Chapter 17

Financial Planning
and Control

Learning Outcomes
Chapter 17

Construct simple pro forma financial statements that can

be used to forecast financing and investment needs.

Discuss some of the complications that management

should consider when constructing pro forma financial
statements.

Describe and compute (a) operating breakeven and

operating leverage, (b) financial breakeven and financial
leverage, and (c) total leverage.

Discuss how knowledge of leverage is used in the

financial forecasting and control process and why financial
planning is critical to firm survival.
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Financial Planning and Control

Financial Planning:
The projection of sales, income, and assets based
on alternative production and marketing
strategies, as well as the determination of the
resources needed to achieve these projections

Financial Planning and Control

Financial Control
The phase in which financial plans are
implemented, control deals with the feedback and
adjustment process required to ensure adherence
to plans and modification of plans because of
unforeseen changes.

Financial Planning: The Sales Forecast

A forecast of a firms unit and dollar sales for

some future period, generally based on
recent sales trends plus forecasts of the
economic prospects for the nation, region,
industry, etc.

Projected (Pro Forma)

Financial Statements

A method of forecasting financial

requirements based on forecasted financial
statements

AFN = additional funds needed to support the

level of forecasted operations

Projected Financial Statements

Determine how much money the firm will

need in a given period.

Determine how much money the firm will

generate internally during the same period.

Subtract

the funds generated internally from

the funds required to determine the external
financial requirements.

Step 1. Forecast the 2013 Income

Statement: Unilate Textiles
Assumptions:
Unilate

operated at full capacity in 2012.

Sales are expected to grow by 10 percent.

The variable cost ratio remains at 82 percent

(same as 2012).

2013 dividend per share will be the same as

in 2012.

Step 1. Forecast the 2013 Income Statement

Step 2. Forecast the 2013 Balance Sheet

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Step 3. Raising the

Additional Funds Needed (AFN)

Higher sales must be supported by higher

assets.

Asset increase can be financed by

spontaneous increases in accounts payable
and accruals and by retained earnings.

Any short fall must be financed from external

sources--by borrowing or by selling new
stock.

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Step 4. Financing Feedbacks

The effects on the income statement and

balance sheet of actions taken to finance
forecasted increases in assets

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2013 Adjusted Forecast of Income Statement

a
b

The upper portion of the income statement is not affected by financing feedbacks.
The adjustment to RE shows up in the balance sheet as well.

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2013 Adjusted Forecast of Balance Sheet

b
c

The adjustment to RE shows up in the balance sheet as well.

Total AFN = $45.0 million, which equals $42.7 million plus the $2.3 million decrease in RE.

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Unilate Textiles: Adjusted Key Ratios

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Other Considerations in Forecasting:

Excess Capacity

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Other Considerations in Forecasting:

Economies of Scale
Unilatesvariable

cost ratio is 82% of sales.

Ratio might decrease to 80% if operations

increase significantly.

Changes in variable cost ratio affect the

addition to retained earnings which affects the
amount of AFN.

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Other Considerations in Forecasting:

Lumpy Assets
Assets

that cannot be acquired in small

increments, but must be obtained in large,
discrete amounts

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How Different Factors Affect the AFN

Forecast.

Dividend payout ratio changes.

If reduced, more RE, reduce AFN.

Profit margin changes.

If increases, total and retained earnings increase, reduce
AFN.

Plant capacity changes.

Less capacity used, less need for AFN.

Payment terms increased to 60 days.

Accounts payable would double, increasing liabilities, reduce
AFN.
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Financial Control Budgeting and Leverage

The phase in which financial plans are

implemented; control deals with the feedback
and adjustment processes required to
ensure the firm is following the right financial
path to accomplish its goals, and, if not, to
make necessary corrections.

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Operating Breakeven Analysis

An analytical technique for studying the

relationship between sales revenues, operating
costs, and profits

Operating breakeven analysis deals only with the

upper portion of the income statementthe
portion from sales to NOI

At the operating breakeven point, EBIT = 0

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Unilates 2013 Forecasted Operating

Income

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Operating Breakeven Chart

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Breakeven Computation

For the proposal to break even, Unilate must sell 57

million units or $855.6 million of product.
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Operating Leverage

The existence of fixed operating costs, such

that a change in sales will produce a larger
change in operating income (EBIT)

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Degree of Operating Leverage

The percentage change in NOI

(or EBIT) associated with a given percentage
change in sales

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Calculating the Degree of Operating

Leverage

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Operating Income/Leverage at Sales

Levels of 110 and 121 Million Units

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Financial Breakeven Analysis

Determining the operating income (EBIT) the

firm needs to just cover all of its fixed
financing costs and produce earnings per
share equal to zero

At

the financial breakeven point, EPS = 0

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Financial Breakeven Graph

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Financial Breakeven Computation

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Financial Breakeven Computation

The financial breakeven point for Unilate

Textiles in 2013 is:

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Financial Leverage

The existence of fixed financial costs such as

interest and preferred dividends when a
change in EBIT results in a larger change in
EPS

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Degree of Financial Leverage

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Degree of Financial Leverage

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EPS/Financial Leverage at Sales Levels of

110 and 121 Million Units

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Degree of Total Leverage

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Importance of Forecasting and Control

Functions

If projected operating results are not satisfactory,

management can reformulate its plans.

If funds required to meet sales forecast cannot be

obtained, management can scale back projected
levels of operations.

If required funds can be raised, it is best to plan for

their acquisition in advance.

Any deviation from projections needs to be handled

to improve future forecasts.

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