1. Slide 1 Financial Forecasting, Planning, and Budgeting Financial Forecasting: 1. Project sales revenues and expenses 2. Estimate current assets and fixed assets necessary to support projected sales Percent of sales forecast

2. Slide 2 Percent of Sales Method Suppose this year’s sales will total $32 million Next year, we forecast sales of $40 million Net income should be 5% of sales Dividends should be 50% of earnings

3. Slide 3 Construction of Forecast Balance Sheet All asset accounts are assumed to vary proportionally with sales Accounts Payable and Accrued Expenses are the Current Liability accounts that vary with sales directly – remember liabilities and equity are financing sources for a firm Because of this Accounts Payable and Accrued Expenses are called spontaneous sources of financing

4. Slide 4 Percent of Sales Method (Continued) This year % of $32m Assets Current Assets$8m25% Fixed Assets$16m50% Total Assets$24m Liab. and Equity Accounts Payable$4m12.5% Accrued Expenses$4m12.5% Notes Payable$1mn/a Long Term Debt$6mn/a Total Liabilities$15m Common Stock$7mn/a Retained Earnings$2m Equity$9m Total Liab. & Equity$24m

5. Slide 5 Percent of Sales Method (Continued) Next year % of $40m Assets Current Assets$10m25% Fixed Assets$20m50% Total Assets$30m Liab. and Equity Accounts Payable$5m12.5% Accrued Expenses$5m12.5% Notes Payable$1mn/a Long Term Debt$6mn/a Total Liabilities$17m Common Stock$7mn/a Retained Earnings??? Equity??? Total Liab. & Equity

6. Slide 6 Predicting Retained Earnings Next year’s projected retained earnings = last year’s $2 million, plus: $40 million x 0.05 x (1 - 0.50) = $2 million + $1 million = $3million

7. Slide 7 Predicting Discretionary Financing Needs Next year % of $40m Assets Current Assets$10m25% Fixed Assets$20m50% Total Assets$30m Liab. and Equity Accounts Payable$5m12.5% Accrued Expenses$5m12.5% Notes Payable$1mn/a Long Term Debt$6mn/a Total Liabilities$17m Common Stock$7mn/a Retained Earnings$3m Equity$10m Total Liab. & Equity$27m How much Discretionary Financing will we Need?

8. Slide 8 Predicting Discretionary Financing Needs (Continued) Discretionary Financing Needed = [Projected Total Assets] – [Projected Total Liabilities] – [Projected Shareholders’ Equity] Alternatively: DFN = [Projected Total Assets] – [Projected Liabilities & Shareholders’ Equity] DFN = $30 million – $17 million – $10 million DFN = $3 million in discretionary financing

9. Slide 9 Predicting Discretionary Financing Needs (Continued) At this point corporation has to decide how to finance the DFN The Company can sell Bonds (Long-Term Debt) or Equity This is why we call Long-Term Debt and Equity as sources of external capital Note that paid-in capital is the difference between selling price of equity and face value times the number of shares sold

10. Slide 10 Sustainable Rate of Growth Sustainable rate of growth is the rate the sales can grow without selling new equity and maintaining debt ratio (this means that if a firm retains earnings it would need to issue new debt to maintain debt ratio) g* = ROE (1 – b) where b = dividend payout ratio (dividends / net income) ROE = return on equity (net income / common equity)

11. Slide 11 Budgets Budget: a forecast of future events Budgets indicate the amount and timing of future financing needs Budgets provide a basis for taking corrective action if budgeted and actual figures do not match Budgets provide the basis for performance evaluation