Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.

Saturday Morning


Published on

  • Be the first to comment

  • Be the first to like this

Saturday Morning

  1. 1. MBA 610- Forecasting Welcome!! Don Pagach
  2. 2. Today’s Scedule <ul><li>Short review of financial statements </li></ul><ul><li>Discussion of budgeting </li></ul><ul><li>Analysis of budgets </li></ul><ul><li>External forecasting </li></ul><ul><li>Building a model </li></ul><ul><li>Next Time </li></ul><ul><li>Two case studies </li></ul><ul><ul><li>Shirts and Pants & MGM Mirage </li></ul></ul>
  3. 4. My background <ul><li>Research </li></ul><ul><ul><li>Forecasting research – time series properties of earnings </li></ul></ul><ul><ul><li>Analyst forecasts vs. time series forecasts </li></ul></ul><ul><li>Work </li></ul><ul><ul><li>Accounting/finance for a number of startups </li></ul></ul><ul><ul><li>Preparation of pro forma financial statements for VCs and other investors </li></ul></ul>
  4. 5. Your background <ul><li>Are you involved in forecasting at work? </li></ul><ul><ul><li>In what manner? </li></ul></ul><ul><li>What do you want to get out of this course? </li></ul><ul><ul><li>Information for work </li></ul></ul><ul><ul><li>Information for personal investing </li></ul></ul>
  5. 6. Forecasting <ul><li>Financial forecasting is a key activities for CFO’s and financial analysts. </li></ul><ul><li>representing an extension of a firm’s strategic planning efforts. </li></ul><ul><ul><ul><li>Critical to the sustainability of the organization. Generally, closely aligned with the firm’s strategic planning activity. </li></ul></ul></ul><ul><ul><ul><li>A methodology for assessing potentially critical resource gaps. </li></ul></ul></ul><ul><ul><ul><li>Given uncertainty, a range of possible outcomes and the key risks associated with each should be considered. Precision is an unlikely outcome </li></ul></ul></ul><ul><ul><ul><li>The planning process cannot be static, it must be responsive to and reflect changing internal and external realities. </li></ul></ul></ul>
  6. 7. Forecasting <ul><li>Financial Forecasting is driven by financial and non-financial information: </li></ul><ul><ul><ul><li>Market structure, growth potential, pricing, competitive position </li></ul></ul></ul><ul><ul><ul><li>Critical skills (technology, marketing, manufacturing…) </li></ul></ul></ul><ul><ul><ul><li>Scarce resources (people, distribution channels, capital…) </li></ul></ul></ul><ul><ul><ul><li>Product and market mix </li></ul></ul></ul><ul><ul><ul><li>Cost structure </li></ul></ul></ul><ul><ul><ul><li>Target rate of return and risk tolerance </li></ul></ul></ul><ul><ul><ul><li>International (foreign exchange, product fit, culture…) </li></ul></ul></ul>
  7. 8. Forecasting <ul><li>Financial Forecasting supports the non-financial strategy by identifying and quantifying </li></ul><ul><ul><ul><li>Sources and cost of capital </li></ul></ul></ul><ul><ul><ul><li>Key relationships </li></ul></ul></ul><ul><ul><ul><li>Investment levels (hard assets, working capital, training…) </li></ul></ul></ul><ul><ul><ul><li>Potential product/market profitability </li></ul></ul></ul><ul><ul><ul><li>Simulating a range of possible outcomes based upon the interaction of key planning assumptions (internal and external) </li></ul></ul></ul>
  8. 9. Forecasting <ul><li>Goal of forecasting is to provide a set of pro forma financial statements </li></ul><ul><ul><li>representing the range of potential outcomes </li></ul></ul><ul><ul><li>the investment levels and financing necessary to support the forecasted mix and level of business </li></ul></ul><ul><ul><li>a measurement benchmark for actual business performance that can be continuously reviewed and adjusted </li></ul></ul><ul><ul><li>See pro forma Financials for VC </li></ul></ul>
  9. 10. Best Practices <ul><li>Budgeting must be linked to strategic planning since strategic decisions usually have financial implications. </li></ul><ul><li>Make budgeting procedures part of strategic planning. For example, strategic assessments should include historical trends, competitive analysis, and other procedures that might otherwise take place within the budgeting process. </li></ul><ul><li>The Budgeting Process should minimize the time spent collecting and gathering data and spend more time generating information for strategic decision making. </li></ul><ul><li>Get agreement on summary budgets before you spend time preparing detail budgets. </li></ul>
  10. 11. Best Practices <ul><li>Automate the collection and consolidation of budgets within the entire organization. Users should have access to budgeting systems for easy updating. </li></ul><ul><li>Budgets need to accept changes quickly and easily. Budgeting should be a continuous process that encourages alternative thinking. </li></ul><ul><li>Budgets should give lower level managers some form of fiscal control over what is going on. </li></ul><ul><li>Leverage your financial systems by establishing a data warehouse that can be used for both financial reporting and budgeting. </li></ul>
  11. 12. Outside Forces <ul><li>Life cycle of the business </li></ul><ul><li>Financial conditions of the business </li></ul><ul><li>General economic conditions </li></ul><ul><li>Competitive situation </li></ul><ul><li>Technology trends </li></ul><ul><li>Availability of resources </li></ul>
  12. 13. Short Accounting Review <ul><li>Let’s examine Coldwater Creek’s Financial Statements </li></ul>
  13. 21. Forecasting <ul><li>Where to start? </li></ul><ul><li>Sales is the one account from which most others can be tied. Expenses are incurred to generate sales, assets are put in place to generate sales, and liabilities are assumed (indirectly) to generate sales. </li></ul>
  14. 22. Pro Forma Financial Statement Development
  15. 23. Pro Forma Income Statement – Simple Corporation
  16. 24. Pro Forma Balance Sheet – Simple Corporation
  17. 25. Pro Forma Cash Flow - Simple Corporation
  18. 26. Pro Forma Financial Ratios - Simple Corporation
  19. 27. Pro Forma Du Pont Analysis - Simple Corporation
  20. 28. Budgeting, Standard Costs and Variance Analysis <ul><li>Our initial discussion will focus on budgeting and more detailed internal forecasts </li></ul><ul><ul><li>Budgets are simply plans of actions expressed in monetary terms. </li></ul></ul><ul><ul><li>Most companies prepare a strategic plan to identify strategies for future activities and operations, a key component of the strategic plan is the budget </li></ul></ul><ul><ul><li>The strategic plan should set the overall goals and strategic objectives </li></ul></ul>
  21. 29. Budgeting, Standard Costs and Variance Analysis <ul><li>The strategic plan should provide the foundation for long range planning, which is a five or ten year plan </li></ul><ul><li>The long range plan needs to be supported by capital budget (long-term investments and sources of funds) </li></ul>
  22. 31. Budgeting, Standard Costs and Variance Analysis <ul><li>The Master Budget is short-term and has two components </li></ul><ul><ul><li>Operating Budget –Focused on the firm’s operating activities </li></ul></ul><ul><ul><li>Financial Budget - Focused on the firm’s investing and financing activities </li></ul></ul>
  23. 32. Types of Forecasts Used in Budgeting <ul><li>The sales forecast is primary to most organizations. </li></ul><ul><li>The collection period for sales on account. </li></ul><ul><li>Percent of uncollectible sales on account. </li></ul><ul><li>Cost of materials , supplies, utilities, etc. </li></ul><ul><li>Employee turnover . </li></ul><ul><li>Time required to perform activities . </li></ul><ul><li>Interest rates </li></ul><ul><li>Development time for new products or services. </li></ul>
  24. 33. Why Budget? <ul><li>Forces management to plan </li></ul><ul><li>Provides resource information that can be used to improve decision making </li></ul><ul><li>Provides a standard for performance evaluation </li></ul><ul><ul><li>achieved by comparing actual results with budgeted results - feedback component of useful information </li></ul></ul><ul><li>Improves communication and coordination </li></ul>
  25. 34. Budgeting Best Practices <ul><li>Link budget development to corporate strategy. </li></ul><ul><li>Design procedures that allocate resources strategically. </li></ul><ul><li>Tie incentives to performance measures other than meeting budget targets. </li></ul><ul><li>Link cost management efforts to budgeting. </li></ul><ul><li>Reduce budget complexity and cycle time. </li></ul><ul><li>Develop budgets that accommodate change. </li></ul>
  26. 35. Problems with Budgeting <ul><li>Main criticisms (from Beyond Budgeting or Better Budgeting) </li></ul><ul><ul><li>Too time consuming </li></ul></ul><ul><ul><li>Slow to detect problems </li></ul></ul><ul><ul><li>Not reliable for performance evaluation </li></ul></ul><ul><ul><li>Quickly out of date </li></ul></ul><ul><ul><li>Process lacks rigor </li></ul></ul><ul><ul><li>Disrupts cooperation </li></ul></ul>
  27. 36. How to Budget <ul><li>In the output/input approach physical inputs and costs are budgeted as a function of planned unit level activities. </li></ul><ul><li>The incremental approach budgets costs for a coming period as a dollar or percentage change from the amount budgeted for (or spent during) some previous period. </li></ul>
  28. 37. How to Budget <ul><li>The minimum level approach - an organization establishes a base amount for budget items and requires explanation or justification for any budgeted amount above the minimum (base). </li></ul><ul><ul><li>Zero-Based Budgets require managers to build budgets from the ground up each year rather than just add a percentage increase to last year’s numbers . All dollars must be justified. </li></ul></ul>
  29. 38. Developing a Master Budget <ul><li>The master budget consists of all the interrelated budgets of the organization. Usually one component is the operating budget. </li></ul><ul><li>The Master Budget always starts with a Sales forecast. </li></ul>
  30. 39. Developing Sales Budget <ul><li>Begin by forecasting sales volume in units </li></ul><ul><li>Convert unit volume into sales $ volume </li></ul><ul><li>Begin to consider Cash Flow differences </li></ul><ul><ul><li>Some sales are cash sales </li></ul></ul><ul><ul><li>Some are credit sales </li></ul></ul><ul><ul><ul><li>Sales may be paid in current month (2/10, n30) </li></ul></ul></ul><ul><ul><ul><li>Others paid in later months </li></ul></ul></ul>
  31. 40. Forecasting sales <ul><li>Where to start? </li></ul><ul><li>Past patterns of sales </li></ul><ul><li>Sales force estimates </li></ul><ul><li>General economic conditions </li></ul><ul><li>Competitors – what are they doing? </li></ul><ul><li>Pricing – increasing/decreasing, is the product elastic/inelastic </li></ul><ul><li>What product is selling? What is happening to the product mix? </li></ul><ul><li>Advertising plans/sales promotions </li></ul>
  32. 41. Coldwater Creek Model <ul><li>How are Sales forecast in this model? </li></ul>
  33. 42. Example of a Sales Budget- Exercise 7-30 <ul><li>Current Accounts Receivable = $120,000 </li></ul><ul><li>Forecasted Sales </li></ul><ul><ul><li>June = $400,000 </li></ul></ul><ul><ul><li>July = $440,000 </li></ul></ul><ul><ul><li>August =$500,000 </li></ul></ul><ul><ul><li>September =$530,000 </li></ul></ul><ul><ul><li>Sales are 70% cash and 30% credit (collected within one month) </li></ul></ul><ul><ul><li>Prepare a sales and cash collection budget </li></ul></ul>
  34. 43. Developing a Master Budget <ul><li>After the sales budget we focus on production and purchases: </li></ul><ul><li>For a manufacturing company the production budgets contain: </li></ul><ul><ul><li>Direct materials budget </li></ul></ul><ul><ul><li>Direct labor budget </li></ul></ul><ul><ul><li>Overhead budget </li></ul></ul><ul><li>Separately, the company would also develop a budget for SG&A </li></ul><ul><li>All of these would then tie into the CASH Budget </li></ul>
  35. 44. Developing a Master Budget <ul><li>For a Merchandising company the Sales Budget drives the Purchases and SG&A budgets </li></ul><ul><li>These budgets would then tie into the CASH Budget </li></ul>
  36. 45. Developing the Purchases Budget <ul><li>Reminder of how to Think About Inventory Needs: </li></ul><ul><li>Beginning Inventory </li></ul><ul><li>+ Purchases </li></ul><ul><li>= Goods Available for Sale </li></ul><ul><li>- Ending Inventory </li></ul><ul><li>= Cost of Goods Sold </li></ul><ul><li>Develop Purchases Budget based on what is needed to ensure that there is enough inventory for budgeted sales and for estimated ending inventory </li></ul>
  37. 46. Developing a Purchases Budget – exercise 7-33 <ul><li>Quantrill Furniture plans inventory levels and sales as follows: </li></ul><ul><li>Month Inventory Sales </li></ul><ul><li>May $250,000 </li></ul><ul><li>June $220,000 $440,000 </li></ul><ul><li>July $270,000 $350,000 </li></ul><ul><li>August $240,000 $400,000 </li></ul>
  38. 47. Example of a Purchases Budget <ul><li>ADDITIONAL INFORMATION </li></ul><ul><li>COGS = .6*Sales </li></ul><ul><li>Payment = 10% down, 80% 30 days,10% 60 days </li></ul>
  39. 48. Cash Budgets <ul><li>Many managers consider managing cash flow to be the single most important consideration in running a successful business. </li></ul><ul><li>The cash budget summarizes all cash receipts and disbursements </li></ul><ul><li>Needs to take into account when the firm will pay bills, customer terms, purchases & sales </li></ul>
  40. 49. Cash Budget, Ex. 7-37 <ul><li>Sales forecast </li></ul><ul><ul><ul><li>October - $30,000 </li></ul></ul></ul><ul><ul><ul><li>November - $22,000 </li></ul></ul></ul><ul><li>Sales terms 1/30,net/30 </li></ul><ul><li>All sales on credit: 60%in first month, 30% next, 6% in two months –4% uncollected </li></ul><ul><li>COGS = 60% of sales, paid within 10 days </li></ul><ul><li>Expect inventory to be 50% of next month sales </li></ul><ul><li>SG&A = $61,500 year ($24,000 fixed ($13,200 depreciation expense)), balance varies with sales </li></ul><ul><li>Oct. 1 cash balance = $4,800 </li></ul>
  41. 50. Spreadsheet analysis <ul><li>Exercise 7-41 </li></ul>
  42. 51. Flexible Budgeting <ul><li>Flexible budgets vary with activity levels </li></ul><ul><li>The main benefit of flexible budgets is that they are based on cost-volume relationships so that evaluations are based on comparisons at the actual level of activity </li></ul><ul><li>The main drawback is assuming that the same cost-volume relationship exists at all levels of activity </li></ul>
  43. 52. Flexible Budgeting <ul><li>Benefits of Standard Costs </li></ul><ul><ul><li>Standard costs are carefully predetermined costs. </li></ul></ul><ul><ul><li>They help managers plan by providing the unit amounts, which are the building blocks of budgeting. </li></ul></ul><ul><ul><li>They help simplify record keeping. </li></ul></ul><ul><ul><li>Standard quantity often is referred to as the quantity that should have been used. </li></ul></ul>
  44. 53. Evaluation of Performance <ul><li>Variance analysis is used to examine how actual results differ from budgeted expectations </li></ul><ul><li>Focus should be on Flexible-budget variances </li></ul><ul><li>However, variances from the Master Budget (which are a result of variances in sales activity) are important since these are the foundation of the budgeting process </li></ul><ul><ul><li>Sales activity variances = (actual sales units – master budget sales units) * budgeted contribution margin </li></ul></ul>
  45. 54. What causes variances from budgeted results? <ul><li>Easy explanations: </li></ul><ul><ul><li>Price differences </li></ul></ul><ul><ul><li>Quantity differences </li></ul></ul><ul><li>Difficult explanations </li></ul><ul><ul><li>errors/mistakes </li></ul></ul><ul><ul><li>poor execution </li></ul></ul>
  46. 55. Flexible Budget Variances <ul><li>Flex Budget Variance = </li></ul><ul><li>Total actual results – Total Flex budget results </li></ul>
  47. 56. Variance Analysis <ul><li>Standard price indicates how much should be paid for each input unit of direct materials or Direct labor. </li></ul><ul><ul><li>Price variance is the difference between actual and standard cost of materials or labor inputs. </li></ul></ul><ul><li>Standard quantity indicates the amount of direct materials/labor allowed to produce one unit of output. </li></ul><ul><ul><li>Quantity variance is the difference between standard cost of actual materials/labor inputs and flexible budget cost for materials/labor. </li></ul></ul>
  48. 57. Variance formulas <ul><li>For Direct Materials Costs </li></ul><ul><ul><li>Price Variance = </li></ul></ul><ul><ul><li>(Actual Price - Standard Price) * Actual Quantity </li></ul></ul><ul><ul><li>Materials Variance = </li></ul></ul><ul><ul><li>(Actual Quantity - Standard Quantity) * Std. Price </li></ul></ul><ul><li>Total Variance = </li></ul><ul><li>(Standard Price*Standard Quant.)-(Actual Price* Actual Quant.) </li></ul>
  49. 58. Variance formulas <ul><li>For Direct Labor Costs </li></ul><ul><ul><li>Rate Variance = </li></ul></ul><ul><ul><li>(Actual Rate - Standard Rate) * Actual hours </li></ul></ul><ul><ul><li>Efficiency Variance = </li></ul></ul><ul><ul><li>(Actual hours - Standard hours) * Std. Rate </li></ul></ul><ul><li>Total Variance = </li></ul><ul><li>(Standard Rate*Standard hours) - (Actual Rate* Actual hours) </li></ul>
  50. 59. Understanding Variances <ul><li>Favorable price variance indicates that management paid less per unit than the price allowed by the standard </li></ul><ul><li>Favorable quantity variance means that the actual quantity of materials used was less than the quantity allowed for the units produced. </li></ul><ul><li>[Unfavorable just the opposite] </li></ul>
  51. 60. Fixed OH Budgeting <ul><li>Fixed OH Budgeting is based on determining the amount of OH that SHOULD be incurred at the normal production levels. This is called the “overhead absorption rate”. </li></ul><ul><li>OH Absorption Rate = Total Budgeted Indirect Costs </li></ul><ul><li>Expected Production </li></ul>
  52. 61. Fixed OH Budgeting <ul><li>OH Variances result from two circumstances: </li></ul><ul><ul><li>Actual production differs from budgeted production - a VOLUME variance </li></ul></ul><ul><ul><li>Actual OH costs differ from budgeted costs - a SPENDING variance. </li></ul></ul>
  53. 62. What makes budgeting successful <ul><li>Emphasize the importance of budgeting as a planning device. </li></ul><ul><li>Encourage wide participation in budget preparation at all levels of the organization. This requires that all employees understand budgeting and why it is being done. </li></ul><ul><li>Demonstrate that the budget has the complete support of top management. </li></ul><ul><li>Recognize that the budget can be changed </li></ul><ul><li>Use budget performance reports not just to identify poor performers, but also to recognize good performance. </li></ul>