Chapter
Chapter 4 - Outline
What is Financial Forecasting?
3 Financial Statements for Forecasting
Constructing Pro Forma Statements
Basis for Sales Projections
Steps in a Pro Forma Income Statement
Production or Purchases Schedule
Purposes of Cash Budgets
Development of a Pro forma Balance Sheet
Percent-of-Sales Method
What is Financial Forecasting?
Financial forecasting uses
projections
to anticipate
short-term financial results and position
Provides
lead time
to make necessary adjustments before
actual events occur
Helps to plan for significant
growth
in firm
Can be used as a
target
for measuring performance
Forecasting Vs. Planning Vs. Budgeting
Planning
- Setting operational and financial goals, and
choosing strategies and actions for achieving goals
Budgeting
- Documenting expected route for achieving goals,
and assigning responsibilities for achieving goals
Forecasting
- projecting future position and results without
3 Financial Statements for Forecasting
Pro Forma Income Statement (I/S)
Cash Budget
Pro Forma Balance Sheet (B/S)
Figure 4-1
Development of pro forma statements
Cash budget Sales
projection Productionplan
Development of pro forma income
statements
Establish a sales projection
Forecast economic conditions
Survey sales personnel
Determine production needs, COGs, and gross profit
Determine units to be produced
Determine the cost of producing the units
Compute cost of goods sold
Compute gross profit
Compute other expenses
General and administrative
Interest expense
Basis for Sales Projections
External Factors
Recession or boom?
Export sales?
Consumer spending?
Competition?
New technology?
etc.
Internal Factors
New product lines?
Turnover in people?
Profit targets?
Employee training?
Price changes?
Wheels Casters Quantity Sales price Sales revenue Total . . . . . . . . . . . . . 1,000 2,000 $30 $35 $30,000 $70,000 . . . $100,000
Table 4-1
Projected wheel and caster sales
(first six months, 2003)
Production (or Purchases) Schedule
Projected sales
-in Units or $
PLUS
Desired ending inventory
MINUS
Beginning inventory
EQUALS
Table 4-2
Stock of beginning inventory
Wheels Casters
Quantity . . . 85 180 Cost . . . . $16 $20 Total value . . $1,360 $3,600
Table 4-3
Production requirements for six months
Wheels Casters
Projected unit sales (Table 4-1) . . . +1,000 +2,000 Desired ending inventory (assumed to
represent 10% of unit sales for the
Wheels Casters
Units to be produced (Table 4-3) . . 1,015 2,020 Cost per unit (Table 4-4) . . . . $18 $22 Total cost . . . . . . . . $18,270 $44,440
= $62,710
Table 4-5
Table 4-6
Allocation of manufacturing costs and
determination of gross profits
Wheels Casters Combined
Quantity sold (Table 4-1) . 1,000 2,000 3,000 Sales price . . . . . $ 30 $ 35
Sales revenue . . . . $30,000 $70,000 $100,000 Cost of goods sold:
Old inventory (Table 4-2)
Quantity (units) . . 85 180 Cost per unit . . . $16 $20
Total . . . . $1,360 $ 3,600 New inventory (the remainder)
Quantity (units) . . 915 1,820 Cost per unit (Table 4-4) $18 $22
Total . . . . 16,470 40,040
Table 4-7
Value of ending inventory
Table 4-8
Pro Forma Income Statement June 30, 2003
Cash budget
Estimate cash sales and collection timing of credit sales
Forecast cash payments
Payments for materials purchase according to credit terms
Wages
Capital expenditures
Principal payments
Interest payments
Taxes
Dividends
Determine monthly cash flow (recepits minus payments)
Construct cash budget
Purposes of Cash Budgets
Identify
cash shortage
in advance
Forecast amount available for
major expenditures
Basis for arranging
financing
Show ability to repay
debt
Suggest possible changes in
plans
delay capital expenditures
Table 4-9
Monthly sales pattern
January February March April May June
December January February Sales . . . . . . . $12,000 $15,000 $10,000 Collections: (20% of current sales) . $ 3,000 $ 2,000 Collections: (80% of previous month’s sales). . . . 9,600 12,000 Total cash receipts . . $12,600 $14,000
March April May June
Sales . . . . . . . $15,000 $25,000 $15,000 $20,000 Collections: (20% of current sales) . $ 3,000 $ 5,000 $ 3,000 $ 4,000 Collections: (80% of previous month’s sales . . . . 8,000 12,000 20,000 12,000 Total cash receipts . . $11,000 $17,000 $23,000 $16,000
Table 4-10
Table 4-11
Component costs of manufactured goods
Materials . . . 1,015 $10 $10,150
Labour . . . 1,015 5 5,075
Overhead . . . 1,015 3 3,045
Casters
Units Cost Total Combined
Produced per Unit Cost Cost
Materials . . . 2,020 $12 $24,240 $34,390 Labour . . . 2,020 6 12,120 17,195 Overhead . . . 2,020 4 8,080 11,125 $62,710
Wheels
Units Cost Total
Total Time Average
Costs Frame Monthly Cost
Materials . . . $34,390 6 months $5,732 Labour . . . . 17,195 6 months 2,866 Overhead . . . 11,125 6 months 1,854
Table 4-12
Table 4-13a
Summary of all monthly cash payments
(a)
December January February
From Table 4-12:
Monthly material purchase . $4,500 $ 5,732 $ 5,732 Payment for material
(prior month’s purchase) $ 4,500 $ 5,732 Monthly labour cost . . . 2,866 2,866 Monthly overhead. . . . 1,854 1,854
From Table 4-8:
Selling, general and administrative expense ($12,000 over
6 months) . . . . . 2,000 2,000 Interest expense . . . .
Taxes (two equal payments) Cash dividend . . . . . Also:
Table 4-13b
Summary of all monthly cash payments (b)
March April May June
From Table 4-12:
Monthly material purchase . . $5,732 $ 5,732 $ 5,732 $ 5,732 Payment for material
(prior month’s purchase) . . $5,732 $ 5,732 $ 5,732 $5,730* Monthly labor cost . . . . 2,866 2,866 2,866 2,866 Monthly overhead . . . . 1,854 1,854 1,854 1,854 From Table 4-8:
Selling, general and administrative expense ($12,000 over
6 months) . . . . . . 2,000 2,000 2,000 2,000 Interest expense. . . . . 1,500 Taxes (two equal payments) . . 2,503 2,503 Cash dividend . . . . . . 1,500 Also:
New equipment purchases . . 10,000 Total payments . . . . . $14,955 $12,452 $12,452 $27,953
January February March
Total receipts (Table 4-10) . $12,600 $14,000 $11,000 Total payments (Table 4-13). 11,220 20,452 14,955 Net cash flow . . . . . $ 1,380 ($ 6,452) ($ 3,955)
April May June
Total receipts (Table 4-10) . $17,000 $23,000 $16,000 Total payments (Table 4-13). 12,452 12,452 27,953 Net cash flow . . . . . $ 4,548 $10,548 ($11,953)
Table 4-14
Table 4-15
Cash budget with borrowing and
repayment provisions
1. Net cash flow . . . . . . $1,380 ($6,452.) ($3,955.) $4,548 $10,548 ($11,953.)
2. Beginning cash balance . . 5,000.* 6,380 5,000 5,000 5,000 11,069 3. Cumulative cash balance. . 6,380 (72.) 1,045 9,548 15,548 (884.)
4. Monthly loan or (repayment) — 5,072 3,955 (4,548.) (4,479.). 5,884
5. Cumulative loan balance . . — 5,072 9,027 4,479 — 5,884 6. Ending cash balance . . . 6,380 5,000 5,000 5,000 11,069 5,000
Jan. Feb. March April May June
Development of a Pro Forma Balance
Sheet
Pro forma balance sheet Prior balance sheet
(Unchanged items) Marketable securities Long-term debt
Common stock
Cash budget analysis Cash
Accounts receivable Plant and equipment Accounts payable Notes payable
Pro forma income statement analysis Inventory
Construction of pro forma balance sheet
Assets (source of information)
Cash - (cash budget)
Marketable securities - (previous balance sheet and cash budget) Accounts receivable - (sales forecast, cash budget)
Inventory - (COGS computation for pro forma income statement) Plant and equipment (previous balance sheet + purchase
- amortization)
Liabilities and Net Worth
Account payable - (Cash budget work sheet)
Table 4-16
Balance Sheet December 31, 2002 Assets Current assets: Cash . . . . . . . . . . . . . $ 5,000 Marketable securities . . . . . . . . 3,200 Accounts receivable . . . . . . . . 9,600 Inventory. . . . . . . . . . . . 4,960 Total current assets . . . . . . . . 22,760 Plant and equipment . . . . . . . . . 27,740 Total assets . . . . . . . . . . . . $50,500Liabilities and Shareholders’ Equity
Table 4-17
Pro Forma Balance Sheet
June 30, 2003 Assets Current assets: 1. Cash . . . . . . . . . . . . $ 5,000 2. Marketable securities . . . . . . . 3,200 3. Accounts receivable. . . . . . . . 16,000 4. Inventory . . . . . . . . . . . 6,200 Total current assets . . . . . . 30,400 5. Plant and equipment . . . . . . . 45,740 Total assets . . . . . . . . . . . $76,140
Liabilities and Shareholders' Equity
2 Methods of Financial Forecasting:
Using
Pro Forma, or Projected, Financial
Statements
(more exact, time consuming
)
Percent-of-Sales Method
for the pro forma
Percent-of-Sales Method
A short-cut, less exact, easier method of determining
financing needs (The “quick and dirty” approach)
Assumes that B/S accounts will maintain a constant
percentage relationship to sales
More
sales
will mean more
assets
which will require more
financing
Determine external financing
Project assets levels on basis of forecasted sales
Project spontaneous financing: Some financing is provided
spontaneously when asset levels increase: for example,
account payable and accrued expenses )
Project internal financing from profit
HOWARD CORPORATION
Balance Sheet and Percent-of-Sales Table
Assets Liabilities and Shareholders' Equity Cash . . . . . . $ 5,000 Accounts payable . . .$ 40,000 Accounts receivable . 40,000 Accrued expenses. . . 10,000 Inventory . . . . 25,000 Notes payable . . . . 15,000 Total current assets 70,000 Common stock . . . 10,000 Equipment . . . . 50,000 Retained earnings . . 45,000 Total assets . . . . $120,000 Total liabilities and
shareholders' equity $120,000
$200,000 sales
Percent of Sales
Cash . . . . . . 2.5% Accounts payable . . 20.0% Accounts receivable . 20.0 Accrued expenses . . 5.0 Inventory . . . . 12.5 25.0%
Total current assets 35.0 Equipment . . . . 25.0
60.0%
Table 4-19
Balance sheet with sales increase
HOWARD CORPORATION
Sales $200,000
Sales increase 50.00% $100,000
Assets Before Increase RNF After
Cash $ 5,000 $ 2,500 $ 7,500 $ 7,500 Accounts receivable 40,000 20,000 60,000 60,000
Inventory 25,000 12,500 37,500 37,500
Total current assets $ 70,000 35,000 105,000 105,000
Equipment 50,000 25,000 75,000 75,000
Total assets $120,000 $ 60,000 $180,000 $180,000
Liabilities and Shareholders’ Equity
Accounts payable $ 40,000 $20,000 $ 60,000 $ 60,000
Accrued expenses 10,000 5,000 15,000 15,000
Notes payable 15,000 0 15,000 41,000
Total current liabilities $ 65,000 25,000 $90,000 $116,000
Common stock 10,000 10,000 10,000
Retained earnings 45,000 9,000 54,000 54,000
Total liabilities and shareholders’ equity $120,000 $34,000 $154,000 $180,000
Required new funds 26,000
Selected ratios
Debt/Total assets 65/120 = 0.54 116/180 =.064 Debt/Equity 65/(10+45) = 1.18 116/(10+54) =1.81
Table 4-20
Balance sheet with sustainable sales
increase
HOWARD CORPORATION
Sales $200,000
Sales increase 12.24% $ 24,480
Assets Before Increase RNF After
Cash $ 5,000 $ 612 $ 5,612 $ 5,612 Accounts receivable 40,000 4,896 44,896 44,896
Inventory 25,000 3,060 28,060 28,060
Total current assets $ 70,000 8,568 78,568 78,568
Equipment 50,000 6,120 56,120 56,120
Total assets $120,000 $14,688 $134,688 $134,688
Liabilities and Shareholders’ Equity
Accounts payable $ 40,000 $ 4,896 $ 44,896 $ 44,896 Accrued expenses 10,000 1,224 11,224 11,224
Notes payable 15,000 0 15,000 16,834
Total current liabilities $ 65,000 6,120 $ 71,120 $ 72,954
Common stock 10,000 10,000 10,000
Retained earnings 45,000 6,734 51,734 51,734 Total liabilities and shareholders’ equity $120,000 $12,854 $132,854 $134,688
Required new funds 1,834
Selected ratios
Summary and Conclusions
Financial forecasting is used to anticipate events
in
advance
, particularly a need to raise more money
for the business
A complete forecast would include:
a
pro forma income statement
a
pro forma balance sheet
a
cash budget
