4 Financial Planning and Forecasting ©2006 Thomson/South-Western.

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Financial Planning and Forecasting

©2006 Thomson/South-Western

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Introduction

This chapter discusses techniques for forecasting a company’s future cash flows and need for funds.

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Strategic and Operational Planning Strategic planning is long-range in nature

and deals with the overall direction of the firm.

Operational planning serves as a blueprint for detailing the resources needed to meet the strategic goals.

Financial forecasting is an important component of operational planning!

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Corporate Planning

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The Concept of Cash Flow

Reported net income can be modified to produce a measure of after-tax cash flow from current operations to pay for:

1. Capital expenditures

2. Dividends

3. Retirement of debt

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Computing After-tax Cash FlowAfter-tax cash flow =

Earnings after taxes + Depreciation expense

+ Deferred Taxes

Note—Net income produces a measure of cash flow when it is adjusted for non-cash expenses!

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What are Non-cash Expenses?Depreciation is a non-cash expense because

it represents an allocation of the original cost of an asset to a particular year, not a cash outlay.

Deferred taxes is a non-cash expense because it represents the difference between actual taxes paid and the tax expense reported on the income statement.

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Example of After-tax Cash Flow Ellwood Appliance Company has net

income of $12 million, on a depreciation expense of $10 million and deferred taxes of $800,000.

After-tax cash flow for the company is computed as:

$12.0 + 10.0 + 0.80 = $22.8 million

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Forecasting Methods

Percent of sales

Cash budgets

Pro forma statement of cash flow

Computerized financial forecasting

models

Forecasting with financial ratios

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Percent of Sales Forecasting

Relies on a forecast of sales Obtains estimates of variables as a percent of sales

Forecasted Current

Liability Increases–

Forecasted Asset

Increases=

TotalFinancing

Needed

Tied to a sales increase

Dividends–Forecasted

EAT=

Increased Retained Earnings

Portion of financing needed internally

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Additional Financing Needed The difference between the total financing

needed and the internal financing provided:

Additional Financing

Needed=

External

[ A/S(ΔS) – CL/S(ΔS) ] – [EAT – D]

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Cash Budgeting A financial plan Projects receipts and disbursements over

future periods of time. Receipts on credit sales lag projected sales. Payments for purchases depend on

How much the purchase precedes the sale Credit terms

Other scheduled receipts and disbursements Long-term loans Capital expenditures Dividend payments Wages Salaries Rent…

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Pro Forma Statement of Cash Flows

Measures the increases (and decreases) in cash and cash equivalents CFs expected from operations CFs expected from investing activities CFs expected from financing activities

Add cash and cash equivalents at the beginning of year

Sums up to expected cash and cash equivalents at the end of year

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Cash Budgeting Tools

Check out the interactive tools for cash budgeting at this Web site:http://www.edgeonline.com/

Check out business planning with a cash flow forecast at this Web site:http://www.sb.gov.bc.ca

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Computerized Forecasting and Financial Planning Deterministic model

Uses single-value forecasts of each financial variable

Probabilistic models Utilize probability distributions for input data

Optimization models Choose the optimal levels of some variables

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Forecasting with Financial Ratios

Forecasting bankruptcy with discriminant analysis

5 ratios Net working capital/Total assets Retained earnings/Total assets EBIT/Total assets Market value equity/Book value total debt Sales/Total assets