1. 4 Financial Planning and Forecasting ©2006 Thomson/South-Western

2. 2 Introduction This chapter discusses techniques for forecasting a company’s future cash flows and need for funds.

3. 3 Strategic and Operational Planning Strategic planning is long-range in nature and deals with the overall direction of the firm. Operational planning serves as a blueprint for detailing the resources needed to meet the strategic goals. Financial forecasting is an important component of operational planning!

4. 4 Corporate Planning

5. 5 The Concept of Cash Flow Reported net income can be modified to produce a measure of after-tax cash flow from current operations to pay for: 1. Capital expenditures 2. Dividends 3. Retirement of debt

6. 6 Computing After-tax Cash Flow After-tax cash flow = Earnings after taxes + Depreciation expense + Deferred Taxes Note—Net income produces a measure of cash flow when it is adjusted for non-cash expenses!

7. 7

8. 8

9. 9 What are Non-cash Expenses? Depreciation is a non-cash expense because it represents an allocation of the original cost of an asset to a particular year, not a cash outlay. Deferred taxes is a non-cash expense because it represents the difference between actual taxes paid and the tax expense reported on the income statement.

10. 10 Example of After-tax Cash Flow Ellwood Appliance Company has net income of $12 million, on a depreciation expense of $10 million and deferred taxes of $800,000. After-tax cash flow for the company is computed as: $12.0 + 10.0 + 0.80 = $22.8 million

11. 11 Forecasting Methods Percent of sales Cash budgets Pro forma statement of cash flow Computerized financial forecasting models Forecasting with financial ratios

12. 12 Percent of Sales Forecasting Relies on a forecast of sales Obtains estimates of variables as a percent of sales Forecasted Current Liability Increases – Forecasted Asset Increases = Total Financing Needed Tied to a sales increase Dividends– Forecasted EAT = Increased Retained Earnings Portion of financing needed internally

13. 13

14. 14 Additional Financing Needed The difference between the total financing needed and the internal financing provided: Additional Financing Needed = External [ A/S(ΔS) – CL/S(ΔS) ] – [EAT – D]

15. 15 Cash Budgeting A financial plan Projects receipts and disbursements over future periods of time.  Receipts on credit sales lag projected sales.  Payments for purchases depend on How much the purchase precedes the sale Credit terms  Other scheduled receipts and disbursements Long-term loans Capital expenditures Dividend payments Wages Salaries Rent…

16. 16

17. 17

18. 18 Pro Forma Statement of Cash Flows Measures the increases (and decreases) in cash and cash equivalents  CFs expected from operations  CFs expected from investing activities  CFs expected from financing activities Add cash and cash equivalents at the beginning of year Sums up to expected cash and cash equivalents at the end of year

19. 19

20. 20 Cash Budgeting Tools Check out the interactive tools for cash budgeting at this Web site: http://www.edgeonline.com/ Check out business planning with a cash flow forecast at this Web site: http://www.sb.gov.bc.ca

21. 21 Computerized Forecasting and Financial Planning Deterministic model  Uses single-value forecasts of each financial variable Probabilistic models  Utilize probability distributions for input data Optimization models  Choose the optimal levels of some variables

22. 22 Forecasting with Financial Ratios Forecasting bankruptcy with discriminant analysis 5 ratios  Net working capital/Total assets  Retained earnings/Total assets  EBIT/Total assets  Market value equity/Book value total debt  Sales/Total assets