Financial

Planning &
Forecasting
Financial
Statement
Chapter 3
Arsalan Haneef
Financial Statement Forecasting: The Percent of
Sales Method (Step-1)

• Being with sales forecast, expressed as an annual growth rate.

• Income statement and Balance sheet items are assumed to increase proportionally with sales.
• E.g., inventory-to-sales ratio, receivables/sales.
• If the forecasted percentage of sales for each item is the same as that for the prior year, then
each item will grow at the same rate as sales during the forecast period.
• This approach is called constant ratio method.
• It is not in the interest of managers to use this method.
Financial Statement Forecasting: The Percent of
Sales Method (Step-1)

• Growth is initially expected to be 10 percent, but high growth attracts competitors, and
eventually the market becomes saturated.
• The average financial plan has a forecast period of 5 to 15 years, depending on how long the
competitive advantage will last.
• Other items on the forecasted statements, which are not directly related to sales, are set at
"reasonable" levels.
Analyse the Historical Ratios

• It is important to note that these ratios differ from those taught in IBF.
• Some items may increase spontaneously with sales.
• Such items are called spontaneously generated funds.
Analyse the Historical Ratios (Step-1)
 Year
2007
Sales $3,000
Cost except depreciation $2,616
Depreciation $100 Forecasting Income
Total Operating Cost
EBIT
$2,716
$284
Statement (Step-2)
Less Interest $88
EBT $196
Taxes @40% $78
Net Income before Pref dividends $118
Dividends to Pref $4
Net Income avaiable for Common $114
Dividends to Common $58
Carried frwd to R/E $56

Shares of common equity 50

Dividends are expected to grow by 8%
Forecasting the Balance Sheet (Step-3)

Year 2007
Cash & Cash equivalent 10
A/C Rec: 375
Inventories 615
Total Current Assets 1,000
Net PP&E 1,000
Total Assets 2,000
A/c Payables 60
Notes Payable 110
Accruals 140
Total current liabilities 310
Long-term bonds 754
Total debt 1,064
Preferred stock 40
Common stock 130
Retained earnings 766
Total common equity 896
Total liabilities and equity 2,000
Additional Funds
Required (AFN) (Step-4)

• Funds may be raised based

on a number of factors, such
as the firm's target capital
structure, the effect of short-
term borrowing on the
current ratio, conditions in
the debt and equity markets,
and restrictions imposed by
existing debt agreements.
Financing Feedbacks (Step-5)

• Interest must be paid on the debt used to help finance the AFN, and that dividends will be paid
on the shares issued to raise the common stock portion of the AFN.
• Those payments would lower net income and retained earnings shown in the projected
statements.