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Financial Planning and Forecasting


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Financial Planning and Forecasting

  1. 1. Financial Planning and Forecasting: Cash Flows and Financial Statement Analysis Corporate Finance Dr. A. DeMaskey
  2. 2. Learning Objectives <ul><li>Questions to be answered: </li></ul><ul><ul><li>What are the basic financial statements and how are they used? </li></ul></ul><ul><ul><li>What kinds of financial information do users need? </li></ul></ul><ul><ul><li>What is the difference between accounting income and cash flow? </li></ul></ul><ul><ul><li>How are different sources of income taxed based on the U.S. tax code? </li></ul></ul><ul><ul><li>How are financial statements used by managers to improve performance? </li></ul></ul>
  3. 3. Financial Statements <ul><li>Balance Sheet </li></ul><ul><li>Income Statement </li></ul><ul><li>Statement of Retained Earnings </li></ul><ul><li>Statement of Cash Flows </li></ul>
  4. 4. Cash Flows <ul><li>Net Cash Flows </li></ul><ul><li>Free Cash Flows </li></ul><ul><li>Operating Cash Flows </li></ul>
  5. 5. MVA and EVA <ul><li>Market Value Added (MVA) </li></ul><ul><li>Economic Value Added (EVA) </li></ul>
  6. 6. Individual Income Taxes <ul><li>Taxable Income </li></ul><ul><li>Marginal versus Average Tax Rate </li></ul><ul><li>Taxes on Dividend and Interest Income </li></ul><ul><li>Capital Gains versus Ordinary Income </li></ul>
  7. 7. Corporate Income Taxes <ul><li>Interest and Dividend Income Received by a Corporation </li></ul><ul><li>Interest and Dividend Income Paid by a Corporation </li></ul><ul><li>Ordinary Gains and Losses </li></ul><ul><li>Capital Gains and Losses </li></ul><ul><li>Corporate Loss Carry-Back and Carry-Forward </li></ul>
  8. 8. Financial Statement Analysis <ul><li>Ratio Analysis </li></ul><ul><ul><li>Liquidity ratios </li></ul></ul><ul><ul><li>Asset management ratios </li></ul></ul><ul><ul><li>Debt management ratios </li></ul></ul><ul><ul><li>Profitability ratios </li></ul></ul><ul><ul><li>Market value ratios </li></ul></ul><ul><li>Du Pont System </li></ul><ul><ul><li>ROA </li></ul></ul><ul><ul><li>ROE </li></ul></ul>Expense control (PM) Asset utilization (TATO) Debt utilization (EM)
  9. 9. Limitations of Ratio Analysis <ul><li>Large firms </li></ul><ul><li>Industry averages </li></ul><ul><li>Inflation </li></ul><ul><li>Window dressing </li></ul><ul><li>Accounting practices </li></ul><ul><li>Operating policies </li></ul><ul><li>Interpretation of ratios </li></ul>
  10. 10. Qualitative Factors <ul><li>Key customer </li></ul><ul><li>Key product </li></ul><ul><li>Single supplier </li></ul><ul><li>Foreign sales </li></ul><ul><li>Competition </li></ul><ul><li>Future prospects </li></ul><ul><li>Legal and regulatory environment </li></ul>
  11. 11. Financial Planning and Forecasting Financial Statements <ul><li>Plans: strategic, operating, and financial </li></ul><ul><li>Pro forma financial statements </li></ul><ul><ul><li>Sales forecasts </li></ul></ul><ul><ul><li>Percent of sales method </li></ul></ul><ul><li>Additional Funds Needed (AFN) formula </li></ul>
  12. 12. Pro Forma Financial Statements <ul><li>Three important uses: </li></ul><ul><ul><li>Forecast the amount of external financing that will be required </li></ul></ul><ul><ul><li>Evaluate the impact that changes in the operating plan have on the value of the firm </li></ul></ul><ul><ul><li>Set appropriate targets for compensation plans </li></ul></ul>
  13. 13. Steps in Financial Forecasting <ul><li>Forecast sales </li></ul><ul><li>Project the assets needed to support sales </li></ul><ul><li>Project internally generated funds </li></ul><ul><li>Project outside funds needed </li></ul><ul><li>Decide how to raise funds </li></ul><ul><li>See effects of plan on ratios and stock price </li></ul>
  14. 14. Sales Forecast <ul><li>Division sales forecasts based on historical growth </li></ul><ul><li>Level of economic activity and overall demand for the product </li></ul><ul><li>Market share for each product line in each market </li></ul><ul><li>If foreign sales, include currency fluctuations, trade agreements, governmental policies, etc. </li></ul><ul><li>Inflation </li></ul><ul><li>Advertising campaigns, promotional discounts, credit terms, etc. </li></ul>
  15. 15. Projecting Pro Forma Statements with the Percent of Sales Method <ul><li>Project sales based on forecasted growth rate in sales </li></ul><ul><li>Forecast some items as a percent of the forecasted sales </li></ul><ul><ul><li>Costs </li></ul></ul><ul><ul><li>Cash </li></ul></ul><ul><ul><li>Accounts receivable </li></ul></ul><ul><li>Items as percent of sales </li></ul><ul><ul><li>Inventories </li></ul></ul><ul><ul><li>Net fixed assets </li></ul></ul><ul><ul><li>Accounts payable and accruals </li></ul></ul><ul><li>Choose other items </li></ul><ul><ul><li>Debt (which determines interest) </li></ul></ul><ul><ul><li>Dividends (which determines retained earnings) </li></ul></ul><ul><ul><li>Common stock </li></ul></ul>
  16. 16. What are the additional funds needed (AFN)? AFN = Required asset increase - Spontaneous liability increase - Increase in retained earnings
  17. 17. Summary: How different factors affect the AFN forecast <ul><li>Excess capacity: </li></ul><ul><ul><li>Existence lowers AFN. </li></ul></ul><ul><li>Base stocks of assets: </li></ul><ul><ul><li>Leads to less-than-proportional asset increases. </li></ul></ul><ul><li>Economies of scale: </li></ul><ul><ul><li>Also leads to less-than-proportional asset increases. </li></ul></ul><ul><li>Lumpy assets: </li></ul><ul><ul><li>Leads to large periodic AFN requirements </li></ul></ul>
  18. 18. Other Techniques for Forecasting Financial Statements <ul><li>Regression Analysis for Asset Forecasting </li></ul><ul><ul><li>Relationship between type of asset and sales is linear. </li></ul></ul><ul><ul><li>Get historical data on a good company, then fit a regression line to see how much a given sales increase will require in way of asset increase. </li></ul></ul><ul><li>Excess Capacity Adjustments </li></ul><ul><ul><li>Full capacity sales </li></ul></ul><ul><ul><li>Target fixed assets-to-sales ratio </li></ul></ul><ul><ul><li>Required level of fixed assets </li></ul></ul>