Chapter 4

Financial Forecasting

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Chapter 4 - Outline LT 4-1

What is Financial Forecasting?2 Methods of Financial Forecasting3 Financial Statements for ForecastingSteps in a Pro Forma Income Statement

(I/S)Determining Production RequirementsPercent-of-Sales Method

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What is Financial Forecasting? LT 4-2

Financial forecasting is looking ahead to develop a financial plan for the future

Very important for the strategic growth of a firm

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2 Methods of Financial Forecasting: LT 4-3

– Using Pro Forma, or Projected, Financial Statements (more exact, time consuming)

– Percent-of-Sales Method (less precise, easier to calculate)

Often times these statements are required

by lenders

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4-24.Cambridge Prep Shops Cambridge Prep Shops, a national clothing chain, had sales of $200 million last year. The business

has a steady net profit margin of 12 percent and a dividend payout ratio of 40 percent. Balance Sheet End of Year ($ millions)

Cambridge’s marketing staff tells the president that in the coming year there will be a large increase in the demand for tweed sport coats and various shoes. A sales increase of 15 percent is forecast for the Prep Shop. All balance sheet items are expected to maintain the same percent-of-sales relationships as last year, except for common stock and retained earnings. No change is scheduled in the number of common stock shares outstanding, and retained earnings will change as dictated by the profits and dividend policy of the firm. (Remember the net profit margin is 12 percent.)

a. Will external financing be required for the company during the coming year? b. What would be the need for external financing if the net profit margin went up to 14 percent

and the dividend payout ratio was increased to 70 percent? Explain.

Assets Liabilities and Stockholders EquityCash 10$ Accounts Payable 15$ Accounts Receivable 15$ Accrued Expenses 5$ Inventory 50$ Other Payables 40$ Plant and Equipment 75$ Common Stock 30$

Total Liabilities and Stockholders Equity 60$ 150$ 150$

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4-24.Cambridge Prep Shops (cont.) A negative figure for required new funds

indicates that an excess of funds ($3.06 mil.) is available for new investment. No external funds are needed.

Note:

The Problem states “All balance sheet items are expected to maintain the same percent-of-sales relationships as last year, except for common stock and retained earnings.” This means that Assets (A) include Plant and Equipment. (emphasis added)

$3,060,000RNF

000,560,16$000,000,9$000,500,22$

6. 000,000,230$

12.000,000,30$30.000,000,30$75.

4.1 000,000,230$

12.000,000,30$200

60000,000,30$

200

150RNF

0$30,000,0000$200,000,015%S

D1PSSS

LS

SFunds New Required 2

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3 Financial Statements forForecasting LT 4-4

Pro Forma Income Statement (I/S)Cash BudgetPro Forma Balance Sheet (B/S)

The first step is to develop a sales projection

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Steps in a Pro FormaIncome Statement (I/S)

Establish a sales projectionDetermine a production schedule (or

production requirements)Compute other expensesDetermine profit by completing an actual

pro forma income statement (I/S)

LT 4-5

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PPT 4-1

FIGURE 4-1Developmentof pro formastatements

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PPT 4-2

TABLE 4-1Projected wheel andcaster sales (first sixmonths, 2005)

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Determining ProductionRequirements LT 4-6

Projected Units Sales PLUS

Desired Ending Inventory (EI) MINUS

Beginning Inventory (BI) EQUALS

Production Requirements

(or Units to be Produced)

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PPT 4-3

TABLE 4-2Stock of beginninginventory

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PPT 4-3

TABLE 4-3Productionrequirements for sixmonths

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PPT 4-3

TABLE 4-4Unit costs

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PPT 4-3

TABLE 4-5Total production costs

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PPT 4-3TABLE 4-6Allocation of manufacturing costand determination of gross profits

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PPT 4-3

TABLE 4-7Value of endinginventory

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PPT 4-4

TABLE 4-8

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PPT 4-5

TABLE 4-9Monthly sales pattern

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PPT 4-5

TABLE 4-10Monthly cast receipts

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PPT 4-5

TABLE 4-11Component costs ofmanufactured goods

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PPT 4-6

TABLE 4-12Average monthlymanufacturing costs

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PPT 4-7

TABLE 4-14Monthly cash flow

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PPT 4-7

TABLE 4-15Cash budget with borrowing andrepayment provisions

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PPT 4-8TABLE 4-16

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PPT 4-9

FIGURE 4-2Development of a pro formabalance sheet

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PPT 4-10TABLE 4-17

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PPT 4-6

TABLE 4-13Summary of all monthlycash payments

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PPT 4-11TABLE 4-18

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Percent-of-Sales Method LT 4-7

A short-cut, less exact, easier method of determining financing needs (The “quick and dirty” approach)

Assumes that B/S accounts will maintain a constant percentage relationship to sales

Assets / Current Sales = % of Sales