1. FINANCIAL PLANNING AND
FORECASTING
By Prof Sameer Lakhani

2. OUTLINE
• The Planning System
• What and Why of Financial Planning
• Sales Forecast
• Proforma Profit and Loss Account
• Proforma Balance Sheet
• Financial modeling using spreadsheets
• Growth and External Financing Requirement
• Key Growth Rates

3. THE PLANNING SYSTEM
Goals
Strategy
Research and
development Marketing Production Personnel Financial
policy policy policy policy policy
Research and Capital budget
development Marketing Production Personnel
and financing
budget budget budget budget
plan
FINANCIAL PLAN
Profit and loss account
Balance sheet
Cash flow statement

4. COMPONENTS OF A FINANCIAL PLAN
• Economic Assumptions
• Sales Forecast
• Proforma Statements
• Asset Requirements
• Financing Plan
• Cash Budget

5. SALES FORECAST
• The sales forecast is typically the starting point of the
financial forecasting exercise.
• Sales forecasting techniques fall into three broad categories:
• Qualitative techniques : Based on Judgement
• Time series projection methods : Past behavior of time
series
• Causal models – Develop forecast based on Cause &
Effect relationship.

6. PROFORMA PROFIT & LOSS ACCOUNT
PERCENT OF SALES METHOD
Historical Data Pro forma profit and
20X1 20X2 Average loss account of 20X3
percent assuming sales of 1400
of Sales
Net sales 1200 1280 100 . 0 1400 . 0
Cost of goods sold 775 837 65 . 0 910 . 0
Gross profit 425 443 35 . 0 490 . 0
Selling expenses 25 27 2.1 29 . 4
General and administration
expenses 53 54 4.3 60 . 2
Depreciation 75 80 6.3 88 . 2
Operating profit 272 282 22 . 3 312 . 2
Non-operating surplus/ deficit 30 32 2.5 35 . 0
Profit before interest and tax 302 314 24 . 8 347 . 2
Interest on bank borrowings 60 65 5.0 70 . 0
Interest on debentures 58 60 4.8 67 . 2
Profit before tax 184 189 15 . 0 210 . 0
Tax 82 90 6.9 96 . 6
Profit after tax 102 99 8.1 113 . 4
Dividends 60 63

7. PROFORMA PROFIT & LOSS ACCOUNT
COMBINATION METHOD
Historical Data Average Proforma
Percent Profit and loss
20X1 20X2 of sales account of for
20X3
Net sales 1200 1280 100.0 1400.0
Cost of goods sold 775 837 65.0 910.0
Gross profit 425 443 35.0 490.0
Selling expenses 25 27 2.1 29.4
General and administration 53 54 Budgeted 56.0
Depreciation 75 80 Budgeted 85.0
Operating profit 272 282 @ 319.6
Non-operating surplus/ deficit 30 32 2.5 35.0
Profit before interest and tax 302 314 @ 354.6
Interest on bank borrowings 60 65 5.0 70.0
Interest on debentures 58 60 Budgeted 65.0
Profit before tax 184 189 @ 219.6
Tax 82 90 Budgeted 90.0
Profit after tax 102 99 @ 129.6
Dividends 60 63 Budgeted 70.0
Retained earnings 42 36 @ 59.6

8. PROFORMA BALANCE SHEET
Historical Data Projection for
March March Average of Percent March 31, 20X3
31, 20X1 31, 20X1 of Sales or some other based on a fore-
basis -cast sales of 1400
Net sales 1200 1280 100.0 1400.0
Assets
Fixed assets (net) 800 850 66.5 931.0
Investments 30 30 No change 30
Current assets, loans and advances
• Cash and bank 25 28 2.1 29.4
• Receivables 200 212 16.6 232.4
• Inventories 375 380 30.4 425.6
• Pre-paid expenses 50 55 4.2 58.8
Miscellaneous expenditures and losses 20 20 No change 20
Total 1500 1575 1727.2
Liabilities
Share capital
• Equity 250 250 No change 250.0
• Preference 50 50 No change 50.0
Reserves and surplus 250 286 Proforma income 345.6
statement
Secured loans
• Debentures 400 400 No change 400
• Bank borrowings 300 305 24.4 341.6
Unsecured loans
• Bank borrowings 100 125 9.1 127.4
Current liabilities and provisions
• Trade creditors 100 112 8.5 119.0
• Provisions 50 47 3.9 54.6
External funds requirement Balancing figure 39.0
Total 1500 1575 1727.2

9. Problem
Prepare the pro forma P&L & Balance sheet for the year 3 based on the following
assumptions.
Projected sales for the year 3 is 850
Forecast value for the following P&L accounts items may be derived using the percent of
sales method ( for this purpose assume that the average of the % for year 1 & 2 is
applicable)
COGS , Selling Expenses, General & Admin exp , Non Operating surplus / deficit , Interest
The forecast values for the other items of the P&L account are as follows
Depreciation 45
Tax @ 50 %
Dividends 21

10. Problem
Forecast values for Balance sheet:
Fixed assets : Budgeted at 300
Investments : No change over 2 years
Current assets : Percent of sales method wherein the percentages are based on the average
over 2 years
Mis expenditure & losses : Expected to be reduced to 5
Equity & preference capital : No change over year 2
Reserves & surplus : Proforma P & L
Bank borrowings & Current Liabilities & provision: Percent of sales method wherein the
percentages are based on the average over 2 years
Public deposit : No Change
External fund required : Balancing figure

11. GROWTH AND EXTERNAL FINANCING
REQUIREMENT
EFR = A/S (△S) – L/S (△S) – mS1 (1 – d) – (△IM + SR)
EFR = external funds requirement
A/S = current assets and fixed assets as a proportion of sales
△S = expected increase in sales
L/S = current liabilities and provisions as a proportion of sales
m = net profit margin
S1 = projected sales for next year
d = dividend payout ratio
△IM = Change in level of Investment & miscellaneous Expenditure &

12. GROWTH AND EXTERNAL FINANCING
REQUIREMENT
Manipulating Eq. a bit, we get
EFR A L m (1 + g) (1 – d)
= – –
△S S S g
Illustration
A/S = 0.90, △S = Rs. 6 million, L/S = 0.40,
M = 0.05, S1 = Rs. 46 million, and d = 0.6
EFR = (0.90) (6) – (0.4) (6) – (0.05) (46) (0.4)
= Rs. 2.08 million
EFR 0.05 (1 + g) (1 – 0.60)
= 0.50 –
△S g
0.20 (1 + g)
= 0.50 –
g
g (%) 5 10 15 20 25
EFR/△S 0.08 0.28 0.35 0.38 0.42

13. FORECASTING WHEN THE BALANCE
SHEET RATIOS CHANGE
The assumption of constant ratios and identical growth
rates may be appropriate sometimes, but not always. In
particular its applicability is suspect in the following
situations:
• Economies of scale
• Lumpy assets
• Forecasting errors and excess assets

14. INTERNAL GROWTH RATE
It is the maximum rate at which a firm can grow (in terms of sales or
assets) without external financing of any kind.
Assumptions:
1.Increase in asset of the firm in proportion of the sales.
2.PAT margin is in direct proportion to sales.
3.Firm has a target dividend payout ratio which is wants to maintain.
4.Firm wants to grow by retention it does not raise external funds
(neither equity or debt) to finance assets.
IGR = ROA * b
1 – (ROA * b)

15. SUSTAINABLE GROWTH RATE
It is the maximum rate at which the firm can grow by using both internal
sources (Retained Earnings) as well as additional external debt but without
increasing its financial leverage ( debt equity ratio).
Additional Assumptions:
1.The firm has a target capital structure (D/E ratio) which it wants to maintain.
2.The firm does not intend to sell new equity shares as it is costly source of
finance.
SGR = ROE * b
1 – (ROE * b)
Given the assumptions it enables the corporate to maintain the existing
ROE besides target D/E ratio and the target D/P ratio
SGR = P*A* A/E * b
1- (P*A* A/E * b)

16. SUSTAINABLE GROWTH RATE
SGR of the firm can increased by any one or more of the following factors:
1.Increase in Net profit Margin
2.Increase in Asset turnover ratio
3.Increase in financial leverage
4.Increase in retention ratio (or Decrease in the dividend payout ratio).
Concluding Remarks: When a company grows @ higher than its
SGR,it has better operating margin (Higher NPM or ATR) or it is prepared to
revise its financing policy (by Increasing its RR or its D/E financial leverage
ratio)
In case firm anticipates it is not possible to improve operating
performance nor it is willing to assume more risk it is prefer to grow at SGR or
a rate lower to conserve financial resources to avoid problem of liquidity &
solvency in future.

17. Thank You