chapter 4 – financial forecasting, planning, and budgeting

Chapter 4 –Chapter 4 – Financial Forecasting,Financial Forecasting,

Planning, and BudgetingPlanning, and Budgeting

Financial ForecastingFinancial Forecasting

1)1) Project sales revenues and expenses. Project sales revenues and expenses.

2)2) Estimate current assets and fixed Estimate current assets and fixed assets necessary to support projected assets necessary to support projected sales.sales. Percent of sales forecastPercent of sales forecast

Percent of Sales MethodPercent of Sales Method

Suppose this year’s sales will total Suppose this year’s sales will total $32 million$32 million..

Next year, we forecast sales of Next year, we forecast sales of $40 million$40 million..

Net income should be Net income should be 5%5% of sales. of sales. Dividends should be Dividends should be 50%50% of of

earnings.earnings.

This yearThis year % of % of $32m$32m

AssetsAssetsCurrent AssetsCurrent Assets $8m$8m 25%25%Fixed AssetsFixed Assets $16m$16m 50%50% Total AssetsTotal Assets $24m$24mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $4m$4m 12.5%12.5%Accrued ExpensesAccrued Expenses $4m$4m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $15m$15mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $2m$2m EquityEquity $9m$9m Total Liab. & EquityTotal Liab. & Equity $24m$24m

Next yearNext year % of % of $40m$40m

AssetsAssetsCurrent AssetsCurrent Assets 25%25%Fixed AssetsFixed Assets 50%50% Total AssetsTotal AssetsLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable 12.5%12.5%Accrued ExpensesAccrued Expenses 12.5%12.5%Notes PayableNotes Payable n/an/aLong Term DebtLong Term Debt n/an/a Total LiabilitiesTotal LiabilitiesCommon StockCommon Stock n/an/aRetained EarningsRetained Earnings EquityEquity Total Liab. & EquityTotal Liab. & Equity


AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets 50%50% Total AssetsTotal AssetsLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable 12.5%12.5%Accrued ExpensesAccrued Expenses 12.5%12.5%Notes PayableNotes Payable n/an/aLong Term DebtLong Term Debt n/an/a Total LiabilitiesTotal LiabilitiesCommon StockCommon Stock n/an/aRetained EarningsRetained Earnings EquityEquity Total Liab. & EquityTotal Liab. & Equity


AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal AssetsLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable 12.5%12.5%Accrued ExpensesAccrued Expenses 12.5%12.5%Notes PayableNotes Payable n/an/aLong Term DebtLong Term Debt n/an/a Total LiabilitiesTotal LiabilitiesCommon StockCommon Stock n/an/aRetained EarningsRetained Earnings EquityEquity Total Liab. & EquityTotal Liab. & Equity


AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable 12.5%12.5%Accrued ExpensesAccrued Expenses 12.5%12.5%Notes PayableNotes Payable n/an/aLong Term DebtLong Term Debt n/an/a Total LiabilitiesTotal LiabilitiesCommon StockCommon Stock n/an/aRetained EarningsRetained Earnings EquityEquity Total Liab. & EquityTotal Liab. & Equity


AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses 12.5%12.5%Notes PayableNotes Payable n/an/aLong Term DebtLong Term Debt n/an/a Total LiabilitiesTotal LiabilitiesCommon StockCommon Stock n/an/aRetained EarningsRetained Earnings EquityEquity Total Liab. & EquityTotal Liab. & Equity


AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable n/an/aLong Term DebtLong Term Debt n/an/a Total LiabilitiesTotal LiabilitiesCommon StockCommon Stock n/an/aRetained EarningsRetained Earnings EquityEquity Total Liab. & EquityTotal Liab. & Equity


AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt n/an/a Total LiabilitiesTotal LiabilitiesCommon StockCommon Stock n/an/aRetained EarningsRetained Earnings EquityEquity Total Liab. & EquityTotal Liab. & Equity


AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal LiabilitiesCommon StockCommon Stock n/an/aRetained EarningsRetained Earnings EquityEquity Total Liab. & EquityTotal Liab. & Equity


AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock n/an/aRetained EarningsRetained Earnings EquityEquity Total Liab. & EquityTotal Liab. & Equity


AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings EquityEquity Total Liab. & EquityTotal Liab. & Equity

Predicting Retained EarningsPredicting Retained Earnings

Next year’s projected retained earnings = last Next year’s projected retained earnings = last year’s year’s $2 million$2 million, plus:, plus:

projected net incomeprojected net income cash dividends cash dividends salessales sales sales net income net income

$40 million x .05 $40 million x .05 xx (1 - .50)(1 - .50)

= $2 million + $1 million = = $2 million + $1 million = $3 million$3 million

xx xx ( 1 - ) ( 1 - )



How muchDiscretionary

Financing will weNeed?

Predicting Discretionary Predicting Discretionary Financing NeedsFinancing Needs

Discretionary Financing Needed =Discretionary Financing Needed =

projectedprojected projectedprojected projectedprojected totaltotal -- total total -- owners’ owners’ assetsassets liabilitiesliabilities equity equity

$30 million - $17 million - $10 million$30 million - $17 million - $10 million

= = $3 million$3 million in discretionary financing in discretionary financing

Sustainable Rate of GrowthSustainable Rate of Growth

g* = ROE (1 - b)g* = ROE (1 - b) wherewhere

b =b = dividend payout ratio dividend payout ratio

(dividends / net income)(dividends / net income)

ROE =ROE = return on equity return on equity

(net income / common equity) or(net income / common equity) or

net income sales assetsnet income sales assets

sales assets common equitysales assets common equityROE = x xROE = x x

BudgetsBudgets

Budget:Budget: a forecast of future events. a forecast of future events.

BudgetsBudgets

Budgets indicate the Budgets indicate the amountamount and and timingtiming of of future financing needsfuture financing needs..

Budgets provide a basis for taking Budgets provide a basis for taking corrective actioncorrective action if budgeted and if budgeted and actual figures do not match.actual figures do not match.

Budgets provide the basis for Budgets provide the basis for performance evaluationperformance evaluation..

Example: 4-11A (Harrizon Printing)Example: 4-11A (Harrizon Printing)Harrison PrintingCash BudgetFor the Six Months Ended June 30, 2004

Cash Receipts Nov Dec Jan Feb Mar Apr May Jun Jul AugSales 220,000 175,000 100,000 120,000 150,000 300,000 275,000 200,000 200,000 180,000 Cash Sales (20% of sales) 44,000 35,000 20,000 24,000 30,000 60,000 55,000 40,000 40,000 36,000 Collection of AR:

One-month lag (50%) - 110,000 87,500 50,000 60,000 75,000 150,000 137,500 100,000 100,000 Two-months lag (30%) - - 66,000 52,500 30,000 36,000 45,000 90,000 82,500 60,000

Total Cash Receipts 44,000 145,000 173,500 126,500 120,000 171,000 250,000 267,500 222,500 196,000

Cash Disbursements

Purchases (two months in advance of its sales equal to 65% of sales 65,000 78,000 97,500 195,000 178,750 130,000 130,000 117,000 - - Payment of AP:

One-month lag (100%) 65,000 78,000 97,500 195,000 178,750 130,000 130,000 117,000 - Rent 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 Other expenditures 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 Tax prepayments 22,500 22,500 Total Cash Disbursements 30,000 95,000 108,000 127,500 247,500 208,750 160,000 182,500 147,000 30,000

Cash BudgetCash Receipts 173,500 126,500 120,000 171,000 250,000.00 267,500.00 Less: Cash Disbursements 108,000 127,500 247,500 208,750 160,000.00 182,500.00 Net monthly change 65,500 (1,000) (127,500) (37,750) 90,000.00 85,000.00 Add: Beginning cash balance 22,000 87,500 86,500 20,000 20,000.00 20,000.00 Less: Interest on short-term borrowing (1%) 0 0 0 610 993.60 103.54 Ending cash balance before short-term borrowing 87,500 86,500 (41,000) (18,360) 109,006.40 104,896.46 Financing needed 0 0 61,000 38,360 (89,006.40) (10,353.60) Ending cash balance 87,500 86,500 20,000 20,000 20,000.00 94,542.86 Cumulative borrowing 0 0 61,000 99,360 10,353.60 0

chapter 4 – financial forecasting, planning, and budgeting

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