Chapter 4

Financial Planning and

Forecasting
Forecasting Sales
Projecting the Assets and Internally
Generated Funds
Projecting Outside Funds Needed
Deciding How to Raise Funds
4-1
Preliminary Financial Forecast:
Balance Sheets (Assets)
2008 2009E
Cash and equivalents $ 20 $ 25
Accounts receivable 240 300
Inventories 240 300
Total current assets $ 500 $ 625
Net fixed assets 500 625
Total assets $1,000 $1,250

4-2
Preliminary Financial Forecast: Balance
Sheets (Liabilities and Equity)
2008 2009E
Accts payable & accrued liab. $ 100 $ 125
Notes payable 100 190
Total current liabilities 200 315
Long-term debt 100 190
Common stock 500 500
Retained earnings 200 245
Total liabilities & equity $1,000 $1,250

4-3
Preliminary Financial Forecast:
Income Statements
2008 2009E
Sales $2,000.0 $2,500.0
Less: Variable costs 1,200.0 1,500.0
Fixed costs 700.0 875.0
EBIT $ 100.0 $ 125.0
Interest 16.0 16.0
EBT $ 84.0 $ 109.0
Taxes (40%) 33.6 43.6
Net income $ 50.4 $ 65.40
Dividends (30% of NI) $15.12 $19.62
Addition to retained earnings $35.28 $45.78
4-4
 Key Financial Ratios

2008 2009E Ind Avg Comment

Basic earning power 10.00% 10.00% 20.00% Poor
Profit margin 2.52% 2.62% 4.00% Poor
Return on equity 7.20% 8.77% 15.60% Poor
Days sales outstanding 43.8 days 43.8 days 32.0 days Poor
Inventory turnover 8.33x 8.33x 11.00x Poor
Fixed assets turnover 4.00x 4.00x 5.00x Poor
Total assets turnover 2.00x 2.00x 2.50x Poor
Debt/assets 30.00% 40.40% 36.00% OK
Times interest earned 6.25x 7.81x 9.40x Poor
Current ratio 2.50x 1.99x 3.00x Poor
Payout ratio 30.00% 30.00% 30.00% OK

4-5
Key Assumptions in Preliminary
Financial Forecast for NWC
Operating at full capacity in 2008.
Each type of asset grows proportionally with
sales.
Payables and accruals grow proportionally with
sales.
2008 profit margin (2.52%) and payout (30%)
will be maintained.
Sales are expected to increase by $500 million.
(%DS = 25%)

4-6
Determining Additional Funds
Needed Using the AFN Equation
AFN = (A0*/S0)DS (L0*/S0)DS M(S1)(RR)
= ($1,000/$2,000)($500)
($100/$2,000)($500)
0.0252($2,500)(0.7)
= $180.9 million

4-7
Managements Review of the
Financial Forecast
Consultation with some key managers has
yielded the following revisions:
Firm expects customers to pay quicker next year,
thus reducing DSO to 34 days without affecting
sales.
A new facility will boost the firms net fixed
assets to $700 million.
New inventory system to increase the firms
inventory turnover to 10x, without affecting
sales.

4-8
Managements Review of the
Financial Forecast
These changes will lead to adjustments in the
firms assets and will have no effect on the
firms liabilities and equity section of the
balance sheet or its income statement.

4-9
Revised (Final) Financial Forecast:
Balance Sheets (Assets)
2008 2009F
Cash and equivalents $ 20 $ 67
Accounts receivable 240 233
Inventories 240 250
Total current assets $ 500 $ 550
Net fixed assets 500 700
Total assets $1,000 $1,250

4-10
Key Financial Ratios Final
Forecast
2008 2009F Ind Avg Comment
Basic earning power 10.00% 10.00% 20.00% Poor
Profit margin 2.52% 2.62% 4.00% Poor
Return on equity 7.20% 8.77% 15.60% Poor
Days sales outstanding 43.8 days 34.0 days 32.0 days OK
Inventory turnover 8.33x 10.00x 11.00x OK
Fixed assets turnover 4.00x 3.57x 5.00x Poor
Total assets turnover 2.00x 2.00x 2.50x Poor
Debt/assets 30.00% 40.40% 36.00% OK
Times interest earned 6.25x 7.81x 9.40x Poor
Current ratio 2.50x 1.98x 3.00x Poor
Payout ratio 30.00% 30.00% 30.00% OK

4-11
What was the net investment in
capital?
Capital2009 NWC Net FA
$625 $125 $625
$1,125

Capital2008 $900

Net investment in capital $1,125 $900

$225

4-12
How much free cash flow is expected to
be generated in 2009?

FCF = EBIT(1 T) Net investment in capital

= $125(0.6) $225
= $75 $225
= -$150

4-13
Suppose Fixed Assets Had Been Operating at
Only 85% of Capacity in 2008

The maximum amount of sales that can be

supported by the 2008 level of assets is:

Capacity sales Actual sales/ % of capacity

$2,000/0.85 $2,353

2009 forecast sales exceed the capacity sales,

so new fixed assets are required to support
2009 sales.

4-14
How can excess capacity affect the
forecasted ratios?
Sales wouldnt change but assets would be
lower, so turnovers would improve.
Less new debt, hence lower interest and
higher profits
EPS, ROE, debt ratio, and TIE would improve.

4-15
How would the following items
affect the AFN?
Higher dividend payout ratio?
Increase AFN: Less retained earnings.
Higher profit margin?
Decrease AFN: Higher profits, more retained
earnings.
Higher capital intensity ratio?
Increase AFN: Need more assets for given sales.
Pay suppliers in 60 days, rather than 30 days?
Decrease AFN: Trade creditors supply more
capital (i.e., L0*/S0 increases).

4-16