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Financial planning & forecasting


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entails financial forecasting and planning

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Financial planning & forecasting

  1. 1. PRESENTERS 1
  2. 2. TABLE OF CONTENTS FINANCIAL PLANNING & FORECASTING 1. Financial planning Introduction 3 2. Steps in financial planning 4-6 3. Benefits of financial planning --7 4. Financial forecasting introduction -8 5. Objectives of forecasting - 9 6. Steps in financial forecasting -10 7. Methods of forecasting 11-22 8. Uses of forecasts – 23- 26 9. Conclusion – 25-26 10. References -27 2
  3. 3. Financial planning Financial planning is a continuous process of directing and allocating financial resources to meet strategic goals and objectives. This can be also be viewed as a single process that encompasses both operations and financing. The operating people focuses on sales and production while financial planners are interested on how to finance the operations. The output from financial planning takes the form of budgets. The most widely used form of budgets is Pro Forma or Budgeted Financial Statements. The foundation for Budgeted Financial Statements is Detail Budgets. Detail Budgets include sales forecasts, production forecasts, and other estimates in support of the Financial Plan. Collectively, all of these budgets are referred to as the Master Budget. 3
  4. 4. Steps in Financial planning. There are six steps to the process of doing a financial plan. The beginning step is determining your objectives for the plan. You do this by:1. Quantifying specific amount goals within definite time frames and clarify any financial goals within those parameters; 2. You will rank your objectives according to your priorities; 3. Together, we will examine these objectives in respect to a client’s available resources and other limitations. Our key role at this stage is to assist our clients in the establishment of their financial objectives . The second step of the financial planning process is gathering data. With our help, our clients will complete a data survey form or questionnaire. • - Qualitative provides general information concerning a family’s goals and objectives, lifestyle, health, and investment-risk tolerance level. • - Quantitative provide basic but specific identifying information concerning details of family’s financial status. Examples include info about investments, cash flow, insurance coverage's, and present liabilities or other obligations. 4
  5. 5. Steps in financial planning • Our third step is processing and analyzing the information gathered. We will undertake a review of the following: Our client’s financial position and current cash flow statement; a review of existing insurance policies and other legal papers such as wills, trust agreements, and buy-sell agreements; analyze the information to determine the strengths and weaknesses in the client’s finances; evaluate our client’s objectives in view of available resources, and economic conditions as they relate to future resources and cash flow for the client. It is our planning role to examine the viable options for achieving the determined objectives. We begin here to look at the products and strategies that may be selected for implementing the final plan. • The fourth step is the actual recommendation of a comprehensive financial plan for our client. This is a time for our clients to speak up and ask questions about each strategy or product as it relates to solutions for achieving their goals and dreams.
  6. 6. Steps in financial planning A fifth step in the financial planning process is implementing the plan. Our client may need help in obtaining products and in pursuing strategies identified in step four. Use of products and services through our office is separate from the design fees and those costs and commissions will be disclosed appropriately. Also, if need be, we will work closely with other professionals to carry out the financial plan designed for the client. Our final step is monitoring the plan. Periodically we should review your plan to evaluate the significance of any changes in federal tax, economic conditions, and available investment techniques. If you choose to use our investment advisory services you will be encouraged to have quarterly meetings related to your assets under management. The financial analysis and recommendations are not intended to replace the need for independent tax, accounting, or legal review. Individuals are advised to seek the counsel of such licensed professionals. 6
  7. 7. Benefits of financial planning The benefits of financial planning for the organization are  Identifies advance actions to be taken in various areas.  Seeks to develop number of options in various areas that can be exercised under different conditions.  Facilitates a systematic exploration of interaction between investment and financing decisions.  Clarifies the links between present and future decisions.  Forecasts what is likely to happen in future and hence helps in avoiding surprises.  Ensures that the strategic plan of the firm is financially viable.  Provides benchmarks against which future performance may be measured. 7
  8. 8. Financial forecasting A financial forecast is an estimate of future financial outcomes for a company or country (for futures and currency markets). Using historical internal accounting and sales data, in addition to external market and economic indicators. Financial Forecasting describes the process by which firms think about and prepare for the future. The forecasting process provides the means for a firm to express its goals and priorities and to ensure that they are internally consistent. It also assists the firm in identifying the asset requirements and needs for external financing. Unlike a financial plan or a budget a financial forecast doesn't have to be used as a planning document. Outside analysts can use a financial forecast to estimate a company's success in the coming year 8
  9. 9. Objectives of forecasting To reduce cost of responding to emergencies by anticipating the future occurrences. Prepare to take advantage of future opportunities. Prepare contingency and emergency plans. Prepare to deal with possible outcomes 9
  10. 10. STEPS OF FORECASTING STEPS OF FORECASTING  Establish a base year.  Assess revenue and expenditure growth trends.  Clearly specify underlying assumptions.  Select a forecasting method.  Assess the reliability and validity of the data used to determine assumptions.  Monitor actual revenue and expenditure levels against the forecast and explain variances.  Update the forecast based on changes. 10
  11. 11. FINANCIAL FORECASTING METHODS Quantitative methods 1. Percentage of sales: • Step 1: Estimate year-by-year Sales Revenue and Expenses • Step 2:Estimate Levels of Investment Needs (in Assets) required meeting es timated sales (using Financial Ratios). • Step 3: Estimate the Financing Needs (Liabilities) Explanation: While employing percentage of sales method, we would estimate the cash flo ws  based on    the sales revenue   The first step is to forecast the changes in the sales revenue in   the successive years.        Expenses incurring in successive period would also be estimated. These  expenses include cost of goods  sold expense, administrative, expense, marketing expense, depreciation exp ense, and      other expenses. • However, these revenues and expenses would be estimated on cash, rather t han accrual  basis 11
  12. 12. Methods of forecasting After estimating the  revenues and expenses , we need  to forecast  the  anticipated changes  assets and liabilities as a result of changes  in sales. Identify  how much capital the firm has to invest in assets  and how much a  firm has to borrow  as   a result of any shortfall. Determine  assets and liabilities that do not change  spontaneously with  sales. Forecast the retained earnings, this is the amount of profit  which would be  reinvested in the business.         Projected  retained earning=profit margin  x estimated sales x 1- payout  ratio 12
  13. 13. Methods of forecasting Where  profit margin= net income/ sales              plow back ratio= 1- pay out ratio              pay out ratio=  dividend/net income . Determine external financing- this is the changes in assets and the part  of the  net income that is  to be  reinvested in the business.   External financing= estimated  total assets – estimated total liabilities –  estimated  total equity. This is the borrowing that we need  to raise  in form of loan or the equity, as a  result of growth  in sales. After calculating the estimated revenues, expenses, assets and liabilities we are  in a position to prepare pro forma cash flow  statement. The owners would  like  to see  company grow at a steady rate rather than high growth and  slump scenario. 13
  14. 14. Percent of sales  methods Pro forma cash flow  statement is just  like an ordinary cash flow  statement  ; the only difference is that the figures  in pro forma cash flow  statement   are estimated figures rather than actual  ones. The estimated statement is  later compared to the real after effect cash flow statement to assess the  quality of the estimate. LIMITATIONS OF PERCENT OF SALES METHOD 1. Its is only  a rough  approximation  and is not very detailed 2. The other problem is that if there is  a change in fixed assets during he  forecasted period  the percentage  of sales method would not yield a very  accurate answer.  14
  15. 15. Methods of forecasting 3. The other problem is that  the lumpy  assets are not taken into account while  using  the percentage of sales method. 2) Cash budget This is prepared for the purpose of cash planning and control. It presents the  expected cash inflow and outflow for a designated  time period . The cash   budget helps management to keep cash balances in reasonable relationship  to its needs. STEPS i) Estimate cash sales and collection timing of credit sales. ii) Forecast cash payments. iii)Determine monthly net cash flow( receipts minus payments). iv)Construct cash budget. A typical cash budget is divided into monthly intervals and covers one year. 15
  16. 16. Methods of forecasting Cash budget aids in avoiding unnecessary idle cash  and possible cash  shortages 3) BUDGETED BALANCE SHEET Some balance sheet items vary directly with sales while others do not. To determine which accounts vary directly with sales, a trend analysis may be conducted on historic balance sheets of the firm. Typically, working capital accounts like inventory, accounts receivables and accounts payables vary directly with sales Fixed assets do not always vary directly with sales. It will do so, only if the firm is operating at 100 percent capacity and fixed assets can be incrementally changed. 16
  17. 17. Methods of forecasting The ratio of total assets to net sales is called the capital intensity ratio. This  ratio tells us the amount of assets needed by the firm to generate $1 sales. The higher the ratio, the more capital the firm needs to generate sales—the  more capital intensive the firm. Firms that are highly capital intensive are more risky than those that are not  because a downturn can reduce sales sharply but fixed costs do not change  rapidly. Liabilities and Equity Only current liabilities are likely to vary directly with sales. The exception  here is notes payables (short-term borrowings) that changes as the firm pays  it down or makes an additional borrowing. Long-term liabilities and equity accounts change as a direct result of  managerial decisions like debt repayment, stock repurchase, issuing new  debt or equity. 17
  18. 18. Methods of forecasting  Retained earnings will vary as sales changes but not directly. It is affected  by the firm’s dividend payout policy. 18
  19. 19. Pro-forma balance sheet 2. The Preliminary Pro-forma Balance Sheet  First, calculate the projected values for all the accounts that vary with sales.  Second, calculate the projected value of any other balance sheet account for which an end-of-period value can be forecast or otherwise determined  Third, enter the current year’s number for all the accounts for which the next year’s figure cannot be calculated or forecast.  At this point the balance sheet will be unbalanced. A plug value is necessary to get the balance sheet to balance  First, determine the retained earnings based on the firm’s dividend policy.  Next, the plug figure will represent the external financing necessary to make the total assets equal total liabilities and equity. This calls for management to choose a financing option . 19
  20. 20. Pro forma budget Reasons to why pro forma balance sheet should be prepared i) It could disclose some unfavorable financial conditions that management might want to avoid. ii) Helps management perform a variety of ratio calculations. iii)It highlights future resources and obligations. 20
  21. 21. Cont… 3. The Income Statement  The pro forma income statement is generated by recognizing all variable costs that change directly with sales.  Two key ratios are calculated – dividend payout ratio and retention ratio.  The first measures the percentage of net income paid out as dividends to shareholders, while the second measures the percentage of net income reinvested by the firm as retained earnings. 21
  22. 22. Qualitative methods 4.Delphi method The Delphi Method is an example of a qualitative technique where a group of experts gets together and reaches a consensus on what will happen in the future. A questionnaire is sometimes used to facilitate the process. Two disadvantages of the Delphi Method are low reliability with the consensus and inability to reach a clear consensus. 5 Market research is any organized effort to gather information about target markets or customers. It is a very important component of business strategy.[1] The term is commonly interchanged with marketing research; however, expert practitioners may wish to draw a distinction, in that marketing research is concerned specifically about marketing processes, while market research is concerned specifically with markets 22
  23. 23. Quantitative methods Quantitative forecasting models are used to forecast future data as a function of past data; they are appropriate when past data are available. These methods are usually applied to short- or intermediate-range decisions. Examples of quantitative forecasting methods are last period demand,  simple and weighted N-Period moving averages, simple exponential smoothing, and multiplicative seasonal indexes. 23
  24. 24. TIME SERIES METHOD Is a a collection of quantitative observations that are evenly spaced in time and measured successively. Examples of time series include the continuous monitoring of a person’s heart rate, daily closing price of a company stock and yearly sales figures. Time series analysis is generally used when there are 50 or more data points in a series. If the time series exhibits seasonality, there should be 4 to 5 cycles of observations in order to fit a seasonal model to the data. 24
  25. 25. CONT… A time series is just collection of past values of the variable being predicted. Also known as naïve methods. Goal is to isolate patterns in past data. Trend Seasonality Cycles Randomness 25
  26. 26. CONT….. Time series methods use historical data as the basis of estimating future outcomes. Moving average  Weighted moving average Exponential smoothing  Extrapolation  Linear prediction  Trend estimation  Growth curve (statistics) 26
  27. 27. REGRESSION METHOD 27 Inlinearregression,themodelspecificationisthatthedependentvariable, isalinear combinationoftheparameters(butneednotbelinearintheindependentvariables).For example,insimplelinearregressionformodeling datapointsthereisoneindependent variable: ,andtwoparameters, and : straightline: Inmultiplelinearregression,thereareseveralindependentvariablesorfunctionsofindependent variables.
  28. 28. Characteristics of Forecasts They are usually wrong! A good forecast is more than a single number Includes a mean value and standard deviation Includes accuracy range (high and low) Aggregated forecasts are usually more accurate Accuracy erodes as we go further into the future. Forecasts should not be used to the exclusion of known information 28
  29. 29. What Makes a Good Forecast? It should be timely It should be as accurate as possible It should be reliable It should be in meaningful units It should be presented in writing The method should be easy to use and understand in most cases. 29
  30. 30. USES OF FORECASTS WHO USES FORECASTS 1. Marketing managers use sales forecasts to determine i) Optimal sales force allocation ii) Plan promotions and advertising iii) Set sales goals 2. Production planners needs forecasts inorder to i) Schedule production activities ii) Order materials iii) Establish invemntory labels iv) Plan shipments 30
  31. 31. USES OF FORECASTS 3.Forecast can help the government by;  Developing an understanding of available funding.  Evaluating financial risk.  Assessing the likelihood that services can be sustained.  Assessing the level at which capital investment can be made.  Identifying future commitments and resource demands.  Identifying the key variables that cause changes in the level of revenue and expenditures. 4. Production managers need long –range forecasts to make strategic decisions about products process and facilities. They also need short- range forecasts to assist them in making decisions about production issues. 31
  32. 32. Conclusion Forecasting is an essential element of planning budgeting. It is needed where the future financing needs are being estimated Basically forecasts of future sales and their related expenses provide the firm with the information needed to plan other activities of the business. Emphase was on budgets which is the basic tool of planning and controlling the activities of an organization. The process involves developing a sales forecasts on its magnitude , generating those budgets needed by a specific firm. Once the budgets are developed it provides the management with a means of controlling their activities and monitoring actual performance and comparing it to budget goals. 32
  33. 33. CONCLUSION Financial planning and forecasting are both extremely useful in the creation of an operating budget. While financial planning helps determine the strategies, goals, and operating procedures for a business, forecasting helps determine the likely levels of sales and costs for a given time frame. When combined, financial planning and forecasting allow business owners, shareholders, or board members, to make informed decisions in nearly any financial aspect. For instance, if it is part of the long-term financial plan to give each employee a large bonus when they have worked for ten years, forecasting can work these bonuses into the measurements of cost versus sales, and return an accurate idea of whether the company will be able to afford bonuses in a given year. By creating a system in which financial planning and forecasting are measured and analyzed on a rolling, continuous basis, a business can ensure that it is making financial decisions based on the most up-to-date information 33
  34. 34. REFERENCES 1. Financial management by Prassanna Chandra 2. Advanced Accountancy by S. M . Shukla 3. Financial forecasting tools & applications by Delta publish company 4. Management accounting by M.Y Khan and P. K. Jain. 5. Budgeting and Forecasting sales template by Jessica Ellis 6. Financial planning & forecasting prepared by Matt H Evans 34