Financial Planning & Forecasting

Timothy R. Mayes, Ph.D.

FIN 3300: Chapter 4

The Ingredients of a Financial Plan

A financial plan consists of several ingredients

Expectations about the economic environment A sales forecast Pro forma (forecasted) financial statements Asset requirements Required new financing Cash Budget

We will focus on developing the pro formas and the cash budget
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Forecasting: The % of Sales Method

The most basic method of forecasting financial statements (income statements and balance sheets) is the percent of sales method This method assumes that certain expenses, assets, and liabilities maintain a constant relationship to the level of sales There are two inputs to this method:

A sales forecast (exogenous) The percentages which are assumed to be constant

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Forecasting the Income Statement

Elvis Products International Pro-forma Income Statement For the Year Ended Dec. 31, 1997 ($ 000's)
Sales Cost of Goods Sold Gross Profit No change Selling and G&A Expenses Fixed Expenses Depreciation Expense EBIT Interest Expense Earnings Before Taxes Taxes @ 40% Net Income *Forecasted 1998%* 1998* 1997% 100.00% 4,300.00 100.00% 83.93% 3,609.11 84.42% 690.89 15.58% 7.79% 334.80 8.58% 100.00 2.60% 20.00 0.52% 236.09 3.89% 76.00 1.97% 160.09 1.91% 64.04 0.77% 96.05 1.15% 1997 1996% 3,850.00 100.00% 3,250.00 83.45% 600.00 16.55% 330.30 6.99% 100.00 2.91% 20.00 0.55% 149.70 6.09% 76.00 1.82% 73.70 4.27% 29.48 1.71% 44.22 2.56% 1996 3,432.00 2,864.00 568.00 240.00 100.00 18.90 209.10 62.50 146.60 58.64 87.96

Types of Assets and Liabilities

There are two types of assets:

Current assets are the firms short-term assets and can generally be expected to vary directly with sales Fixed assets are the firms long-term assets and generally do not vary directly with sales

There are two types of liabilities:

Spontaneous liabilities are those that occur naturally during the ordinary course of doing business. These sources vary directly with sales Discretionary liabilities are those that require a special effort for the firm to obtain. These sources do not vary directly with sales
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Forecasting the Balance Sheet

Elvis Products International Balance Sheet As of Dec. 31, 1997
Assets Cash and Equivalents Accounts Receivable Inventory Total Current Assets Plant & Equipment Accumulated Depreciation Net Fixed Assets Total Assets Liabilities and Owner's Equity Accounts Payable Short-term Notes Payable Other Current Liabilities Total Current Liabilities Long-term Debt Total Liabilities Common Stock Retained Earnings Total Shareholder's Equity Total Liabilities and Owner's Equity Discretionary Financing Needed * Forecasted Other Information Sales Dividend 1998* 52.00 444.51 914.90 1411.40 527.00 186.20 1997% 1.35% 10.44% 21.71% 33.51% 13.69% 4.32% 9.37% 42.88% 4.55% 5.84% 3.64% 14.03% 11.03% 25.06% 11.95% 5.87% 17.82% 42.88% Surplus Actual 3850.00 Actual 3432.00 1997 52.00 402.00 836.00 1290.00 527.00 166.20 1996% 1.68% 10.23% 20.84% 32.75% 14.31% 4.26% 10.05% 42.80% 4.24% 5.83% 3.96% 14.03% 9.42% 23.46% 13.40% 5.94% 19.34% 42.80% 1996 57.60 351.20 715.20 1124.00 491.00 146.20

340.80
1752.20 189.05 225.00 163.38 577.43 424.61 1002.04 460.00 300.04 760.04 1762.08 -9.88 Forecast 4300.00 22.00

360.80
1650.80 175.20 225.00 140.00 540.20 424.61 964.81 460.00 225.99 685.99 1650.80

344.80
1468.80 145.60 200.00 136.00 481.60 323.43 805.03 460.00 203.77 663.77 1468.80

Discretionary Financing Needed

Ordinarily, the pro-forma balance sheet will not balance! This is intentional, and the amount needed to make it balance is referred to as the Discretionary Financing Needed, DFN (or External Financing Needed, EFN) This is a plug figure that represents the amount of discretionary financing that the firm will need to obtain in order to support its forecasted level of sales

The Cash Budget

A cash budget is a document which shows the expected cash inflows and outflows for a chosen time period (say, 6 or 9 months). The benefits of the cash budget are:

It provides an estimate of the ending cash balance in each month It provides estimates and sources of the cash inflows and outflows It provides a basis of comparison against which managers can be evaluated
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Parts of the Cash Budget

In a simple cash budget, there are three parts:

The Worksheet Area The Inflows and Outflows The calculation of the ending cash balance

Essentially, a cash budget starts with the beginning cash balance, adds expected cash inflows, and subtracts any expected cash outflows. The result is the expected ending cash balance.
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Cash Budget: An Example

Here is the information required to assemble the cash budget for Bithlo Barbecues:
Expected sales are on the next slide 40% of sales are for cash. Of the remainder, 75% is collected the following month, and 25% is collected two months after the sale. Inventory purchases are equal to 50%of the next months sales. 60% of purchases are paid for the following month, and the remainder one month later. Wages are 20% of sales. Leasing expenses is $10,000 per month. Interest payments of $30,000 are due in June and September. A $50,000 dividend payment will be made in June. Taxes of $25,000 are due in June and September. A $200,000 capital improvement will be paid for in July. The company must keep a minimum cash balance of $15,000.

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Cash Budget: Worksheet Area

The worksheet area is where we gather certain key numbers which will be used in the rest of the cash budget.
Bithlo Barbeques Cash Budget For the Period June to September 1998 April May June July August September October 291,000 365,000 387,000 329,000 238,000 145,000 92,000 40% 45% 15% 154,800 131,600 95,200 164,250 174,150 148,050 43,650 54,750 58,050 362,700 360,500 301,300 50% 182,500 193,500 164,500 119,000 72,500 60% 40% 116,100 98,700 71,400 73,000 77,400 65,800 189,100 176,100 137,200 58,000 107,100 49,350 214,450 46,000 43,500 47,600 91,100

Sales Collections: Cash First Month Second Month Total Collections Purchases Payments: First Month Second Month Total Payments

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Cash Budget: Inflows & Outflows

This section shows all of the cash collections and disbursements. Note that these are only cash inflows and outflows. The cash budget is not the same as the income statement.
Collections Less Disbursements: Inventory Payments Wages Lease Payment Interest Dividend (Common) Taxes Capital Outlays Total Disbursement 362,700 360,500 301,300 214,450 91,100 29,000 10,000 30,000 0 25,000 0 185,100 20% 189,100 176,100 137,200 77,400 65,800 47,600 10,000 10,000 10,000 30,000 0 0 50,000 0 0 25,000 0 0 0 200,000 0 381,500 451,900 194,800

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Cash Budget: The Ending Cash Balance

This section is where we calculate the ending cash balance and determine if we will need to borrow for each month.
Beginning Cash Balance Collections - Disbursement Unadjusted Cash Balance Current Borrowing Needed Ending Cash Balance Notes: Minimum Acceptable Cash 15,000 20,000 0 20,000 20,000 (18,800) 1,200 13,800 15,000 15,000 15,000 (91,400) 106,500 (76,400) 121,500 91,400 0 15,000 121,500 121,500 29,350 150,850 0 150,850

Note that Bithlo Barbecues will need to borrow in June and July, and will have excess cash in August and September.

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