1. Financial Forecasting and Short-term Financing

2. Forecasting and Pro Forma Analysis
Timing of financial needs
Amount of financial needs
Flow of funds
Check the covenants

3. Pro forma Income Statement Pro forma Balance Sheet Plug Figure
Financing Options
Depreciation
Capital Expenditures
Change in Net Plant & Equipment
Sales
Forecast
Net Income
Dividend Policy
Change in Retained Earnings
Working Capital Accounts
External
Financing
Required
Short-Term Debt
Long-Term Debt

4. Steps in Financial 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 and stock price

5. Sales Forecast Seasonal changes Business cycle Market segment
Recession
Expansion
Market segment
High growth
Contraction
Inflation

6. 2001 Balance Sheet (Millions of $)
Cash & sec.
$20
Accts. pay. &
accruals
$100
Accounts rec.
240
Notes payable
100
Inventories
Total CL
$200
Total CA
$500
L-T debt
Common stk
500
Net fixed
Retained
Assets
Earnings
200
Total assets
$1000
Total claims

7. 2001 Income Statement (Millions of $)
Sales
$2,000.00
Less: COGS (60%)
1,200.00
SGA costs
700.00
EBIT
$100.00
Interest
16.00
EBT
$84.00
Taxes (40%)
33.60
Net income
$50.40
Dividends (30%)
$15.12
Add’n to RE
35.28

8. AFN (Additional Funds Needed)
Key Assumptions
Operating at full capacity in 2001.
Each type of asset grows proportionally with sales.
Payables and accruals grow proportionally with sales.
2001 profit margin (2.52%) and payout (30%) will be maintained.
Sales are expected to increase by $500 million. (%ΔS = 25%)

9. AFN (Additional Funds Needed)
AFN= (A*/S0) ΔS - (L*/S0) ΔS - M(S1)(1 - d)
= ($1,000/$2,000)($500) - ($100/$2,000)($500) ($2,500)( )
= $180.9 million.

10. Projecting Pro Forma Statements with the Percent of Sales Method:
Project sales based on forecasted growth rate in sales
Forecast some items as a percent of the forecasted sales
Costs
Cash
Accounts receivable
Items as percent of sales
Inventories
Net fixed assets
Accounts payable and accruals
Choose other items
Debt (which determines interest)
Dividends (which determines retained earnings)
Common stock

11. Percent of Sales: Inputs
2001
2002
Actual
Proj.
COGS/Sales
60%
SGA/Sales
35%
Cash/Sales 1%
Acct. rec./Sales
12%
Inv./Sales
Net FA/Sales
25%
AP & accr./Sales 5%

12. Other Inputs Percent growth in sales 25% Growth factor in sales (g)
1.25
Interest rate on debt 8%
Tax rate
40%
Dividend payout rate
30%

13. 2002 1st Pass Income Statement
2002
2001
Factor
1st Pass
Sales
$2,000
g=1.25
$2,500
Less: COGS
Pct=60%
1,500
SGA
Pct=35%
875
EBIT
$125
Interest 16
EBT
$109
Taxes (40%) 44
Net. Income
$65
Div. (30%)
$19
Add. to RE
$46

14. 2002 1st Pass Balance Sheet (Assets) Forecasted assets are a percent of sales.
2002 Sales = $2,500
2002
Factor
1st Pass
Cash
Pct= 1%
$25
Accts. rec.
Pct=12%
300
Inventories
Total CA
$625
Net FA
Pct=25%
Total assets
$1250

15. 2002 1st Pass Balance Sheet (Claims)
2002 Sales = $2,500
2002
2001
Factor
1st Pass
AP/accruals
Pct=5%
$125
Notes payable
100
Total CL
$225
L-T debt
Common stk.
500
Ret. earnings
200
+46*
246
Total claims
$1,071

16. What are the additional funds needed (AFN)?
Forecasted total assets = $1,250
Forecasted total claims = $1,071
Forecast AFN = $ 179
NWC must have the assets to make forecasted sales. The balance sheets must balance. So, we must raise $179 externally

17. How will the AFN be financed?
Additional notes payable= 0.5 ($179) = $89.50  $90.
Additional L-T debt= 0.5 ($179) = $89.50  $89.
But this financing will add 0.08($179) = $14.32 to interest expense, which will lower NI and retained earnings.

18. 2002 2nd Pass Income Statement
1st Pass
Feedback
2nd Pass
Sales
$2,500
Less: COGS
$1,500
SGA
875
EBIT
$125
Interest 16
+14 30
EBT
$109
$95
Taxes (40%) 44 38
Net income
$65
$57
Div (30%)
$19
$17
Add. to RE
$46
$40

19. 2002 2nd Pass Balance Sheet (Assets)
1st Pass
AFN
2nd Pass
Cash
$25
Accts. rec.
300
Inventories
Total CA
$625
Net FA
625
Total assets
$1,250

20. 2002 2nd Pass Balance Sheet (Claims)
1st Pass
Feedback
2nd Pass
AP/accruals
$125
Notes payable
100
+90
190
Total CL
$225
$315
L-T debt
+89
189
Common stk.
500
Ret. earnings
246 -6
240
Total claims
$1,071
$1,244

21. Results After the Second Pass
Forecasted assets= $1,250 (no change)
Forecasted claims= $1,244 (higher)
2nd pass AFN = $ (short)
Cumulative AFN= $179 + $6 = $185.
The $6 shortfall came from the $6 reduction in retained earnings. Additional passes could be made until assets exactly equal claims.

22. Financial Forecasting and Firm Capacity
Balance Sheet ($ in Millions)
Assets
1999
Liabilities and Owners' Equity
Current Assets
Current Liabilities
Cash
200
Accounts Payable
400
Accounts Receivable
Notes Payable
Inventory
600
Total Current Liabilities
800
Total Current Assets
1200
Long-Term Liabilities
Long-Term Debt
500
Fixed Assets
Total Long-Term Liabilities
Net Fixed Assets
Owners' Equity
Common Stock ($1 Par)
300
Retained Earnings
Total Owners' Equity
700
Total Assets
2000
Liab. and Owners' Equity

23. Income Statement ($ in Millions), 1999
Sales
1200
Cost of Goods Sold
900
Taxable Income
300
Taxes 90
Net Income
210
Dividends 70
Addition to Retained Earnings
140

24. Full Capacity
The equation used to calculate EFN when fixed assets are being utilized at full capacity is given below.

25. S0 = Current Sales,
S1 = Forecasted Sales = S0(1 + g),
g = the forecasted growth rate is Sales,
A*0 = Assets (at time 0) which vary directly with Sales,
L*0 = Liabilities (at time 0) which vary directly with Sales,
PM = Profit Margin = (Net Income)/(Sales), and
b = Retention Ratio = (Addition to Retained Earnings)/(Net Income).

26. Full Capacity Example
Given that Fixed Assets are being utilized at full capacity and the forecasted growth rate in Sales is 25%.
Forecasted Sales: S1 = 1200( ) = $1500

27. Excess Capacity
If the firm has excess capacity in its Fixed Assets then the Fixed Assets may not have to increase in order to support the forecasted sales level. Moreover, if the Fixed Assets do need to increase in order to support the forecasted sales level, then they will not have to increase by as much as would be required if they were being used at full capacity.
If Forecasted Sales are less than Full Capacity Sales, then fixed assets do not need to increase to support the forecasted sales level. On the other hand, if Forecasted Sales are greater than Full Capacity Sales, then Fixed Assets will have to increase.

28. Case 1: S1 Less Than SFC
Given that Fixed Assets are currently being utilized at 60% of capacity and the forecasted growth rate in Sales is 25%.
S1 = 1200( ) = $1500
SFC = 1200/.60 = $2000
Forecasted Sales are less than Full Capacity Sales the EFN can be found in one step. Here A*0 is equal to Total Current Assets which equals $1200.

29. Case 2: S1 Greater Than SFC
When the Forecasted Sales are greater than Full Capacity Sales, EFN can be determined in two steps. The first step, EFN1, finds the EFN needed to get to Full Capacity Sales. The second step, EFN2, finds the additional EFN to get from Full Capacity Sales to the Forecasted Sales.
The total EFN is simply EFN1 plus EFN2.

30. Excess Capacity Example: S1 > SFC
Given that Fixed Assets are currently being utilized at 90% of capacity and the forecasted growth rate in Sales is 25%.
S1 = 1200( ) = $1500
SFC = 1200/.90 = $

31. Tracing Cash and Net Working Capital
Current Assets are cash and other assets that are expected to be converted to cash with the year.
Cash
Marketable securities
Accounts receivable
Inventory
Current Liabilities are obligations that are expected to require cash payment within the year.
Accounts payable
Accrued wages
Taxes

32. The Operating Cycle and the Cash Cycle
Order Placed
Stock Arrives
Raw material purchased
Cash received
Finished goods sold
Inventory period
Accounts receivable period
Time
Accounts payable period
Firm receives invoice
Cash paid for materials
Operating cycle
Cash cycle

33. Operating Cycle, Inventory turnover, and A/R turnover
Inventory turnover = Sales / Average Inventory, or COGS / Average Inventory
[Inventory Conversion = 365 / Inventory turnover]
Accounts Receivable turnover = Sales / AR
[Days A/R outstanding = 360 / Accounts Receivable turnover]
Payable turnover = Purchase (or COGS) / AP
[Days A/P outstanding = 360 / Payable turnover]
Operating Cycle = Inventory Conversion + Days A/R outstanding

34. The Operating Cycle and the Cash Cycle=
Operating cycle –
Accounts payable period
In practice, the inventory period, the accounts receivable period, and the accounts payable period are measured by days in inventory, days in receivables and days in payables.

35. Dell’s Working Capital Policy
DSI
DSO
DPO
CCC Q4 31 42 33 40
Improvement
-18 -5
+21
-44 Q4 13 37 54 -4
Dell’s daily sales was about $20M per day. Dell was able to reduce the need of short term financing $800M. Assuming a 6% short term cost of capital, Dell was able to created $48M more pre tax earnings.

36. Beginning Inventory $ 400,000 Purchase $2,600,000
You find the following information from a firm’s financial statements, please calculate its cash (conversion) period?
Beginning Inventory $ 400,000
Purchase $2,600,000
Ending Inventory $ 600,000
Accounts Receivable $ 800,000
Sales $3,600,000
Accounts Payable $ 600,000

38. Operating Cycle = Inventory Conversion + A/R Days
Cash Cycle = Operating cycle – A/P days
Operating Cycle = = 155 days
Cash Cycle = 155 days – 83 days = 72 days

39. Short term financing: Advantages: Disadvantages
Could be obtained quicker.
The amount raised can be flexible.
Usually cheaper. (comparing with long-term finance)
Disadvantages
High solvency risk: need to be repaid in a short period.
High refinance risk: face highly volatile short-term interest rates.

40. Short-term financing strategies
Moderate Approach: matching maturities. Finance long term assets and permanent current assets with long term financing; finance transitory current assets with short term.
Aggressive Approach: Finance part of permanent assets and all transitory assets with short term financing.
Conservative Approach: Finance part of transitory current assets with long-term financing.

41. The Short-Term Financial Plan
The most common way to finance a temporary cash deficit to arrange a short-term loan.
Unsecured Loans
Line of credit down at the bank
Secured Loans
Accounts receivable financing can be either assigned or factored.
Inventory loans use inventory as collateral.
Other Sources
Banker’s acceptances
Commercial paper.