1. Business Finance Michael Dimond

2. Michael Dimond School of Business Administration Module H: Forecasting for Financial Management Financial planning process Building pro forma financial statements Analyzing & using pro forma financials You can skip P4-7 & P4-8 in the homework (cash receipts & cash disbursements) You can skip P4-19 & P4-20 in the homework (comprehensive pro forma statement problems)

3. Michael Dimond School of Business Administration Financial Planning Process Plans are developed according to purpose Strategic Plan - long term (e.g. 5-year) Necessarily less specific than operating plan Tied to strategic goals Strategic plan guides CapEx budget Operating Plan - short term (e.g. 1-year) Based on forecasts of sales & capacity Operating Plan (O.P.) provides operating budget & cash budget Used with pro forma financial statements to predict profit & cash flow Plans are adjusted as needed Strategic plan usually updated annually (or sooner, if events warrant) Operating plan usually updated quarterly

4. Michael Dimond School of Business Administration Pro Forma Financial Statements Pro forma = “in the form of” Pro forma financials use the form of a balance sheet and income statement to present forecast information and support financial planning & analysis (FP&A) Profit is the foundation of cash flow (see 4.1 Analyzing the firm's cash flow) Cash flow is usually forecast through budgets: Capital budget, cash budget, operating budget, etc. Profit comes from operations Pro forma income statement Assets support operations Pro forma balance sheet Pro forma financials are based on past performance and adjusted for expectations Common-size financials Marketing forecasts Capacity analysis CapEx budgets

5. Michael Dimond School of Business Administration Preparing the Pro Forma Income Statement Start with sales forecast Volume x Price = Revenue Estimate direct costs Volume x Variable Cost per Unit = Total Variable Costs OR COGS as % of Sales (from common size income statement) Estimating other costs Percent-of-sales method uses data from common-size income statement Not everything grows at the same rate as sales (e.g. Depreciation)

6. Michael Dimond School of Business Administration Preparing the Pro Forma Balance Sheet Three approaches Percent-of-sales method Simplest method: All line items are estimated as a percent of sales Not necessarily accurate for all items (e.g. PP&E) Judgmental Approach Estimate specific line items Determine imbalance (i.e. does A=L+SE?) “Plug” the imbalance with external funds (debt or equity brought into the firm) External funds figure is frequently abbreviated EFR, EFN, AFR, AFN Total Asset Turnover suggest what total assets should be TAT = Sales/Total Assets, :. Sales/TAT = Total Assets Forecasted Estimate line item values based on common-size balance sheet Consider how stable the common-size B/S has been over past years

7. Michael Dimond School of Business Administration Evaluating Pro Forma Financials Forecasts are not certain Check the arithmetic & the internal logic Common-size financials (vertical analysis) Rates of growth of line items (horizontal analysis) Ratio analysis (what questions do you need to answer?) Examine OCF & FCF compared to history How would you value a company based on pro forma financial information?

8. Michael Dimond School of Business Administration Example: Sources & Uses of cash

9. Michael Dimond School of Business Administration Example: Pro Forma IS with assumptions

10. Michael Dimond School of Business Administration Spreadsheet Assignment #3: Smithfield Forecast Assume Smithfield Foods, when acquired, will have sales growth of 15% next year. Forecast their Income Statement and Balance Sheet based on the Percent of Sales method.