Financial Planning and Forecasting - Introduction and Primary Concepts

Financial Planning and Forecasting (Introduction and Primary Concepts)

I .Topics

• Strategic planning;
• Sales forecast;
• Additional financing needed (AFN) equation;
• Forecasted financial statements;
• Using regression to improve forecasts;
• Analyzing the effects of changing ratios;
• Other/Additional topics.

1. Long-term Financial Planning and Forecasting (Rationale)

• Long term;
• Application in companies: strategic plan (2-5 year forecast), for corporate valuation (using free cash flows);
• Application in the academe:

• financial aspect of strategic management plan (for 4th year BSMA students);
• using forecasted performance or results and compare it with actual performance or results (e.g. for determining the impact or effect of the following activities but not limited to mergers acquisitions, application of government regulations, new accounting standards, etc.); for thesis of 4th year BSA students;

1. Master Budget

• Short term;
• Forecasting to obtain budgets;
• Planning and control (monitoring using variance analysis).

1. Elements of a Strategic Plan

• Mission statement (condensed version of a strategic plan);
• Corporate scope (defines lines of business and geographic areas of operations);
• Statement of corporate objectives (specific goals to guide management);
• Corporate strategies (broad approaches to achieve goals);
• Operating plan (provides management with detailed implementation guidelines based on corporate strategy);
• Financial plan (includes assumptions, projected FS and ratios which ties the entire planning process).

1. Definition of Basic Terms

• Financial planning establishes guidelines for change and growth in a firm;
• It focuses on the major elements of a firm's financial and investment policies without examining the individual components of those policies in detail.

1. How It Works

• Forecast sales using growth rates;
• Forecast growth in assets needed to support sales and matched with the corresponding growth in financing:

• Start with forecasting the growth in assets;
• Determine how much additional financing is needed;
• Determine whether internal funds are sufficient;
• If necessary, plan for external financing;
• See effects of plan on ratios.

1. Determination of Growth Rate

• Growth for the past years (average the growth rates manually via simple average or using the computation of getting the interest rate of compound interest, similar with YTM computation – exact YTM using excel or financial calculator or estimated or approximate using the YTM formula);
• Growth rate based on most probable scenario – best case, normal case, worst case;
• Growth based on economic macroeconomic factors – forecasted inflation, forecasted GDP, forecasted exchange rate % gain/loss, forecasted industry growth rates.

1. Using the Percentage of Sales Method

• Represent expenses as percentage of sales (exception: fixed expenses such as depreciation, rent and interest expense);
• Represent assets (current assets and fixed assets) as percentage of sales (exception: FA may not be dependent on sales, at times); the ratio of Total Assets to Sales (Total Assets/Sales) is known as the Capital Intensity Ratio; the ratio of Current Assets to Sales (Current Assets/Sales) is simple known as the Current Assets to Sales Ratio
• Represent current liabilities, specifically spontaneous liability (AP, accruals- salaries and taxes) as percentage of sales; the ratio of Spontaneous Liabilities to Sales (Spontaneous Liabilities/Sales) is known as the Spontaneous Liabilities to Sales Ratio;
• Other liabilities: short-term interest bearing liabilities (e.g. notes payables, bank loans), and long-term liabilities (e.g. bonds payable) – not sales dependent;
• Contributed Capital (common stock or ordinary share capital and share premium) - not sales dependent;
• Retained earnings – increase with sales but not directly proportional.

1. Sample Illustration

JMV Company has the following current IS and BS information