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Financial Planning and Forecasting

Ing. Zuzana Čierna, PhD.Department of Finance

SPU – FEM, Nitra

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From an investor’s standpoint, predicting the future is

what financial statement analysis is all about, while

from management’s standpoint, financial statement

analysis is useful both to help anticipate future

conditions and, more important, as a starting point for

planning actions that will improve the firm’s future

performance.

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Projected financial statements are used to estimate future free cash flows, which determine the company’s overall value. Thus, managers forecast free cash flows under different operating plans, forecast their capital requirements, and then choose the plan that maximizes shareholder value.

Operating plans provide detailed implementation guidance, based on the corporate strategy, to help meet the corporate objectives. These plans can be developed for any time horizon.

Financial plan – a document which involves current and future needs of funds and currently existing and expected future resources to cover.

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• long-term financial plan • short-term financial plan

Content of  short-term FP 

- profit plan,- financial statement,- cash flow plan,- plan distribution of profit

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Five-Year Operating Plan Outline

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Percent of Sales Method

A method of forecasting future financial statements that expresses each account as a percentage of sales.

Once sales have been forecasted, we must forecast future balance sheets and income statements.

• FORECASTED INCOME STATEMENT• FORECAST THE BALANCE SHEET• RAISING THE ADDITIONAL FUNDS NEEDED• FORECASTING FREE CASH FLOW

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Percent of Sales Method (steps)

1.step: Financial analysis of current period

2.step: Aims formulation for time horizon of FP

3.step: Assessment of basic requirements:

a) balance sheet items is most closely linked to sales

b) structure of assets and liabilities of current period

are adequate to the level of sales

4.step: If 3.b) is not fulfill there is necessary to make correction of balance sheet items of current period. It can be made by Financial ratios method.

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Percent of Sales Method (steps)

5.step: Identification of those balance sheet items, which are changed in dependence on the sales changes. Share quantification of sheet balance items on sales.

6.step: Calculation of planned balance sheet items. Share of balance sheet items on sales times planned sales. Balance sheet items without dependence on sales changes are taken from current balance sheet.

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Percent of Sales Method (steps)

7.step: Calculation of additional funds needed. Disparity between higher assets and lower liabilities.

8.step: Structure of additional funds needed in accordance with aims of financial plan.

9.step: New plan of balance sheet and plan of cash flow.

10.step: Control if aims of FP were fulfill.

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Financial ratios method

Selected financial ratios are used as „model values“. Firm wants to reach these values in future.

These values can be formulated as: • specific aims of firm• average values of firms in the same sector• values of competitive firm

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Example:

We want to make a financial plan for year 2013.

Expected Balance sheet 31.12.2012

Fixed assets 375 Registered Capital 475

Inventories 300 Retained Profit 52

Receivables 215 Liabilities to suppliers 130

Financial Accounts 25 Short-term bank loans 35

Current Assets 540 Wages, taxes and other liabilities 105

Short-term liabilities 270

Long-term bank loans 118

Total Assets 915 Total capital and liabilities 915

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(1., 2.step)

Expected sales in year 2012 = 1600 euro; Net income = 80 euro; Dividends = 20 euro.

Expected growth of sales in 2013 is 25% in compare with sales in year 2012.

Aims formulation for year 2013:

1.) 5% profitability of sales.2.) Dividends 50% from net income. 3.) Debts from total assets – no more than 40%.

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(3.step)

Structure of assets (Expected Balance sheet 31.12.2012) are not adequate to the level of sales!

We have to make correction by Financial ratios method:

Selected financial ratios values of competitive firm:

Inventories turnover ratio = 6

DSO = 40

Inventories turnover ratio = sales/inventories

Days sales outstanding = (receivables * 365)/sales

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(4.step)

Correction of balance sheet items of current period.

Model values:

Inventories turnover ratio = 6

DSO = 40

We have to make correction in inventories and receivables.

Inventories turnover ratio = sales/inventories = 1600/300 = 5,33

New value of inventories = 1600/6 = 266,6 270

Days sales outstanding = (receivables * 365)/sales = (215 * 365)/1600 = 41,9

New value of receivables = (40 * 1600)/365 = 175,3 180

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(4.step)

Expected Balance sheet (after correction) 31.12.2012

Fixed assets 375 Registered Capital 475

Inventories 270 Retained Profit 52

Receivables 180 Liabilities to suppliers 130

Financial Accounts90 Short-term bank loans 35

Current Assets 540 Wages, taxes and other liabilities 105

Short-term liabilities 270

Long-term bank loans 118

Total Assets 915 Total capital and liabilities 915

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(5., 6.step)Expected growth of sales in 2013 is 25%: 1600 + 25% = 2000 euro

(1) (2) Share on sales (in current period) Planned balance

sheet(% from 1600 euro) (planned sales * column

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Financial accounts (90/1600) * 100 = 5,6 2000 * 0,056 = 112Receivables (180/1600)*100 = 11,3 2000 * 0,113 = 226Inventories (270/1600)*100 = 16,9 2000 * 0,169 = 338Current assets (540/1600)*100 = 33,8 2000 * 0,338 = 676Fixed assets (373/1600)*100 = 23,4 2000 * 0,234 = 468Total assets (915/1600)*100 = 57,1 2000 * 0,571 = 1144Liabilities to suppliers (130/1600)*100 = 8,1 2000 * 0,081 = 162 Short-term bank loans without dependence on sales changes are taken from current balance sheet: 35

Wages, taxes and other liabilities (105/1600)*100 = 6,6 2000 * 0,066 = 132Short-term liabilities –– 329Long-term bank loans without dependence on sales changes are taken from current balance sheet: 118Registered Capital without dependence on sales changes are taken from current balance sheet: 475

Retained Profit 102Total capital and liabilities ––

1024

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Calculation of Retained Profit: (5.,6.step)

Change in Retained profit = Net income – Dividends

Retained profit Retained profit Change in of planned period = of current period + Retained profit

Net income (from aims formulation: 1.) 5% profitability of sales): 100 euro (5% from planned sales 2000 euro)

Dividends (from aims formulation: 2.) 50% from net income):50 euro (50% from net income 100 euro)

Change in Retained profit = 100 – 50 = 50 euro

Retained profit of planned period = 52 + 50 = 102 euro

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(7.step)

Calculation of additional funds needed. Disparity between higher assets and lower liabilities.

Total assets - Total capital and liabilities: 1144 – 1024 = 120 euro

(8.step)

Structure of additional funds needed in accordance with aims of financial plan : 3.) Debts from total assets – no more than 40%.

Maximal Debts = 0,4 * Total assets (planned) = 0,4 * 1144 = 458 euro

Short-term liabilities (planned) 329Long-term bank loans 118 Total debts (planned) 447

Maximal debts – Total debts (planned) = 458 – 447 = 11 euro (maximal additional debts)

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(8.step)

Structure of additional funds needed:

New long-term debt 11 New share issue (shareholder's investment) 109Total additional funds needed 102 euro

(9.step)

Plan of Balance sheet 31.12.2013

Fixed assets 468 Registered Capital(475+109)=584

Inventories 338 Retained Profit 102Receivables 226 Liabilities to suppliers 162Financial Accounts112 Short-term bank loans 35Current Assets 676 Wages, taxes and other liabilities 132

Short-term liabilities 329Long-term bank loans (118+11)=129

Total Assets 1144 Total capital and liabilities 1144

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Plan of Cash flow (9.step)

1. Operating activitiesNet income ..................................................... + 100increase in Liabilities to suppliers ..................... + 32increase in Receivables ..................................... - 46increase in Wages, taxes and other liabilities ..... +27 increase in Inventories ..................................... - 68resources from Operating activities ..................... + 159use of resources ..................................... - 114Total operating activities ..................................... + 45

2. Investment activities increase in Fixed assets ..................................... - 93

3. Financial activitiesincrease in Long-term bank loans ..................... - 11New share issue ..................................... + 109Dividends..................................................... - 50

resources from Financial activities ..................... + 120use of resources ..................................... - 50 Total financial activities ..................................... + 70

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Plan of Cash flow (9.step)

1. Operating activities + 45

2. Investment activities - 93

3. Financial activities + 70

CASH FLOW + 22

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Than you for your attention!