Finma1 Chapter 6 Financial Planning and Forecasting
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kikoFinma1 Chapter 6 Financial Planning and Forecasting
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kikoFINANCIAL PLANNING
AND FORECASTING
CHAPTER 6
FINANCIAL MANAGEMENT 1
SEPTEMBER 16, 2024
Strategic planning
• Mission statement
• Corporate scope
• Statement of corporate objectives
• Corporate strategies
• Operating plan
• Financial plan
Strategic planning
• Mission statement – condensed version of a firm’s strategic plan
• Corporate scope – defines a firm’s lines of business and geographic areas of
operation
• Statement of corporate objectives – sets forth specific goals to guide
management
• Corporate strategies – broad approaches developed for achieving a firm’s
goals
• Operating plan – provides management detailed implementation guidance,
based on the corporate strategy, to help meet the corporate objectives
• Financial plan – document that includes assumptions, projected FSs, and
projected ratios and ties the entire planning process together
Corporate scope
• defines a firm’s lines of business and geographic areas of operation
• Firms deliberately limit their scope
• Managers focus on a narrow range of functions as opposed to
spreading the company over many different types of businesses
• Investor generally value focused firms more than diversified ones
• Should be logical and consistent with the firm’s capabilities
Statement of corporate objectives
• Sets forth specific goals to guide management
• Goals that operating managers are expected to meet
Operating plan
• Can be developed for any time horizon but most use 5-year horizon
• Explains in considerable detail the people responsible for each
particular function, deadlines for specific tasks, sales and profit
targets
Financial plan
1. Assumptions are made about the future levels of sales, costs,
interest rates, etc for use in the forecast
2. A set of projected FS is developed
3. Projected ratios are calculated and analyzed
4. The entire plan is reexamined, assumptions are reviewed, and the
management team considers how additional changes in operations
might improve results
5. Reconsideration of all the earlier parts of the overall plan
Financial planning
• Ties the entire planning process together
• Value-based management
• Effects of various decisions on the firm’s financial position and value
are studied by simulating their effects within the firm’s financial
model
Sales forecast
• Starts with a review of sales during the past 5 years
• Most important input in the firm’s forecast of FS (with projected EPS)
• Management likes higher sales growth but not at any cost
• Sales growth must be balanced against cost of achieving that growth
• Consequences:
• Market expands more than expected, firm will not be able to meet demand and
customers will buy from competitors and it will lose market share
• Overly optimistic projections, firm will end up with too much inventory, plant,
and equipment (low turnover ratios, high costs for depreciation and storage,
write-offs of spoiled inventory = low profits and depressed stock price)
• Financed expansion with debt, high interest expenses
AFN equation
• Additional funds needed
• Amount of external capital that will be necessary to acquire the
required assets
• Growth is low = change in sales is zero = no increase in assets
• Sales grow very rapidly = requirement for additional assets will be
large
• Increase in assets is dependent on the growth rate in sales
• Assets grow = liabilities and equity must also grow by the same
amount
AFN EQUATION
• Increase in sales = Δsales
• 0.10 (3,000) = 300
• Required increase in assets
• 0.6667(Δsales) = 0.6667(300) = 200
Primary capital sources
1. Spontaneous increases in AP and accruals
2. Addition to retained earnings
3. AFN (additional funds needed)
Spontaneous increases in AP and
accruals
• Funds that arise out of normal business operations from its suppliers,
employees, and the government that reduce the firm’s need for
external financing
• Additional purchases = to increase inventories = hire more workers
• Purchases = additional AP = loans from suppliers
• More workers = higher accrued wages = loans from workers
Addition to retained earnings
• Proportion of net income that is reinvested in the firm
• Retention ratio = 1 – dividend payout ratio
• Has positive earnings and does not pay out all of it as dividends =
retained earnings will grow
• Addition to retained earnings depends on the firm’s profit margin and
its retention ratio
Additional funds needed
• Amount of external capital that will be necessary to acquire the
required assets
• Interest-bearing debt and preferred and common stock
• Additional borrowing and/or sale of new stock
• Firm is growing very slowly = not increasing assets very much =
spontaneous funds + addition to RE may be larger than the required
increase in assets = AFN is negative = surplus of capital is forecasted
AFN Equation
• Show the relationship of external funds needed by a firm to its
projected increase in assets, spontaneous increase in liabilities, and
its increase in retained earnings
• AFN = projected increase in assets – spontaneous increase in liabilities
– increase in retained earnings
• AFN = (A0*/S)ΔS – (L*/S)ΔS – MS(1-payout)
• Used to get an idea of how much new capital the firm will need to
support the targeted growth rate, assuming the various operating
ratios remain constant
Sustainable growth rate
• Max achievable growth rate without the firm having to raise external
funds
• Growth rate at which the firm’s AFN equals zero
• Negative AFN = retained earnings and spontaneous capital are
sufficient to finance the amount of additional assets needed
Excess capacity adjustments
• Capital intensity ratio = A0=S0 = (A*/S)
• 2,000 / 3,000 = 0.6667
• Ratio of assets required per dollar of sales
• Excess capacity adjustments
• Changes made to the existing asset forecast because the firm is not
operating at full capacity
• Current assets/sales = 1,000/3,000 = 33.3%
• Fixed assets/sales = 1,000/3,000 = 33.3%
1. Inputs
1. Adjustable inputs
2. Fixed inputs
2. Forecasted income statement
3. Forecasted balance sheet
4. Ratios and EPS
