1. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt 6 C H A P T E R SIX Financial Forecasting Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc. 2000

2. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt What is Financial Forecasting?LT 4-2 Financial forecasting is looking ahead to develop a financial plan for the future Very important for the strategic growth of a firm

3. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt 2 Methods of Financial Forecasting:LT 4-3 –Using Pro Forma, or Projected, Financial Statements (more exact, time consuming) –Percent-of-Sales Method (less precise, easier to calculate) A short-cut, less exact, easier method of determining financing needs (The “quick and dirty” approach) Assumes that B/S accounts will maintain a constant percentage relationship to sales Often times these statements are required by lenders

4. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Figure 4-1 Development of pro forma statements Cash budge t Sales projection Production plan Pro forma income statement Pro forma balance sheet Prior balance sheet Other supportiv e budgets Capital budget 1 2 3 T 4-1

5. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Wheels Casters Quantity Sales price Sales revenue Total.......... 1,000 2,000 $30 $35 $30,000 $70,000.............. $100,000 T 4-2 Table 4-1 Projected wheel and caster sales (first six months, 2000)

6. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 4-2 Stock of beginning inventory WheelsCasters Quantity...85180 Cost....$16$20 Total value.. $1,360 $3,600 Total............$4,960 T 4-3

7. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 4-3 Production requirements for six months WheelsCasters Projected unit sales (Table 4-1)...+1,000+2,000 Desired ending inventory (assumed to represent 10% of unit sales for the time period)........+100+200 Beginning inventory (Table 4-2)... – 85–180 Units to be produced...... 1,015 2,020 T 4-3

8. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 4-4 Unit costs WheelsCasters Materials....$10$12 Labor..... 5 6 Overhead.... 3 4 Total....$18$22 T 4-3

9. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt WheelsCasters Units to be produced (Table 4-3).. 1,015 2,020 Cost per unit (Table 4-4)....$18$22 Total cost......$18,270$44,440 $62,710 T 4-3 Table 4-5 Total production costs

10. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 4-6 / Allocation of manufacturing costs and determination of gross profits Wheels Casters Combined Quantity sold (Table 4-1).. 1,000 2,000 3,000 Sales price..... $30 $35 Sales revenue.... $30,000$70,000$100,000 Cost of goods sold: Old inventory (Table 4-2) Quantity (units)... 85180 Cost per unit... $16$20 Total.....$1,360$3,600 New inventory (the remainder) Quantity (units)... 9151,820 Cost per unit (Table 4-4) $18$22 Total.....16,47040,040 Total cost of goods sold.17,83043,640$61,470 Gross profit.....$12,170$26,360$38,530 T 4-3

11. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 4-8 Pro Forma Income Statement June 30, 2001 Sales revenue.......$100,000 Cost of goods sold......61,470 Gross profit.......38,530 General and administrative expense..12,000 Operating profit (EBIT)26,530 Interest expense......1,500 Earnings before taxes (EBT)....25,030 Taxes (20%)*.......5,006 Earnings after taxes (EAT)....20,024 Common stock dividends....1,500 Increase in retained earnings....$18,524 *20 percent is applied for simplicity. T 4-4

12. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 4-9 Monthly sales pattern (first part) January February March April May June $15,000 $10,000$15,000$25,000$15,000$20,000 T 4-5

13. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt DecemberJanuary February Sales.......$12,000$15,000$10,000 Collections: (20% of current sales)..$ 3,000$ 2,000 Collections: (80% of previous month’s sales).... 9,600 12,000 Total cash receipts..$12,600$14,000 March April May June Sales.......$15,000$25,000$15,000$20,000 Collections: (20% of current sales)..$ 3,000$ 5,000$ 3,000$ 4,000 Collections: (80% of previous month’s sales.... 8,000 12,00020,00012,000 Total cash receipts..$11,000$17,000$23,000$16,000 T 4-5 Table 4-10 Monthly cash receipts (final part)

14. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 4-11 Component costs of manufactured goods Materials...1,015$10$10,150 Labor....1,01555,075 Overhead...1,01533,045 Casters Units Cost Total Combined Produced per Unit Cost Cost Materials...2,020$12$24,240$34,390 Labor....2,020 6 12,120 17,195 Overhead...2,0204 8,080 11,125 $62,710 Wheels Units Cost Total Produced per UnitCost T 4-6

15. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Total TimeAverage CostsFrameMonthly Cost Materials...$34,3906 months$5,732 Labor.... 17,1956 months 2,866 Overhead... 11,1256 months 1,854 T 4-6 Table 4-12 Average monthly manufacturing costs

16. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 4-13 Summary of all monthly cash payments (first part) December January February From Table 4-12: Monthly material purchase..$4,500$5,732$5,732 Payment for material (prior month’s purchase)..$4,500$5,732 Monthly labor cost....2,8662,866 Monthly overhead....1,8541,854 From Table 4-8: General and administrative expense ($12,000 over 6 months).....2,0002,000 Interest expense..... Taxes (two equal payments). Cash dividend..... Also: New equipment purchases..8,000 Total payments.....$11,220$20,452 T 4-6

17. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 4-13 Summary of all monthly cash payments (final part) March April May June From Table 4-12: Monthly material purchase..$5,732$5,732$5,732$5,732 Payment for material (prior month’s purchase)..$5,732$5,732$5,732 $5,732 Monthly labor cost....2,8662,8662,866 2,866 Monthly overhead....1,8541,8541,854 1,854 From Table 4-8: General and administrative expense ($12,000 over 6 months)......2,0002,000 2,000 2,000 Interest expense.....1,500 Taxes (two equal payments)..2,5032,503 Cash dividend......1,500 Also: New equipment purchases.. 10,000 Total payments.....$14,955$12,452$12,452 $27,953 T 4-6

18. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt January February March Total receipts (Table 4-10)..$12,600$14,000$11,000 Total payments (Table 4-13).11,22020,45214,955 Net cash flow.....$ 1,380 ($ 6,452) ($ 3,955) April May June Total receipts (Table 4-10)..$17,000$23,000$16,000 Total payments (Table 4-13).12,45212,45227,953 Net cash flow.....$ 4,548$10,548 ($11,953) T 4-7 Table 4-14 Monthly cash flow

19. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 4-15 Cash budget with borrowing and repayment 1.Net cash flow......$1,380($6,452. )($3,955. )$4,548$10,548($11,953. ) 2.Beginning cash balance..5,000.*6,3805,0005,0005,00011,069 3.Cumulative cash balance..6,380(72. )1,0459,548 15,548 (884. ) 4.Monthly loan or (repayment) ---5,0723,955 (4,548. )(4,479. ). 5,884 5.Cumulative loan balance.. ---5,0729,0274,479---5,884 6.Ending cash balance...6,3805,0005,0005,00011,0695,000 Jan. Feb. March April MayJune * We assume the Goldman Corporation has a beginning cash balance of $5,000 on January 1, 2000, and it desires a minimum monthly ending cash balance of $5,000. T 4-7

20. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 4-16 Balance Sheet December 31, 2000 Assets Current assets: Cash.............$ 5,000 Marketable securities........3,200 Accounts receivable.........9,600 Inventory............4,960 Total current assets........22,760 Plant and equipment..........27,740 Total assets............$50,500 Liabilities and Stockholders’ Equity Accounts payable..........$ 4,500 Notes payable............0 Long-term debt...........15,000 Common stock...........10,500 Retained earnings.......... 20,500 Total liabilities and stockholders’ equity....$50,500 T 4-8

21. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Figure 4-2 Development of a Pro Forma Balance Sheet Pro forma balance sheet Prior balance sheet (Unchanged items) Marketable securities Long-term debt Common stock Pro froma income statement analysis Inventory Retained earnings Cash budget analysis Cash Accounts receivable Plant and equipment Accounts payable Notes payable T 4-9

22. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 4-17 Pro Forma Balance Sheet June 30, 2001 Assets Current assets: 1.Cash............$ 5,000 2.Marketable securities........3,200 3.Accounts receivable.........16,000 4.Inventory............6,200 Total current assets........30,400 5.Plant and equipment........45,740 Total assets............$76,140 Liabilities and Stockholders’ Equity 6.Accounts payable.........$ 5,732 7.Notes payable..........5,884 8.Long-term debt.........15,000 9.Common stock..........10,500 10.Retained earnings.........39,024 Total liabilities and stockholders’ equity....$76,140 T 4-10

23. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt HOWARD CORPORATION Balance Sheet and Percent-of-Sales Table AssetsLiabilities and Stockholders’ Equity Cash......$ 5,000Accounts payable...$ 40,000 Accounts receivable..40,000Accrued expenses...10,000 Inventory.....25,000 Notes payable...15,000 Total current assets.70,000 Common stock...10,000 Equipment.... 50,000 Retained earnings...45,000 Total assets.... $120,000 Total liabilities and stockholders’ equity..$120,000 $200,000 sales Percent of Sales Cash......2.5% Accounts payable...20.0% Accounts receivable..20.0 Accrued expenses... 5.0 Inventory.....12.5 25.0% Total current assets.35.0 Equipment....25.0 60.0% T 4-11 Table 4-18

24. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Percent-of-Sales MethodLT 4-6 Ex: If sales increase from $200,000 to $300,000, profit margin 6% and dividend 50% Required new funds = ( A / S ) (  S ) – ( L /S ) (  S ) ‑ PS2 ( 1 – D ) A/S = percentage relationship of variable assets to sales  S = change in sales L/S = percentage relationships of variable liabilities to sales P = profit margin S = new sales level D = payout ratio. RNF = 60 % ( 100,000 ) – 25 % ( 100,000 ) – 6 % ( 300,000) ( 1- 50% ) = 26,000 required sources of new fund