INTRODUCTION TO BUSINESS

FINANCE (FIN201)

Financial Planning and Forecasting

Lecture 6:
Financial Planning and
Forecasting

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THE % OF SALES FORECASTING METHOD IS
BASED ON SOME KEY ASSUMPTIONS…

 Forecast the sales based on internal and

external factors.

Financial Planning and Forecasting

 Balance sheet and income statement items
related to sales grow proportionately with
sales.
 Firm is operating at full capacity.
 Fixed assets and depreciation expense also
increase in same proportion.
 Some ratios are assumed to stay same.
 Ignore financing feed back initially.
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LETS PREPARE THE FORECASTED
STATEMENTS WITH A SIMPLE

Financial Planning and Forecasting

EXAMPLE…

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BALANCE SHEET AT YEAR-END 2010
(IN MILLIONS)

Cash 20 Accounts Payable 100

Financial Planning and Forecasting

Accounts
Receivable 240 Notes Payable (6%) 100
Inventory 240 Current Liabilities 200
Current Assets 500 LTD (10%) 100
Net Fixed Assets 500 Common Stock 500
Retained Earnings 200
Total Debt and
Total Assets 1000 Equity 1000

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INCOME STATEMENT FOR THE YEAR ENDED
2010 (IN MILLIONS)
Sales $2,000.00
Less: Var. costs (60%) 1,200.00

Financial Planning and Forecasting

Fixed costs 700.00
EBIT $ 100.00
Interest 16.00
EBT $ 84.00
Taxes (40%) 33.60
Net income $ 50.40
Dividends (30%) $15.12
Addition to RE $35.28
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THE COMPANY EXPECT THE SALES
REVENUE TO INCREASE BY 25% IN

Financial Planning and Forecasting

THE YEAR 2011…

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FORECASTED INCOME STATEMENT (2011)
2010 2011
Sales $2,000 $2,500
Less: VC 1,200 1,500

Financial Planning and Forecasting

FC 700 875
EBIT $ 100 $ 125
Interest 16 16
EBT $ 84 $ 109
Taxes (40%) 34 44
Net income $ 50 $ 65
Div. (30%) $15 $19
Addition to RE $35 $46 7
FORECASTED BALANCE SHEET (2011)

2010 2011

Financial Planning and Forecasting

Cash $ 20 $ 25
Accts. rec. 240 300
Inventories 240 300
Total CA $ 500 $ 625
Net FA 500 625
Total assets $1,000 $1,250

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FORECASTED BALANCE SHEET (2011)
2010 2011
AP/accruals $ 100 $ 125

Financial Planning and Forecasting

Notes payable 100 100
Total CL $ 200 $ 225
L-T debt 100 100
Common stk. 500 500
Ret. Earnings 200 +46* 246
Total claims $1,000 $1,071

* From forecasted income statement.

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AFN CAN BE RAISED THROUGH ANY OF THE
FINANCING OPTIONS AVAILABLE WITH THE
FIRM…

 New common stock can be issued.

Financial Planning and Forecasting

 Notes payable can be increased

 Long term debt can be taken

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 WHAT IS THE ADDITIONAL FINANCING
NEEDED (AFN)???

 Required increase in assets = $ 250

Financial Planning and Forecasting

 Spontaneous increase in liabilities =$ 25
 Increase in retained earnings =$ 46
 Total Additional Funds Needed = $ 179

The balance sheet must balance, so we must

raise $179 million externally.
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LET’S ASSUME THE AFN IS FINANCED SOLELY
THROUGH DEBT…

 Additional N/P

Financial Planning and Forecasting

 0.5 ($179) = $89.50
 Additional L-T debt
 0.5 ($179) = $89.50

But this financing will add to interest

expense, which will lower the net income
and retained earnings. We ignore
financing feedbacks in the initial
forecasts.
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FORECASTED INCOME STATEMENT (2011)
2ND PASS STATEMENT
2011 2011
First Pass Second Pass

Financial Planning and Forecasting

Sales $2,500 $2,500
Less: VC 1,500 1,500
FC 875 875
EBIT $ 125 $ 125
Interest 16 + $14.32 30.32
EBT $ 109 $ 94.68
Taxes (40%) 44 37.87
Net income $ 65 $ 56.81
Div. (30%) $19 $17.04
Addition to RE $46 Decrease by $6.23 $39.77
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FORECASTED BALANCE SHEET (2011)
2ND PASS STATEMENT

2010 2011

Financial Planning and Forecasting

First Pass Second Pass
Cash $ 25 - $ 25
Accts. rec. 300 - 300
Inventories 300 - 300
Total CA $ 625 $ 625
Net FA 625 - 625
Total assets $1,250 $1,250
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 FORECASTED BALANCE SHEET (2011)
2ND PASS STATEMENT
2011 2011
First Pass Second Pass

Financial Planning and Forecasting

AP/accruals $ 125 $ 125
Notes payable 100 +89.5 189.5
Total CL $ 225 $ 314.5
L-T debt 100 +89.5 189.5
Common stk. 500 500
Ret. Earnings 246 -6.23* 239.77
Total claims $1,071 $1,243.77
* From 2nd Pass income statement. 15
TO BALANCE THE TWO SIDES OF BALANCE
SHEET, $6.23 NEED TO BE RAISED… THIS IS
THE AFN FOR THE 2ND PASS FORECASTED

Financial Planning and Forecasting

STATEMENTS…

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HOW WOULD THE FOLLOWING ITEMS AFFECT
THE AFN???

 Higher dividend payout ratio?

Financial Planning and Forecasting

 Increase AFN: Less retained earnings.
 Higher profit margin?
 Decrease AFN: Higher profits, more retained
earnings.
 Lower asset efficiency?
 Increase AFN: Need more assets for given sales.
 Pay suppliers in 60 days, rather than 30 days?
 Decrease AFN: Trade creditors supply more capital (i.e., AP
increases).
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