The document discusses financial planning and forecasting pro forma financial statements. It provides details on: 1) Forecasting sales using projected growth rates and estimating costs, assets, and liabilities as a percentage of sales. 2) Calculating additional funds needed (AFN) by comparing forecasted assets to sources of internal financing. If AFN is positive, external financing is required. 3) Assumptions made in the example forecast, such as how any additional funds needed will be obtained through debt financing split evenly between notes payable and long-term debt.

1. Financial Management - I
Financial Planning and Forecasting Financial
Statements
1

2. Topics
2
 Financial planning
 Additional Funds Needed (AFN) formula
 Pro forma financial statements
 Sales forecasts
 Percent of sales method

3. Financial Planning and Pro Forma
Statements3
 Three important uses:
 Forecast the amount of external financing
 Impact of new operating plan on firm’s value
 Dividend pay out ratio

4. Financial Forecasting

5. Projecting Pro Forma Statements
5
 Project sales based on forecasted growth rate
in sales
 Forecast some items as a percent of the
forecasted sales
 Costs
 Cash
 Accounts receivable

6. 6
 Items as percent of sales
 Inventories
 Net fixed assets
 Accounts payable and accruals
 Long term Liabilities
 Debt
 Dividend policy (which determines retained
earnings)
 Common stock

7. Sources of Financing
7
 Sales & Internal Financing
 Required assets to support sales
 Internal financing
 Additional funds needed (AFN) is:
 Forecasted assets minus sources of financing

8. Implications of AFN
8
 If AFN is positive, External financing needs to
undertaken
 If AFN is negative (surplus of funds)
 Repayment of debt.
 Buy back stock
 Buy short-term investments

9. Interest Expense
9
 Interest expense is based on daily balance of
debt during the year
 There are three ways to approximate interest
expense
 Debt at end of year
 Debt at beginning of year
 Average of beginning and ending debt

10. Debt at End of Year
10
 Will over-estimate interest expense if debt is
added throughout the year instead of all on
January 1
 Causes circularity called financial feedback
 more debt results in more interest leads to
reduction in net income
 This reduces retained earnings
 hence leads to leads more debt

11. Debt at Beginning of Year
11
 Will under-estimate interest expense if debt is
added throughout the year instead of all on
December 31.
 But doesn’t cause problem of circularity

12. Average of Beginning and Ending Debt
12
 Will accurately estimate the interest payments
if debt is added smoothly throughout the year.
 But has problem of circularity.

13. 2007 Balance Sheet
(Millions of $)13
Cash & sec. $ 20 Accts. pay. &
accruals $ 100
Accounts rec. 240 Notes payable 100
Inventories 240 Total CL $ 200
Total CA $ 500 L-T debt 100
Common stk 500
Net fixed
assets
Retained
earnings 200
Total assets $1,000 Total claims $1,000
500

14. 2007 Income Statement
(Millions of $)14
Sales $2,000.00
Less: COGS (60%) 1,200.00
SGA costs 700.00
EBIT $ 100.00
Interest 10.00
EBT $ 90.00
Taxes (40%) 36.00
Net income $ 54.00
Dividends (40%) $21.60
Add’n to RE $32.40

15. Percent of Sales: Inputs
2007
Actual 2008 Proj.
COGS/Sales 60% 60%
SGA/Sales 35% 35%
Cash/Sales 1% 1%
Acct. rec./Sales 12% 12%
Inv./Sales 12% 12%
Net FA/Sales 25% 25%
AP & accr./Sales 5% 5%
15

16. Other Inputs
Percent growth in sales 25%
Growth factor in sales (g) 1.25
Interest rate on debt 10%
Tax rate 40%
Dividend payout rate 40%
16

17. 2008 First-Pass Forecasted
Income Statement
Calculations 2008 1st
Pass
Sales 1.25 Sales07 = $2,500.0
Less: COGS 60% Sales08 = 1,500.0
SGA 35% Sales08 = 875.0
EBIT $125.0
Interest 0.1(Debt07) = 20.0
EBT $105.0
Taxes (40%) 42.0
Net Income $63.0
Div. (40%) $25.2
Add to RE $37.8
17

18. 2008 Balance Sheet (Assets)
Calcuations 2008
Cash 1% Sales08 = $25.0
Accts Rec. 12%Sales08 = 300.0
Inventories 12%Sales08 = 300.0
Total CA $625.0
Net FA 25% Sales08 = 625.0
Total Assets $1,250.0
18

19. 2008 Preliminary Balance
Sheet (Claims)
5 Calculations 2008 Without
AFN
AP/accruals 5% Sales08 = $125.0
Notes payable 100 Carried over 100.0
Total CL $225.0
L-T debt 100 Carried over 100.0
Common stk 500 Carried over 500.0
Ret earnings 200 +37.8* 237.8
Total claims $1,062.8
19

20. Additional funds needed
20
 Required assets = $1,250.0
 Specified sources of fin. = $1,062.8
 Forecast AFN: $1,250 - $1,062.8 = $187.2
 NWC must have the assets to make
forecasted sales, and so it needs an equal
amount of financing. So, we must secure
another $187.2 of financing.

21. Assumptions about how AFN will
be raised
21
 No new common stock will be issued.
 Any external funds needed will be raised as
debt, 50% notes payable, and 50% L-T debt.

22. How will the AFN be financed?
22
 Additional notes payable
=0.5 ($187.2) = $93.6.
 Additional L-T debt
= 0.5 ($187.2) = $93.6.

23. 2008 Balance Sheet (Claims)
w/o AFN AFN With AFN
AP accruals $125.0 $125.0
Notes payable 100.0 +93.6 193.6
Total CL $225.0 $318.6
L-T Debt 100.0 +93.6 193.6
Common stk 500.0 500.0
Ret earnings 237.8 237.8
Total claims $1,071.0 $1250.0
23

24. Increase in these items affect the
AFN?24
 Higher sales:
 Increases asset requirements, increases AFN.
 Higher dividend payout ratio:
 Reduces funds available internally, increases
AFN.

25. Economies of Scale
25
Assets
Sales
0
1,100
1,000
2,000 2,500
Declining A/S Ratio
$1,000/$2,000 = 0.5; $1,100/$2,500 = 0.44. Declining ratio shows economies
of scale. Going fromS = $0 to S = $2,000 requires $1,000 of assets. Next
$500 of sales requires only $100 of assets.
Base
Stock
}

26. Lumpy Assets
26 Assets
Sales
1,000 2,000500
A/S changes if assets are lumpy. Generally will have excess
capacity, but eventually a small ∆S leads to a large ∆A.
500
1,000
1,500

27. Different factors affect the AFN
forecast.
27
 Excess capacity: lowers AFN
 Economies of scale: leads to less-than-
proportional asset increases
 Lumpy assets: leads to large periodic AFN
requirements, recurring excess capacity

28. Thanks…. 