Financial Planning and Forecasting: Reminders and Additional Topics

Financial Planning and Forecasting: Reminders and Additional Topics

1. Strategic Planning

• Read pp.574 – 576 of the text book (including foot notes) for the important concepts on strategic planning (may come out in the theory portion of the exam) such as mission statement, corporate scope, financial plan, etc.)

1. Determination of Growth Rates for Sales Forecast

• 3 Ways to Compute for the Growth Rate in Sales

1. Average growth rates in sales for the past years;
2. Growth rate based on the most probable or most likely forecasted sales or forecasted growth rate in sales;
3. Growth rate based on macroeconomic factors such as the growth rate in GDP and inflation rate, etc;

• In addition to the 3 items above, another factor in determining growth rate is information about the influence of any anticipated events that may materially affect sales trends such as start of a major advertising expense which will boost sales or a change in the firm’s pricing policy that could expand the firm’s market.

1. Additional Financing Needed (AFN)

• Another term used by some finance authors and experts for AFN or EFN is the discretionary financing needed (DFN);

• The capital intensity ratio is the ratio of total assets to sales. This measures the increase in the total assets required per P1 increase in sales.  It is computed using the formula:

• Capital intensity ratio

                        = Total Assets/Sales OR

        = (Current Assets + Fixed Assets)/Sales OR

        = (Current Assets/Sales) + (Fixed Assets/Sales)

The higher the capital intensity ratio, the higher the assets should increase per increase in sales and vice-versa.  

For example, if total assets amount to P3,000 and total sales amount to P1,000, the capital intensity ratio is 3 or P3 (P3,000/P1,000).  This means that a P1 peso increase in sales needs a P3 increase in assets.  

If total assets amount to P5,000 instead, capital ratio will become P5 (P5,000/P1,000), and a P1 peso increase in sales needs a P5 increase in total assets.  This will increase the AFN.

• Growth rate also affects the AFN.  In general, the higher the growth rate (all other things held constant), the higher the increase in total assets, the higher the AFN;

• As for the ratio of AP and accruals to sales, the higher the ratio, the lower the AFN.  The higher the ratio, the more funds will be available, the lower the additional funds needed.  

For example, if total AP and Accruals amount to P300 and total sales amount to P1,000, the ratio of AP and Accruals to sales is 0.30 or P0.30 P300/P1,000).  

If the total amount of AP and Accruals is P500 instead, then the ratio will be P0.50 (P500/P1,000).  Per P1 increase in sales, financing from AP and accruals will increase by P0.50 (instead of P0.30), thus reducing the required AFN.