Financial Planning and Forecasting

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

2006 Sales 10,000, Total Assets 8,000,000 Want to project 2007 financial statements based on a 30% increase in sales. Projected 2007 Sales 10,000,000(1.30) = $13,000,000

Known as percentage of sales approach. Zippy is operating at full capacity in Each type of asset grows proportionally with sales. Accounts payable and accruals grow proportionally with sales profit margin (15%) and payout (30%) will be maintained. Sales are expected to increase by $3 million. (% S = 30%)

Projected 2007 Assets 10,400 Projected 2007 Liab&Eq 9,815 Additional Financing Needed 585 Assume Zippy will raise 40% of additional financing needed through Notes Payable and the rest (60%) through Long-term Debt. Addition to Notes Payable 234 Addition to Long-term Debt351

AFN= (A*/S) S - (L*/S) S - M(S 1 ) (RR) RR = retention ratio = 1 – dividend payout AFN= ($8,000 / $10,000) ($3,000) - ($1,500 / $10,000) ($3,000) ($13,000) (1- 0.3) = $585.

2006 Current1.67 Quick1.04 DSO73.00 InvTurn6.67 debt/assets50.0% FAT2.50 TAT1.25 ROA18.8% ROE37.5% Proj2007 Current1.69 Quick1.05 DSO73.00 InvTurn6.67 debt/assets48.4% FAT2.50 TAT1.25 ROA18.8% ROE36.3%

Sales growth: higher growth leads to more AFN Capital Intensity Ratio (A/S): higher A/S leads to more AFN Spontaneous liabilities to sales ratio (L/S): higher ratio means more internal financing and less AFN Profit Margin (M): higher profit margin means higher net income and less AFN Retention Ratio: higher ratio means more retained earnings and less AFN

Assume Zippys net fixed assets were operating at 80% capacity and current assets at 100% capacity in How would Zippys additional financing needed change? Need to know what level of sales Zippys existing net fixed assets can support or produce = Full Capacity Sales

Full Capacity Sales (FCS) = Current Sales/% of Capacity Zippys 2006 Sales = 10,000 80% Capacity Full Capacity Sales = 10,000/0.8 = 12,500 Target FA Ratio = 2006 FA/ FCS 4000/12,500 = 0.32 = 32% Proj FA = 0.32(proj sales) = 0.32(13,000) = 4,160

New AFN is -455 This means Zippy can reduce debt to make the projected balance sheet balance or just add the surplus financing to the cash account.

We have assumed a constant profit margin which means interest expense is assumed to increase proportionally with sales. A companys financing decision may cause the actual interest expense to be higher or lower than this projection. If the additional financing decision causes interest expense to be higher, then even more financing will be needed.

Instead of assuming individual assets will remain a constant percentage of sales, a company can modify their forecast by: using regression analysis to project individual asset accounts. using target financial ratios to project individual asset accounts.

Zippys 2006 DSO is 73 days, they plan to improve their collection policy and lower their DSO to 60 days in What is their projected 2007 receivables (projected sales 13,000,000) and reduction in AFN vs. their current DSO? DSO = Receivables/(sales/365) Receivables = DSOx(sales/365)

New Receivables projection = 60 x (13,000,000/365) = 2,136,986 Our original projection = 73 x (13,000,000/365) = 2,600,000 Reduction in projected receivables = 2,600,000 – 2,136,986 = 463, ,014 is also the reduction in AFN.

1 Unless stated otherwise, all expenses are assumed to increase proportionally with sales, yielding the same profit margin At full capacity, all assets increase proportionally with sales Only accounts payable and accrued taxes and wages(accruals) increase proportionally with sales Forecasted Retained Earnings are added to the previous years b/s acct.

2 With financial statement forecast, AFN = projected total assets - projected liab&eq Proj. spontaneous assets and liabilities = last years ratio of each account to sales times forecasted sales AFN is plug amount that makes the balance sheet balance With AFN equation, AFN = projected change in assets - proj. change in liabilities - projected new retained earnings

3 If fixed assets are operating at less than 100% capacity, determine full capacity sales Full capacity sales = old sales/ % of capacity If projected sales < full capacity sales, no increase in fixed assets is needed If projected sales > full capacity sales, then proj. FA = old FA/Full capacity sales times projected sales