POST GRADUATE CERTIFICATE PROGRAMME MANAGEMENT

Financial Econometrics
CCBMDO 19

Financial Management I

Session # 3
Any Questions?

Forecasting Financial Statements…

This session looks at the ways of forecasting financial statements and use them to
calculate expected future free cash flows.
For value creation, its important for the firm to have well-thought strategic and
tactical operating plans for future.
Projecting Financial Statements
 Three important uses:
 Managers can assess whether the anticipated performance is in line
with general targets and with investors expectations ---> Set
appropriate targets for compensation plans
 Forecast the amount of external financing (EFN) that will be required
 To estimate the effect of propose operating changes, enabling
managers to conduct ‘what-if’ analyses.
 Evaluate the impact that changes in the operating plan have on the
firm value.
 Strategic Plan → Operating Plan of Action → Sales forecast→
Project financial statements → Determine Additional Funds
Needed required to achieve targeted growth
 Steps in Financial Forecasting
 Strategic Plan → Operating Plan of Action → Sales forecast→ Project
financial statements → Determine Additional Funds Needed required to
achieve targeted growth

 Steps:
 Forecast sales
 Forecast the assets needed to support sales
 Forecast internally generated funds
 Forecast outside funds needed
 Decide how to raise funds
 See effects of plan on ratios and stock price
Strategic Plan → Operating Plan of Action → Sales forecast→ Project financial
statements → Determine Additional Funds Needed required to achieve targeted
growth

To achieve the targeted growth, firm needs to invest in its assets.

Increase in assets / investment should be met either from:

--Internal Sources : Spontaneous liabilities and Retained earnings
(Spontaneous are those increase automatically with rise in sales)
-- External Sources: Bank loan / Bond holders and Equity
Assumptions about How AFN Will Be Raised

 Assets are operating at full capacity

 No new common stock will be issued.
 Any external funds needed will be raised as debt
 AFN = (A*/S0)S - (L*/S0)S - M(S1)(1 - D)

 M=profit margin
 D = Dividend Payout ratio
 S0= Current Sales; S1 = Projected sales
 L = Liabilities (in support of sales growth)
 A = Assets (in support of sales growth)
Look at MicroDrive’s example
Let’s prepare financial statements for the year 2011, with a 10% growth in sales
0.067
Percent of Sales Approach : Forecasting Financial Statement as “status quo”
 Excess Capacity
Self-Supporting Growth Rate
 What is the maximum growth rate the firm could achieve if
it had no access to external capital?
 It can be found as the value of g that, when used in the AFN
equation, results in an AFN of zero.
 Replace Change_in_Sales with gSo and S1 with (1+g)So and
then solve for unknown g
 The AB Corporation has the following ratios:
Ao /So =1.6; Lo /So =0.4; profit margin = 0.10 and dividend payout ratio = 0.45. So
= Rs.100million.
Assuming that these ratios will remain constant, determine the maximum growth rate
ABC can achieve without having to employ non-spontaneous external funds.

0=1.6(100g) – 0.4(100g) – 0.1(100(1+g))(1-0.45)

0=160g-40g-5.5g-5.5
g= 5.5/114.5 = 4.8%
Maximum growth rate without external financing
 A.