm’s goals

 Operating Plan - provides management with detailed implementation guidance based on the
corporate strategy to help meet the corporate objectives; It’s usually a 5-year horizon with
specific details like people responsible for each particular function, deadlines for specific tasks,
sales and profit targets, etc.

 Financial Plan - a document that includes assumptions, projected financial statements,

projected ratios and ties the entire planning process together;
It involves 4 steps:
1. Assumptions made on Future Levels of Sales, Costs, Interest Rates, etc
2. A Set of Projected Financial Statements
3. Projected Ratios are calculated and analyzed
4. Entire Plan is re-examined, assumptions are reviewed, changes in the operating plan to
improve results

 Financial Planning

 Value-Based Management – effects of various decisions on the firm’s financial position and
value are studied by simulating their effects within a firm’s financial model; If management
decision will increase profits and shareholders’ wealth, then it should make that move.

 Revenue Model
Source: /www.incuray.com/how-to-build-a-startup-–-developing-your-revenue model

 Strategy used by a company to

generate cash from each customer
segments.

 If you have multiple customer

segments, you may have multiple
revenue streams.

Sources: Brigham and Houston: Essentials of Financial Management, 13th Ed., Cengage Learning Asia 2013;
Keown, Martin, Petty: Foundations of Finance, 7th Ed., Pearson Education, Inc. / Prentice Hall 2011 1
 ATENEO - J.G. SCHOOL OF M ANAGEMENT FINANCE 103: PRINCIPLES OF FINANCE
Finance & Accounting Department V – Financial Planning & Forecasting
Instructor : Alice Parlan SY 2016 – 2017 Intersession

 Examples of Revenue Models

 Pricing Model
Source: Matyzel Consulting / www.iaop.org

 The tactics you'll use to set the price in each

of your customer segments. To determine
the pricing, you need to understand the
value they are willing to pay for.

 When you're first making your assumptions,

you can guess what the pricing could be,
but you'll quickly validate how much they
are currently paying (and for what value),
and how they are currently paying.

 Constructing a Financial Plan

 Sales Forecast - starts with the review of sales for the past 5 years; Most important input in
the firm’s forecast of financial statements (including projected EPS)

Sources: Brigham and Houston: Essentials of Financial Management, 13th Ed., Cengage Learning Asia 2013;
Keown, Martin, Petty: Foundations of Finance, 7th Ed., Pearson Education, Inc. / Prentice Hall 2011 2
 ATENEO - J.G. SCHOOL OF M ANAGEMENT FINANCE 103: PRINCIPLES OF FINANCE
Finance & Accounting Department V – Financial Planning & Forecasting
Instructor : Alice Parlan SY 2016 – 2017 Intersession

 Assets & Sales Growth

 The firm’s increase in assets is fundamentally dependent on the growth rate in sales.

 If Firm has Assets of Php 200 MM & Sales of Php 300 MM then,
Assets-to-Sales Ratio = 200 = 0.667 = 66.7%
300
This refers to ratio of assets required per peso of sales; also known as Capital Intensity Ratio.

 If Sales are projected to grow 10%, then Sales = (0.10) (300) = Php 30 MM

 Therefore, Projected Sales = 300 + 30 = Php 330 MM

 If Asset-to-Sales Ratio remains constant, then additional assets needed to support the increase
in sales:

Assets = Assets-to-Sales Ratio X Sales

= (0.667) (30 MM) = Php 20 MM

 Firm’s Primary Capital Sources

 If the assets were to grow by X amount, then liabilities and equity must also grow by same
amount

 The firm’s primary capital will come from 3 sources:

1. Spontaneously Generated Funds (Increases in A/P and Accruals) - funds that arise out of
normal business operations from its suppliers, employees, and government that reduce the
need of the firm for external funding

2. Addition to Retained Earnings - depends on the firm’s profit margins and retention ratio,
which is the proportion of net income that is reinvested in the firm and calculated as:
= 1 - Dividend Payout Ratio
= 1 - Dividends_
Net Income

3. Additional Funds Needed (AFN) – the amount of external capital (interest-bearing debt +
preferred and common stocks) needed to acquire additional assets , with the ff situation:
Spontaneously Generated Funds ≠ Forecasted
+ Additional Retained Earnings Increase in Assets

 The AFN Equation (Firm Operating on Full Capacity)

 The total amount of new interest-bearing debt and preferred and common stocks the firm must
issue to support its planned growth:
AFN = Projected Increase in Assets
Less: Spontaneous Increase in Liabilities
Less: Increase in Retained Earnings

Sources: Brigham and Houston: Essentials of Financial Management, 13th Ed., Cengage Learning Asia 2013;
Keown, Martin, Petty: Foundations of Finance, 7th Ed., Pearson Education, Inc. / Prentice Hall 2011 3
 ATENEO - J.G. SCHOOL OF M ANAGEMENT FINANCE 103: PRINCIPLES OF FINANCE
Finance & Accounting Department V – Financial Planning & Forecasting
Instructor : Alice Parlan SY 2016 – 2017 Intersession

 The AFN Equation

= Projected Increase - Spontaneous Increase - Funds Obtained

in Assets in Liabilities as new Retained
(Payables + Accruals) Earnings based
on Projected Sales

= (A) - (L) - (RE)

where A = Asset X (Growth Rate)(Actual Sales)

Sales
where L = Liabilities X (Growth Rate) (Actual Sales)
Sales
where RE = Net Income X Projected Sales X (1 - Dividends )
Sales Net Income

 The AFN Equation (Firm Not Operating on Full Capacity)

 Capital Intensity Ratio – ratio of assets required per peso of sales:

Assets-to-Sales Ratio = Php 200 MM = 0.667 = 66.7%
Php 300 MM

 Excess Capacity Adjustment - changes made to the existing asset forecast since the firm is not
operating at full capacity: Assets = % Currrent Assets + % Fixed Assets
200 = 100 + 100

 Current Asset to Sales Ratio = 100 / 300 = 0.333 = 33.3%

 Fixed Asset to Sales Ratio = 100 / 300 = 0.333 = 33.3%

 With FA = 50% of Assets, and firm operating at 96% Capacity, then:

Full Capacity Sales = Actual Sales___

% Capacity of FA
= 300 / 0.96 = Php 312.5 MM

Target Fixed Assets = Actual Fixed Assets

Actual Sales Full Capacity Sales
= 100 / 312.5 = 0.32 or 32%

 Target Fixed Asset / Sales Ratio should be 32%, and not 33.3% earlier computed
 Sales could increase to Php 312.5 MM with no increase in Fixed Assets

 If the firm were to target a 10% growth in sales, given Assets of Php 200 MM (of which FA = Php
100 MM operating at 96% capacity) and Sales of Php 300 MM, then:

Required Level of FA = Target Fixed Sales X Projected Sales

Assets
= (0.32) (330) = Php 105.6 MM

Earlier Estimate of AFN = 1.1 ( 100 ) = __Php 110 MM__

Difference (Php 4.4 MM)

The existence of excess capacity would lower the required AFN by Php 4.4 MM.

Sources: Brigham and Houston: Essentials of Financial Management, 13th Ed., Cengage Learning Asia 2013;
Keown, Martin, Petty: Foundations of Finance, 7th Ed., Pearson Education, Inc. / Prentice Hall 2011 4
 ATENEO - J.G. SCHOOL OF M ANAGEMENT FINANCE 103: PRINCIPLES OF FINANCE
Finance & Accounting Department V – Financial Planning & Forecasting
Instructor : Alice Parlan SY 2016 – 2017 Intersession

 How would the following items affect the AFN?

 Higher dividend payout ratio?

Increase AFN: Less retained earnings

 Higher capital intensity ratio?

Increase AFN: Need more assets for given sales

 Higher profit margin?

Decrease AFN: Higher profits, more retained earnings

 Pay suppliers in 60 days, rather than 30 days?

Decrease AFN: Trade creditors supply more capital (i.e., Liabilities/Sales increases)

 Forecasted Financial Statements

 Financial statements that project the company’s financial position and performance over a
period of years; F/S show how good or how bad the financial ratios and its impact on EPS

 Why AFN Equation & Financial Statement Method have Different Results

 AFN Equation method assumes a constant profit margin, a constant dividend payout, and a
constant capital structure
 Financial statement method is more flexible. More important, it allows different items to grow at
different rates:

o Adjustable Inputs – Inputs (key o Fixed Inputs – required for the forecast,
ratios) required for the forecast, which are not under management’s
which mgt controls and that may direct control or are not expected to
be adjusted in the future: change:
 Growth Rate  Tax Rate
 Operating Costs/Sales  Interest Rate
 Receivables/Sales  Shares Initially Outstanding
 Inventory/Sales  Initial Stock Price
 Debt Ratio  Fixed Asset/Sales
 Payout Ratio

 Regression Analysis – a statistical technique that fits a line to observed data points so that the
resulting equation can be used to forecast other data points; It is used to improve the financial
forecasts

 Analyzing the Effects of Changing Ratios

 Modifying Accounts Receivables moving closer to

 Modifying Inventories industry averages
 Other Special Studies – the “what if” studies

Sources: Brigham and Houston: Essentials of Financial Management, 13th Ed., Cengage Learning Asia 2013;
Keown, Martin, Petty: Foundations of Finance, 7th Ed., Pearson Education, Inc. / Prentice Hall 2011 5
 ATENEO - J.G. SCHOOL OF M ANAGEMENT FINANCE 103: PRINCIPLES OF FINANCE
Finance & Accounting Department V – Financial Planning & Forecasting
Instructor : Alice Parlan SY 2016 – 2017 Intersession

 Forecasting Financial Statements is a crucial part of the Financial Planning Process

 Helps value the firm’s stock

 Estimates the benefits of potential projects

 Determines the changes in capital structure, dividend policy, and working capital policy, which
influences shareholder value

 If projected operating results are not satisfactory, management can “go back to the drawing
board” and reformulate its plans

 Funds required to meet sales forecast may not be obtainable and knowing this in advance
helps or there may be a need to scale back the projected operations

Sources: Brigham and Houston: Essentials of Financial Management, 13th Ed., Cengage Learning Asia 2013;
Keown, Martin, Petty: Foundations of Finance, 7th Ed., Pearson Education, Inc. / Prentice Hall 2011 6