Financial Forecasting Forecasting and Pro Forma Analysis l

Financial Forecasting

Forecasting and Pro Forma Analysis l l Timing of financial needs Amount of financial needs Flow of funds Check the covenants

Pro forma Income Pro forma Balance Plug Figure Statement Sheet Depreciation Capital Expenditures Financing Options Change in Net Plant & Equipment Short-Term Debt Long-Term Debt Sales Forecast Working Capital Accounts Net Income Dividend Policy Change in Retained Earnings External Financing Required

Steps in Financial Forecasting l l l Forecast sales Project the assets needed to support sales Project internally generated funds Project outside funds needed Decide how to raise funds See effects of plan on ratios and stock price

Sales Forecast Seasonal changes Business cycle l l Market segment l l Recession Expansion High growth Contraction Inflation

2001 Balance Sheet (Millions of $) Cash & sec. $20 Accts. pay. & accruals $100 Accounts rec. 240 Notes payable 100 Inventories 240 Total CL $200 Total CA $500 L-T debt 100 Common stk 500 Net fixed Retained Assets 500 Earnings 200 Total assets $1000 Total claims $1000

2001 Income Statement (Millions of $) Sales $2, 000. 00 Less: COGS (60%) SGA costs 1, 200. 00 700. 00 EBIT $100. 00 Interest 16. 00 EBT $84. 00 Taxes (40%) 33. 60 Net income $50. 40 Dividends (30%) $15. 12 Add’n to RE 35. 28

AFN (Additional Funds Needed) Key Assumptions l Operating at full capacity in 2001. l Each type of asset grows proportionally with sales. l Payables and accruals grow proportionally with sales. l 2001 profit margin (2. 52%) and payout (30%) will be maintained. l Sales are expected to increase by $500 million. (%ΔS = 25%)

AFN (Additional Funds Needed) l AFN= (A*/S 0) ΔS - (L*/S 0) ΔS - M(S 1)(1 - d) = ($1, 000/$2, 000)($500) - ($100/$2, 000)($500) 0. 0252($2, 500)(1 - 0. 3) = $180. 9 million.

Projecting Pro Forma Statements with the Percent of Sales Method: l l l l Project sales based on forecasted growth rate in sales Forecast some items as a percent of the forecasted sales Costs Cash Accounts receivable Items as percent of sales Inventories Net fixed assets Accounts payable and accruals Choose other items Debt (which determines interest) Dividends (which determines retained earnings) Common stock

Percent of Sales: Inputs 2001 2002 Actual Proj. COGS/Sales 60% SGA/Sales 35% Cash/Sales 1% 1% Acct. rec. /Sales 12% Inv. /Sales 12% Net FA/Sales 25% 5% 5% AP & accr. /Sales

Other Inputs Percent growth in sales 25% Growth factor in sales (g) 1. 25 Interest rate on debt 8% Tax rate 40% Dividend payout rate 30%

2002 1 st Pass Income Statement 2002 2001 Factor 1 st Pass Sales $2, 000 g=1. 25 $2, 500 Less: COGS Pct=60% 1, 500 Pct=35% 875 $125 16 16 $109 Taxes (40%) 44 Net. Income $65 Div. (30%) $19 Add. to RE $46 SGA EBIT Interest EBT

2002 1 st Pass Balance Sheet (Assets) Forecasted assets are a percent of sales. 2002 Sales = $2, 500 2002 Factor 1 st Pass Cash Pct= 1% $25 Accts. rec. Pct=12% 300 Inventories Pct=12% 300 Total CA $625 Net FA Pct=25% $625 Total assets $1250

2002 1 st Pass Balance Sheet (Claims) 2002 Sales = $2, 500 2002 2001 Factor 1 st Pass AP/accruals Pct=5% $125 Notes payable 100 $225 L-T debt 100 Common stk. 500 Ret. earnings 200 +46* 246 Total claims $1, 071 Total CL

What are the additional funds needed (AFN)? l l Forecasted total assets Forecasted total claims Forecast AFN = $1, 250 = $1, 071 = $ 179 NWC must have the assets to make forecasted sales. The balance sheets must balance. So, we must raise $179 externally

How will the AFN be financed? l l l Additional notes payable= 0. 5 ($179) = $89. 50 $90. Additional L-T debt= 0. 5 ($179) = $89. 50 $89. But this financing will add 0. 08($179) = $14. 32 to interest expense, which will lower NI and retained earnings.

2002 2 nd Pass Income Statement 1 st Pass Feedback 2 nd Pass Sales $2, 500 Less: COGS $1, 500 875 $125 16 +14 30 $109 $95 Taxes (40%) 44 38 Net income $65 $57 Div (30%) $19 $17 Add. to RE $46 $40 SGA EBIT Interest EBT

2002 2 nd Pass Balance Sheet (Assets) 1 st Pass AFN 2 nd Pass Cash $25 Accts. rec. 300 Inventories 300 $625 Net FA 625 Total assets $1, 250 Total CA

2002 2 nd Pass Balance Sheet (Claims) 1 st Pass Feedback 2 nd Pass AP/accruals $125 Notes payable 100 +90 190 Total CL $225 $315 L-T debt 100 +89 189 Common stk. 500 Ret. earnings 246 -6 240 Total claims $1, 071 $1, 244

Results After the Second Pass l l l Forecasted assets= $1, 250 (no change) Forecasted claims= $1, 244 (higher) 2 nd pass AFN = $ 6 (short) Cumulative AFN= $179 + $6 = $185. The $6 shortfall came from the $6 reduction in retained earnings. Additional passes could be made until assets exactly equal claims.

Financial Forecasting and Firm Capacity Balance Sheet ($ in Millions) Assets 1999 Liabilities and Owners' Equity 1999 Current Assets Current Liabilities Cash 200 Accounts Payable 400 Accounts Receivable 400 Notes Payable 400 Inventory 600 Total Current Liabilities 800 Total Current Assets 1200 Long-Term Liabilities Long-Term Debt 500 Fixed Assets Total Long-Term Liabilities 500 Net Fixed Assets 800 Owners' Equity Common Stock ($1 Par) 300 Retained Earnings 400 Total Owners' Equity 700 Total Assets 2000 Liab. and Owners' Equity 2000

Income Statement ($ in Millions), 1999 Sales 1200 Cost of Goods Sold 900 Taxable Income 300 Taxes Net Income Dividends Addition to Retained Earnings 90 210 70 140

Full Capacity l The equation used to calculate EFN when fixed assets are being utilized at full capacity is given below.

l l l l S 0 = Current Sales, S 1 = Forecasted Sales = S 0(1 + g), g = the forecasted growth rate is Sales, A*0 = Assets (at time 0) which vary directly with Sales, L*0 = Liabilities (at time 0) which vary directly with Sales, PM = Profit Margin = (Net Income)/(Sales), and b = Retention Ratio = (Addition to Retained Earnings)/(Net Income).

Full Capacity Example l l Given that Fixed Assets are being utilized at full capacity and the forecasted growth rate in Sales is 25%. Forecasted Sales: S 1 = 1200(1 +. 25) = $1500

Excess Capacity l l If the firm has excess capacity in its Fixed Assets then the Fixed Assets may not have to increase in order to support the forecasted sales level. Moreover, if the Fixed Assets do need to increase in order to support the forecasted sales level, then they will not have to increase by as much as would be required if they were being used at full capacity. If Forecasted Sales are less than Full Capacity Sales, then fixed assets do not need to increase to support the forecasted sales level. On the other hand, if Forecasted Sales are greater than Full Capacity Sales, then Fixed Assets will have to increase.

Case 1: S 1 Less Than SFC l l Given that Fixed Assets are currently being utilized at 60% of capacity and the forecasted growth rate in Sales is 25%. S 1 = 1200(1 +. 25) = $1500 SFC = 1200/. 60 = $2000 Forecasted Sales are less than Full Capacity Sales the EFN can be found in one step. Here A*0 is equal to Total Current Assets which equals $1200.

Case 2: S 1 Greater Than SFC l l When the Forecasted Sales are greater than Full Capacity Sales, EFN can be determined in two steps. The first step, EFN 1, finds the EFN needed to get to Full Capacity Sales. The second step, EFN 2, finds the additional EFN to get from Full Capacity Sales to the Forecasted Sales. The total EFN is simply EFN 1 plus EFN 2.

Excess Capacity Example: S 1 > SFC l l l Given that Fixed Assets are currently being utilized at 90% of capacity and the forecasted growth rate in Sales is 25%. S 1 = 1200(1 +. 25) = $1500 SFC = 1200/. 90 = $1333. 33