Learning Objectives:

1. Explain the concept of financial

forecasting and planning.
2. Develop the pro forma balance
sheet and income statement.
3. Construct the cash budget.

CHAPTER 3: FINANCIAL FORECASTING

AND PLANNING
Financial planning

Cash planning Profit planning

- through - through sales
construction of projections or
cash budget - forecasting -

Financial
Planning
Financial Forecasting

▪ Financial forecasting is the predictions of the firm's

future financing needs based on a sales forecast.
▪ It also includes a summary of how funds flow in a firm
over a certain accounting period.
▪ This entails the construction of a pro forma income
statement and balance sheet as well as a statement of
sources and uses of funds.
▪ Forecasting also involve the preparation and use of cash
budget and an essential tool of financial planning.
Financial Forecasting

▪ Pro Forma Financial Statement – (financial forecasting)

1. A statements of planned investment and financing for a future
period,
▪ Known as the Pro-forma Balance Sheet

2. The statement of planned profit or loss for a future period.

▪ Known as the Pro-forma Income Statement
Methods of forecasting
▪ Percent of sales method
▪ Regression method

▪ Percent of sales method

1. This method involve estimating the level of an expense, asset
or liability for a future period as a percent of the sales forecast.
2. The percentages used come from the most recent financial
statement item as a percent of current sales
3. Need to know the sources of financing
▪ Spontaneous : items normally vary directly with sales
▪ Discretionary: items like notes payable, long term debt, common or
preferred stock etc which is not vary directly with sales
 ABC Balance Sheet as at 31/12/2011 (in million RM)

2011 2011
Assets Liability
Cash 5 Account payable 10
Account 10 Notes Payable 5
Receivable
Inventor 15 Accrued wages 3
Total Current Assets 30 Accrued Taxes 2
Total Current Liabilities 20
Net Plant 40
Long-term debt 20
Common Stock 10
Retained earnings 20
Total 70 70
 Based on the statement, construct the Pro-Forma Balance
Sheet for ABC Company for 2012.
1. Sales in 2011 were RM 100,000,000
2. Net Profit after tax were RM 15,000,000
3. Company paid dividends of RM 5,000,000 to shareholders

 Using the percentage of sales method, calculate the company’s

projected external capital requirement if sales 2012 is projected
to be RM150,000,000. (The company was operating at full
capacity).
 Step 1: Convert each asset and liability account that varies directly
with the firm’s sales (spontaneous item) to a percent of current
year's sales
Eg: Cash = Cash = 5,000,000 = 5%
Sales 100,000,000

 Step 2: Project the level of each asset and liability account in the
balance sheet using its percent of sales multiplied by projected
sales. Or by leaving the account balance changed where the
account does not vary with the level of sales.
E.g.: Projected Cash = Projected sales x Cash/Sales
= 150,000,000 x 0.05
= 7,500,000
 Step 3: Project the level of retained earnings available to help
finance the firm's operations
 E.g.: Projected addition to Retained Earnings (AREt)

= Projected Sales x Net Profit Margin x (1 – Divident Payout Ratio)

= S1 x NPM* x (1 - DPR**)1
= 150,000,000 x 15,0000 x (1 - 5,000,000
100,000,000 15,000,000
= 150,000,000 x 0.15 x (1 – 0.33)
= 15,075,000

**NPM = NPAT **DPR = Cash dividend

Sales NPAT
 Step 4: Project the firm's needs for discretionary financing as the
projected level of total assets less projected liabilities and owners'
equity. Now, construct the Pro-forma Balance Sheet
Pro-forma Balance Sheet for ABC Company
For the year ended 31/12/2012 (in millions)

Assets Present Percent of Sales Projected

(2011) (2011 sales = RM100m) (2012 sales = RM 150m)

Cash 5 5/100 = 5% 0.05 x 150m = 7.5m

Account Receivables 10 10/100 = 10% 0.10 x 150m = 15.0m
Inventory 15 15/100 = 15% 0.15 x 150m = 22.5m
Total CA 30 45.0m
Net plant 40 40/100 = 40% 0.4 x 150m = 60.0m
Total Asset 70 RM105.0m
 Liabilities and Present Percent of Sales Projected
Liquidity (2011) (2011 sales = RM100m) (2012 sales = RM 150m)

A/C Payable 10 10/100 = 10% 0.10 x 150m = RM15.0m

Notes Payable 5 No change RM5.0m
Accrued Wages, 3 3/100 = 3% 0.03 x 150m = RM4.5m
Accrued 'Faxes 2 2/100 = 2% 0.01 x 150m = 3.0m
TCL 20 RM27.5
Long Term Debt 20 No change RM20
Common stock 10 No change RM10
Retained Earnings 20 RM35.075m*
TL & E 70
Total Financing Provided = RM92.575m
**Discretionary Financing = RM12.425m
RM105.0m
*Retained earnings (REt1)
= REt0 + AREt1
= RM20m + RM15.075m
= RM35.075m

**Refer to Step 4: Discretionary financing needed (DFN)

Projected Projected Projected

= – –
Assets liabilities equity
= RM105m – RM92.575m
= RM12.425m
 ABC Company
Pro-Forma Income Statement
For the year ended 31/1212011

RM (Million)
Sales 100.00
COGS (50%) 50.00
Gross Profit 50.00
Operating Expenses (18%) 18.00
EBIT 32.00
Interest (2%) 2.00
EBT 30.00
Taxes (50% of EBIT) 15.00
NPAT 15.00
Cash Dividend 5.00
Total Retained earnings 10.00
Pro-forma Income Statement
▪ If forecasted sales in 2011 were to the RM150 million and assuming
the firm will pay RM7,425,000 in cash dividends in 2011, construct
the Pro Forma Income Statement
▪ Solution:
▪ Pro-forma statement is developed by using percent of sales method
where the cost of goods sold (COGS), operating expenses and
interest expense are expressed as certain percentages out of sales.
▪ The percentage will be calculated as below:
COGS 50 → 2011 = 50%
Sales 100 → 2011
Operating Expenses 18 → 2011 = 18%
Sales 100 → 2011
Interest Expenses 2 → 2011 = 2%
Sales 100 → 2011
 ABC Company
Pro-Forma Income Statement
For the year ended 31/1212011

RM (Million)
Sales 150.00
COGS (50%) 75.00
Gross Profit 75.00
Operating Expenses (18%) 27.00
EBIT 48.00
Interest (2%) 3.00
EBT 45.00
Taxes (50% of EBIT) 22.50
NPAT 22.50
Cash Dividend 7.425
Total Retained earnings 15.075
Cash Budget

1. Determine whether the firm is facing shortage or

surplus of cash.
2. Cash budget is done for a period of one year.
3. This will help the financial manager to determine the
cash flow pattern of the firm.
4. Surplus in the cash budget will mean that the firm
can do more investments.
5. Shortage in the cash budget will mean that the
financial manager must decide the most appropriate
way to raise funds cheaply.
 Jan Feb March April
Forecasted sales
Collections : Lagged 1 month
Lagged 2 month
Cash receipts
Dividend
Interest
Proceed from sales of equipment
Lease receipt
Less : Cash Payment
Purchase
Payment of account payable
Payment of cash dividend
Rent
 Jan Feb March April
Wages and salary
Tax payment
Net cash flow

Add: Beginning balance

Less: Interest on short term borrowing
End balance
Less: Minimum balance
Total financing required
▪ Example : Prepare cash budget for Syarikat Sakti Jaya

1. Historical and Forecast Sales

Historical (RM) Forecast (RM)
April 80,000 July 130,000
May 100,000 August 130,000
June 120,000 September 120,000
October 100,000

2. The firm incurs and pays a monthly rent expense of RM3,000.

3. Wages and salaries
(RM)
July 18,000
August 18,000
September 16,000

4. Of the firm's sales, 40% is collected in the month of sales, 30

percent one month after sales and the remaining 30 percent
two months after sales.
5. Merchandise is purchased one month before the sales month
and is paid for in the 3 month it is sold. Purchased equal to
80% of sales.
6. Tax prepayment are made on the calendar quarter, with a
prepayment of RM1,000 in July based on earnings for the
quarter ended June 30, 2011.
7. Utilities for the firm average 2% of sales and are paid in the
month of their incurrence.
8. Depreciation expense is RM 12,000 annually.
9. Interest on a RM40,000 bank note (due in November) is
payable at an 8% annual rate in September for the three-
month period just ended.
10. The firm follows a policy of paying no cash dividends.
Based on the information:

a) Prepare a monthly cash budget for the three-month period

ended September 30, 2011.
b) If the firm's beginning cash balance for the budget period is
RM 5,000 and this is its minimum desired balance, determine
when and how much the firm will need to borrow during the
budget period. The firm has an RM80,000 line of credit with
its bank with interest (12% annually) paid monthly (for
example, for a loan taken out at the end of December, interest
would be paid at the end of January and every month
thereafter so long as the loan was outstanding).
Answer: (RM ‘000)
May June July Aug. Sept.
Forecasted sales 100 120 130 130 120
Cash Sales (40%) 40 48 52 52 48
Collections: Lagged 1 month (30%) 30 36 39 39
Lagged 2 month (30%) 30 36 39
Total Cash receipts 118 127 126
Less:
Purchase (80% of next month sales 104 104 96 80
Payment: Lagged 1 month (100%) 104 104 96
Other Cash disbursements:
Rent 3 3 3
Wages and salary 18 18 16
 May June July Aug. Sept.
Tax payment 1
Utilities (2% of sales) 2.6 2.6 2.4
Interest (RM40,000 x 0.08 x 3/12) 0.8
Total cash disbursements: 128.6 127.6 118.2
Net cash flow (10.6) (0.6) 7.8
Add: Beginning balance 5 5 5
Less: Interest on short term borrowing* 0 (0.106) (0.113)
End balance (5.6) 4.294 12.687
Financing needed 10.6 0.706 -
Ending Cash balance 5 5 5
Cumulative borrowing** 10.6 11.306 3.619
Explanation:

*Interest on Short Term borrowing

For August interest = RM10,600 x 0.12 x 1/12 = RM106

For September interest = RM11,306 x 0.12 x 1/12 = RM113,06

**Cumulative Borrowing

For July = RM10,600 = Financing needed

For August = RM10,600 + RM706 = RM11,306
For September = No financing required but we have, excess cash
= RM12,687–RM5,000 = RM7,687

RM7,687 can be used to pay the amount of borrowing that we

have, amount of borrowing = RM11,306

So, the balance amount of borrowing = RM11,306 – RM7,687 =

RM3,619

From cash budget, we are also able to construct the pro-forma

financial statements.
Questions / Exercises
1. Ketupat Bhd. expects its sales to increase by 25% next year. Its
existing profit status is a follows:
Profits and Loss Account
For the Year Ended 31 December 2010
RM
Sales 40,000
Less: Cost of goods sold (fixed RM5,000; variable RM10,000) (15,000)
Gross profit 25,000
Less Operating Cost (fixed RM4,000; variable RM6,000) (10,000)
Operating Profit 15,000
Less: Interest (fixed) (2,500)
Profit Before Tax 12,500
Less: Tax (50%) (6,250)
Profit After Tax 6,250
Less: Ordinary Dividends (1,250)
Retained Profits 5,000
 Balance Sheet
As At 31 December 2010 (RM)

Cash 5,000 Accounts Payable 10,000

Accounts receivables 10,000 Long-Term Debt 25,000
Inventory 15,000 Ordinary Share Capital 40,000
Machines (Net) 22,500 Retained Profits 5,000
Lands and Buildings 27,500
80,000 80,000

Prepare a pro-forma profit statement and a balance sheet for 2011. Show the
calculations for extra finance needed based on the following information:

 Working capital is expected to vary with sales.

 Additional fixed assets (machines) worth RM12,500 will have to be purchased. The
depreciation will be RM2,500 per year.
 Depreciation on the existing machine is expected to remain at RM2,500 in 2011.
 Dividend payment will be RM2,500.
 The additional finance needed will be raised through the issue of RM1 ordinary shares.
 Tax is 50%.
 Ketupat Bhd Pro-forma Profit Statement
For the Year Ended 31 December 2011

RM

Sales 50,000
Less: Cost of Goods Sold (fixed 5,000, variable = 0.25 x 50,000 = 12,500) (17,500)
Gross Profit 32,500
Less: Operating costs (fixed cost = 4,000 + 2,500 = 6,500
Operating cost = 0.15 x 50,000 = 7,500 (14,000)
Operating Profit 18,500
Less: Interest (2,500)
Profit Before Tax 16,000
Less: Tax (50%) (8,000)
Profit After Tax 8,000
Ordinary Dividends 2,500
Retained Earnings 5,500

Answer….
Questions / Exercises
2. PT Inc has estimated sales and purchase requirements for the last
half of the coming year. Past experience indicates that it will collect
20 percent of its sales in the month of the sales, 50 percent of the
reminder one month after the sales and the balance in the second
month following the sales. PT prefers to pay half its purchases in
the month of the purchase and the other half of the following
month. Labour expense for each month is expected to equal 5
percent of that month sales, with cash payment being made in the
month in which the expense is incurred. Depreciation expense is
RM5,000 per month, miscellaneous cash expense are RM4,000 per
month and are paid in the month incurred, general and
administrative expenses of RM50,000 are recognised and paid
monthly.
Questions / Exercises
A RM60,000 truck is to be purchased in August and is to be
depreciated on a straight-line basis over 10 years with no expected
salvage value. The company also plans to pay a RM9,000 cash
dividend to stockholders in July. The company fells that a minimum
cash balance of RM30,000 should be maintained. Any borrowing
will cost 12 percent annually, with interest paid in the month
following the month in which the funds are borrowed. Borrowing
takes place at the beginning of the month in which the need for
funds arises. For example, if during the month of July the firm
should need to borrow RM24,000 to maintain RM30,000 desired
minimum balance, then RM24,000 will be taken out on July 1 with
interest owed for the entire month of July. Interest for the month
of July would then be paid on August 1. Sales and purchase
estimates are shown below:
Questions / Exercises

Prepare a cash budget for the months of July and August (cash on hand
30/6 was RM30,000 while sales for May and June were RM100,000 and
purchases were RM60,000 for each of these months).

Month Sales (RM) Purchase RM)

July 120,000 50,000
August 150,000 40,000
September 110,000 30,000
 May June July August
Sales RM100,000 RM100,000 RM120,000 RM150,000
Purchases 60,000 60,000 50,000 40,000
Cash Receipts:
Collections from month of sales (20%) 20,000 20,000 24,000 30,000
1 month later (50% of uncollected 40,000 40,000 48,000
amount)
2 month later (balance) 40,000 40,000
Total Receipts RM104,000 RM118,000

Answer….
Cash Disbursements:

RM RM

Payment for purchases:

From one month earlier (50%) 30,000 20,000
From current month (50%) 25,000 20,000
Total 55,000 45,000
Miscellaneous cash expenses 4,000 4,000
Labor expenses (5% of sales) 6,000 7,5000
General administrative expense 50,000 50,000
Truck 0 60,000
Cash dividends 9,000 0
Total (124,000) (166,500)

Answer….
 RM RM

Net cash flow (20,000) (48,500)

Plus: Beginning cash balance 30,000 30,000
Les: Interest on short term borrowing
(1% of prior month’s borrowing) 0 (200)
Equals: Ending cash balance without borrowing 10,000 (18,700)
Financing needed to reach target cash balance 20,000 48,700
Cumulative borrowing 20,000 68,7000

Answer….