CHAPTER 16 Financial Planning and Forecasting

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CHAPTER 16Financial Planning and Forecasting

• Forecasting sales
• Projecting the assets and internally generated
  funds
• Projecting outside funds needed
• Deciding how to raise funds

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Preliminary financial forecastBalance sheets
(Assets)
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Preliminary financial forecast Balance sheets
(Liabilities and equity)
4
Preliminary financial forecast Income statements
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Key financial ratios
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Key assumptions in preliminary financial forecast
for NWC

• Operating at full capacity in 2005.
• Each type of asset grows proportionally with
  sales.
• Payables and accruals grow proportionally with
  sales.
• 2005 profit margin (2.52) and payout (30) will
  be maintained.
• Sales are expected to increase by 500 million.
  (DS 25)

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Determining additional funds needed, using the
AFN equation

• AFN (A/S0)?S (L/S0) ?S M(S1)(RR)
• (1,000/2,000)(500)
• (100/2,000)(500)
• 0.0252(2,500)(0.7)
• 180.9 million.

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Managements review of the financial forecast

• Consultation with some key managers has yielded
  the following revisions
• Firm expects customers to pay quicker next year,
  thus reducing DSO to 34 days without affecting
  sales.
• A new facility will boost the firms net fixed
  assets to 700 million.
• New inventory system to increase the firms
  inventory turnover to 10x, without affecting
  sales.
• These changes will lead to adjustments in the
  firms assets and will have no effect on the
  firms liabilities on equity section of the
  balance sheet or its income statement.

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Revised (final) financial forecastBalance
sheets (Assets)
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Key financial ratios final forecast
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What was the net investment in operating capital?

• OC2006 NOWC Net FA
• 625 - 125 625 1,125
• OC2005 900
• Net investment in OC 1,125 - 900
• 225

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How much free cash flow is expected to be
generated in 2006?

• FCF NOPAT Net inv. in OC
• EBIT (1 T) Net inv. in OC
• 125 (0.6) 225
• 75 225
• -150.

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Suppose fixed assets had only been operating at
85 of capacity in 2005

• The maximum amount of sales that can be supported
  by the 2005 level of assets is
• Capacity sales Actual sales / of capacity
• 2,000 / 0.85 2,353
• 2006 forecast sales exceed the capacity sales, so
  new fixed assets are required to support 2006
  sales.

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How can excess capacity affect the forecasted
ratios?

• Sales wouldnt change but assets would be lower,
  so turnovers would improve.
• Less new debt, hence lower interest and higher
  profits
• EPS, ROE, debt ratio, and TIE would improve.

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How would the following items affect the AFN?

• Higher dividend payout ratio?
• Increase AFN Less retained earnings.
• Higher profit margin?
• Decrease AFN Higher profits, more retained
  earnings.
• Higher capital intensity ratio?
• 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., L/S0 increases).