2. INTRODUCTION
Pro-forma financial statements –FS that forecast
the company’s financial position and performance
over a period of years
To assess whether the firm’s anticipated performance
is in line with the firm’s own general targets and with
investors’ expectations.
Used to estimate the effect of proposed operating
changes
Anticipate the firm’s future financing needs
Estimate future free cash flows
3. Strategic Plans
Mission statement –a condensed version of a
firm’s strategic plan
Corporate purpose –the starts of mission and
strategic plan
Corporate scope –defines a firm’s lines of
business and geographic area of operations
Corporate objectives –state the general
philosophy of the business
Corporate strategies –broad approaches rather
than detailed plans
4. Operating Plans
Provide detailed implementations guidance
based on corporate strategy to help to meet
the corporate objectives
5. Financial Plan
Steps
Project FS and use these projections to analyze
the effects of the operating plan
Determine the funds needed to support the five-
year plan
Forecast funds availability over the next 5 years
Establish and maintain a system of control to
govern the allocation and use of funds within the
firm
Develop procedures for adjusting the basic plan if
the economic forecasts upon which the plan was
based do not materialize
Establish a performance-based management
6. Sales Forecasts
A forecast of a firm’s unit and dollar sales for
some future period
Generally based on recent sales trends plus
forecasts of the economic prospects for the
nation, region, industry and so forth
7.
8. Financial Statement Forecasting :
The Percent Of Sales Method
A method of forecasting future FS that
expresses each account as a percentage of
sales (constant/ change over time)
Step
Forecasted income statement
Forecast balance sheet
Raising the additional funds needed
10. Financial Statement Forecasting :
The Percent Of Sales Method
Spontaneously Generated Funds –some items
on the liability side can be expected to
increase spontaneously with sales
Higher sales must be supported by additional
assets
Some of the asset increases can be financed by
spontaneous increases in accounts payable and
accruals and by retained earnings
Any shortfall must be financed from external
sources
11. Financial Statement Forecasting :
The Percent Of Sales Method
Additional Funds Needed –funds that a firm
must raise externally through borrowing or by
selling new common or preferred stock
12. AFN Formula
AFN = Required Increase in Assets – Spontaneous Increase in Liabilities –
Increase in Retained Earnings
𝐴𝐹𝑁 =
𝐴∗
𝑆0
∆𝑆 −
𝐿∗
𝑆0
∆𝑆 − 𝑀𝑆1(𝑅𝑅)
A* =assets that are tied directly to sales
𝑆0 = sales during last year
𝐴∗
𝑆0
=% required assets to sales (Capital Intensity Ratio)
L* = liabilities that increase spontaneously
𝐿∗
𝑆0
= liabilities increase spontaneously as a % of sales
𝑆1 = total sales projected next year
∆𝑆 = changes of sales
M = profit margin / profit per RM1 of sales
R= retention ratio (% of income that is retained)
13. AFN Formula
2017 2018 2019
RM RM RM
Sale 50,100 65,500 70,400
Asset 120,000 126,400 141,300
Liabilitie
s
70,000 71,400 73,000
Equity 50,000 55,000 62,000
AFN = Required Increase in Assets – Spontaneous Increase in Liabilities –
Increase in Retained Earnings
1) 2018
2) 2019
14. Forecasting Free Cash Flow
FCF =operating Cash Flow – Gross
Investment in Operating Capital
Or FCF = NOPAT –Net investment in operating
capital
15. Free Cash Flow Formula
FCF = Operating Cash
Flow – Gross Investment
in Operating Capital
16. Forecasting Financial Requirements When
the Balance Sheet Ratios are Subject to
Change
Economies of scale
Ratios are likely to change over time as the size
of the firm increases
Lumpy assets
Assets that cannot be acquired in small
increments but must be obtained in large, discrete
units
Major effect on the fixed assets/sales ratio
Excess assets due to forecasting errors
Actual sales often different from projected sales
17. Other Techniques For Forecasting
FS
Simple Linear Regression
Assume that the relationship between
a certain type of asset and sales is linear
Estimated regression equations,
determined using a financial calculator or a spreadsheet
Excess Capacity Adjustments
Excess capacity occurs when the actual production of a
firm is less than the amount that is achievable or optimal.
This can indicate that the demand for the product is below
the amount that the business could potentially supply to
the market. A company can use excess capacity to offer
customers a special order price and generate more sales
toward the end of the month.
