Engineering Management 452 Advanced Financial Management

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Engineering Management 452 Advanced Financial
Management
Chapter 4 Financial Planning and Forecasting
Financial Statements
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Financial Planning and Forecasting Financial
Statements

• Plans strategic, operating, and financial
• Pro forma financial statements
• Sales forecasts
• Percent of sales method
• Additional Funds Needed (AFN) formula

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Pro Forma Financial Statements

• Three important uses
• Forecast the amount of external financing that
  will be required
• Evaluate the impact that changes in the operating
  plan have on the value of the firm
• Set appropriate targets for compensation plans

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Steps in Financial Forecasting

• 1) Forecast sales
• 2) Project the assets needed to support sales
• 3) Project internally generated funds
• 4) Project outside funds needed
• 5) Decide how to raise funds
• 6) See effects of plan on ratios and stock price

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Projecting Pro Forma Statements with the Percent
of Sales Method

• Project sales based on forecasted growth rate in
  sales
• Forecast some items as a percent of the
  forecasted sales
• Costs
• Cash
• Accounts receivable
• Inventories
• Net fixed assets
• Accounts payable and accruals

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Projecting Pro Forma Statements with the Percent
of Sales Method

• Select other items as a percent of the forecasted
  sales
• Debt (which determines interest)
• Dividends (which determines retained earnings)
• Common stock

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Financial Statement ForecastingPercent of Sales
Method

• 1) Analyze the Historical Ratios
• 2) Forecast the Income Statement
• 3) Forecast the Balance Sheet
• 4) Determine How the Additional Funds Needed Will
  be Raised
• 5) Determine Financing Feedback

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Additional Funds Needed (AFN)

• If the Pro Forma ratios are expected to remain
  constant AFN can be used to forecast financial
  requirements
• Additional Funds Needed Required Increase in
  Assets - Spontaneous Increase in Liabilities
  Increase in Retained Earnings

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Factors That Affect External Financial
Requirements

• Sales Growth
• Capital Intensity
• Spontaneous Liabilities-to Sales Ratio
• Profit Margin
• Retention Ratio

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Relationship Between Sales Growth and Financial
Requirements

• Financial Feasibility
• Dividend Policy
• Capital Intensity

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Other Techniques For Forecasting Financial
Statements

• Linear Regression
• Excess Capacity Adjustments

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Factors That Affect External Financial
Requirements

• Sales Growth
• Capital Intensity
• Spontaneous Liabilities-to Sales Ratio
• Profit Margin
• Retention Ratio