CHAPTER 17
Financial Planning and
Forecasting
Forecasting sales
Projecting the assets and
internally generated funds
Projecting outside funds needed
Deciding how to raise funds
17-1
Preliminary financial
forecast:
Balance sheets2005
(Assets)
2006E
Cash and equivalents
20
25
Accounts receivable
240
300
Inventories
240
300
$ 500
$ 625
500
625
$1,000
$1,250
Total current assets
Net fixed assets
Total assets
17-2
Preliminary financial forecast:
Balance sheets (Liabilities and
equity)
Accts payable & accrued
liab.
Notes payable
Total current liabilities
Long-term debt
Common stock
Retained earnings
Total liabilities & equity
2005
2006E
$ 100 $ 125
100
190
200
315
100
190
500
500
200
245
$1,000 $1,250
17-3
Preliminary financial
forecast: Income
statements
2005
Sales
Less: Variable costs
2006E
$2,000.0 $2,500.0
1,200.0
1,500.0
700.0
875.0
$100.0
$125.0
16.0
16.0
$84.0
$109.0
33.6
43.6
$50.4
$65.40
Dividends (30% of NI)
$15.12
$19.62
Addition to retained earnings
$35.28
$45.78
Fixed costs
EBIT
Interest
EBT
Taxes (40%)
Net income
17-4
Key financial ratios
2005
2006E
Ind Avg
Comme
nt
10.00%
10.00%
20.00%
Poor
Profit margin
2.52%
2.62%
4.00%
Poor
Return on equity
7.20%
8.77%
15.60%
Poor
Days sales
outstanding
43.8
days
43.8
days
32.0
days
Poor
Inventory turnover
8.33x
8.33x
11.00x
Poor
Fixed assets
turnover
4.00x
4.00x
5.00x
Poor
Total assets
turnover
2.00x
2.00x
2.50x
Poor
Debt/assets
30.00%
40.34%
36.00%
Basic earning power
OK
17-5
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. (%S = 25%)
17-6
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.
17-7
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.
17-8
Revised (final) financial
forecast:
Balance sheets (Assets)
2005
Cash and equivalents
20
2006E
$
67
Accounts receivable
240
233
Inventories
240
250
$ 500
$ 550
500
700
$1,000
$1,250
Total current assets
Net fixed assets
Total assets
17-9
Key financial ratios final
forecast
2005
2006F
Ind Avg
Comme
nt
10.00%
10.00%
20.00%
Poor
Profit margin
2.52%
2.62%
4.00%
Poor
Return on equity
7.20%
8.77%
15.60%
Poor
Days sales
outstanding
43.8
days
34.0
days
32.0
days
OK
Inventory turnover
8.33x
10.00x
11.00x
OK
Fixed assets
turnover
4.00x
3.57x
5.00x
Poor
Total assets
turnover
2.00x
2.00x
2.50x
Poor
Debt/assets
30.00%
40.34%
36.00%
Basic earning power
OK
17-10
What was the net investment
in operating capital?
OC2006 = NOWC + Net FA
= $625 - $125 + $625
OC2005 = $900
Net investment in OC
$900
= $225
= $1,125
= $1,125 -
17-11
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.
17-12
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.
17-13
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.
17-14
How would the following
items affect the AFN?
Higher dividend payout ratio?
Higher profit margin?
Decrease AFN: Higher profits, more retained
earnings.
Higher capital intensity ratio?
Increase AFN: Less retained earnings.
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).
17-15