FINANCIAL PLANNING AND

FORECASTING
CRUZ, TALION AND TIMBANG
CA 51012 Financial Management
UST Alfredo M. Velayo College of Accountancy
University of Santo Tomas
 1. LEARNING OBJECTIVES
• Recognize that financial forecasting is essential to the strategic growth
of the firm.
• List the three financial statements used for forecasting.
• Know the percent-of-sales method may also be used for forecasting
on a less precise basis.
• Explain why the various methods of forecasting enable the firm to
determine the amount of new funds required in advance.
• Understand the process of forecasting forces the firm to consider
seasonal and other effects on cash flow.
 2. FINANCIAL FORECASTING
Ability to plan ahead and make necessary adjustments before events
occur.
• Firm’s outcome through external events involves.
• Risk-taking desires.
• Ability to hedge against risk with careful planning.
• No growth or a decline in volume are not necessarily the primary
cause of a shortage of funds.
• Comprehensive financing plan must be developed for significant
growth.
 3. CONSTRUCTING PRO FORMA STATEMENTS
Pro forma financial statements enable a firm to estimate future
receivables, inventory, and payables, as well as anticipated profits and
borrowing requirements.
Statements are often required by bankers, other lenders as guide for the
future.
Systems approach to develop pro forma statements.
• Construct income statement based on sales projections and the
production plan.
• Translate this into a cash budget.
• Assimilate all materials into pro forma balance sheet.
4. DEVELOPING OF PRO FORMA STATEMENTS

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5. PRO FORMA INCOME STATEMENT
Provides projection on anticipated profits over subsequent period.
• Important steps.

1. Establish sales projection.

2. Determine production schedule, associated use of new material, direct
labor, and overhead to arrive at gross profit.
3. Compute other expenses.
4. Determine profit by completing actual pro forma statement.
6. TABLE 4 -1 PROJECTED WHEEL AND CASTER SALES (FIRST 6 MONTHS 2022)

• Assume Goldman Corporation has two primary

products: wheels and casters.

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 7. CLASSIFICATION SYSTEM CONCLUDED
Number of units produced depends on
• Beginning inventory.
• Sales projections.
• Desired ending inventory.
To determine production requirements
Units
+ Projected sales
+ Desired ending inventory
− Beginning inventory
= Production requirements
8. TABLE 4 - 2 TOCK OF BEGINNING INVENTORY
Goldman Corporation has in stock the items shown

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9. TABLE 4 - 3 PRODUCTION REQUIREMEMENTS FOR 6
MONTHS

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 10. TABLE 4 – 4 UNIT COSTS
• Cost to produce each unit

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11. TABLE 4 – 5 TOTAL PRODUCTION COSTS

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 12. COST OF GOODS SOLD
Costs associated with units sold during time period.
• Assumptions for illustration.
• F I F O accounting used.
• First allocates cost of current sales to beginning
inventory, then to goods manufactured during period.
13. TABLE 4 – 6 ALLOCATION OF MANUFACTURING COST AND DETERMINATION OF GROSS PROFIT

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14. TABLE 4 – 7 VALUE OF ENDING INVENTORY

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 15. OTHER EXPENSE ITEMS
Must be subtracted from gross profits to arrive at a net profit figure.
• Earnings before taxes.
• General and administrative expenses, interest expenses subtracted from gross
profit.

• After tax income.

• Subtract taxes to determine after tax income.

• Contribution to retained earnings.

• Deduct dividends to ascertain the contribution to retained earnings.
16. TABLE 4 – 8 INCOME STATEMENT

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 17. CASH BUDGET
Pro forma income statement must be translated into cash
flows.
• Divide longer-term pro forma income statement into smaller
units.
• More precise time frames are set to anticipate seasonal and
monthly patterns of cash inflows and outflows.
• May represent highs or low sales volume.
• May require dividends, taxes, or capital expenditures.
18. TABLE 4 – 9 MONTHLY SALES PATTERN

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 19. CASH RECEIPTS
In the case of Goldman Corporation.
• Break down the pro forma income statement for first half of
the year.
• Divided into monthly cash budgets.
• Analysis of past sales and collection records show.
• 20 percent of sales collected in month of sales.
• 80 percent collected in following month.
20. TABLE 4 – 10 MONTHLY CASH RECEIPTS

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21. TABLE 4 – 11 COMPONENT COSTS OF MANUFACTURED GOODS

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 21. CASH PAYMENTS
Primary considerations are monthly costs associated with:
• Inventory manufactured during period.
• Material.
• Labor.
• Overhead.
• Disbursements for general and administrative expenses.
• Interest payments, taxes, and dividends.
• Cash payments for new plant and equipment.
 21A. CASH PAYMENTS
Assumptions for next two tables.
• Costs incurred on equal monthly basis over six-month
period.
• Even production level to ensure maximum efficiency.
• Payment for material made once per month after purchases
have been made.
22. TABLE 4 -12 AVERAGE MONTHLY MANUFACTURING COSTS

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23. TABLE 4 – 13 SUMMARY OF ALL MONTHLY CASH PAYMENTS

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24. TABLE 4 – 14 MONTHLY CASH FLOW
Difference between monthly receipts and payments is net
cash flow for month.
• Allows firm to anticipate need for outside funding at
end of each month.

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25. TABLE 4 – 15 CASH BUDGET WITH BORROWING AND REPAYMENT
PROVISIONS
Assumptions for Table 4-15.
• Firm wishes to maintain minimum cash balance of $5,000.
• If balance goes below minimum, firm will borrow.
• If balance goes above minimum, firm will use excess to repay
outstanding loan.

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 26. PRO FORMA BALANCE SHEET
Represents cumulative changes over time.
• Important to examine prior period’s balance sheet.
• Some accounts remain unchanged, while others take on new
values.
• Information derived from pro forma income statement
and cash budget.
27. DEVELOPMENT OF A PRO FORMA BALANCE SHEET

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28. TABLE 4 – 16 BALANCE SHEET DECEMBER 31, 2021

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29. TABLE 4 -17 PRO FORMA BALANCE SHEET JUNE 30, 2022

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30. EXPLANATION OF A PRO FORMA BALANCE SHEET
1. Cash ($5,000) minimum cash balance in Table 4-15.
2. Marketable securities ($3,200) remains unchanged from prior
period’s value in Table 4-16.
3. Accounts receivable ($16,000) based on June sales of $20,000
in Table 4-10.

• 20 percent will be collected that month.

• 80 percent will become accounts receivable at the end of
month.

4. Inventory ($6,200) shown in Table 4-7.

5. Plant and equipment: $27,740 (initial value) + $18,000
(purchases) = $45,740.

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31A. EXPLANATION OF A PRO FORMA BALANCE SHEET
6. Accounts payable ($5,732) based on June purchases in Table 4-
13.
7. Notes payable ($5,886) amount to be borrowed to maintain
$5,000 in cash in Table 4-15.
8. Long-term debt ($15,000) unchanged from prior period’s value
in Table 4-16.
9. Common stock ($10,500) unchanged from prior period’s value
in Table 4-16.
10. Retained earnings ($39,024) equals the initial value plus pro
forma income ($20,500 + $18,524).

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 32. ANALYSIS OF PRO FORMA STATEMENT
Growth ($25,642) was financed by accounts payable,
notes payable, and profit.
• Reflected by increase in retained earnings.

Total assets (June 30, 2022) $76,142

Total assets (Dec. 31, 2021) $50,500
Increase $25,642

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 33. PERCENT OF SALES METHOD
Based on assumption that.
• Accounts on balance sheet will maintain given
percentage relationship to sales.
• Percentages are not computed for.
• Notes payable.
• Common stock.
• Retained earnings.
• Not assumed to maintain a direct relationship
with sales volume.

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34. Table 4-18 Balance Sheet and Percentage-of-Sales Table for Howard
Corporation

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 35. PERCENT OF SALES METHOD
Establish funds required to finance growth.
Decide to finance based on
• Notes payable.
• Sale of common stock.
• Use of long-term debt.

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 36. PERCENT OF SALES METHOD 3

Company operating at full capacity—needs to buy new plant and equipment to produce more goods
to sell:
• Required new funds:
• (RNF) = A/S (ΔS) – L/S (ΔS) – PS2 (1 – D).
• A/S = Relationship of variable assets to sales [60%].
• ΔS = Change in sales [$100,000].
• L/S = Percentage of variable liabilities to sales [25%].
• P = Profit margin [6%].
• S2 = New sales level [$300,000].
• D = Dividend payout ratio [0.50].

R N F = 60% (100,000) – 25% ($100,000) – 6% ($300,000) (1 – 0.50)

= $60,000 – $25,000 – $18,000 (0.50)
= $35,000 – $9,000
= $26,000 required sources of new funds (at full capacity)

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 37. PERCENT OF SALES METHOD 3

Company not operating at full capacity.

• Needs to add more current assets to increase sales.
• Does not need to buy new equipment.

R N F = 35% ($100,000) – 25% ($100,000) – 6% ($300,000)

(1 – 0.50)
= $35,000 – $25,000 – $18,000 (0.50)
= $35,000 – $25,000 – $9,000
= $1,000 required sources of new funds
(at less than full capacity)

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38. FINANCIAL FORECASTING - AFN
EQUATION
An equation that shows the relationship of external funds
needed by a firm to its projected increase in assets, the
spontaneous increase in liabilities, and its increase in
retained earnings
Additional funds needed = Projected increase in assets –
Spontaneous increase in liabilities – Increase in retained
earnings
AFN = (A0*/S0)S – (L0*/S0)S – M(S1)(1 – Payout)
 39. AFN EQUATION – PROBLEM 01 -
QUESTION
Carter Corporation’s sales forecast are expected to increase
from 5M in 2015 to 6M in 2016, or by 20%. Its assets
totaled 3M at the end of 2015. Carter is at full capacity, so
its assets must grow in proportion to projected sales. At
the end of 2015, current liabilities are 1M, consisting of
250,000 of AP, 500,000 of NP and 250,000 of Accrued
Liabilities. Its profit margin is forecasted to be 5%, and the
forecasted retention ratio is 30%. Use the AFN equation to
forecast the additional funds Carter will need for the
coming year
 40. AFN EQUATION – PROBLEM 01 -
ANSWER
AFN = (A0*/S0)S – (L0*/S0)S – M(S1)(1 – Payout)

= 3M x 1,000,000 – 500,000 x 1,000,000 - .05 (6M)

(.30)
5M 5M

= 410,000
41. AFN EQUATION – PROBLEM 02 -
QUESTION
Refer to Problem 01, what additional funds would be
needed if the company’s year end 2015 assets had been
4M? Assume that all other numbers are the same. Why
is the AFN different from the one you found in Problem
01
 42. AFN EQUATION – PROBLEM 02 -
ANSWER
AFN = (A */S )S – (L */S )S – M(S )(1 – Payout)
0 0 0 0 1

= 4M x 1,000,000 – 500,000 x 1,000,000 - .05 (6M)

(.30)
5M 5M
= 610,000
The capital intensity ratio is measured as A 0*/S0. This firm’s capital
intensity ratio is higher than that of the firm in Problem 01; therefore,
this firm is more capital intensive—it would require a large increase in
total assets to support the increase in sales.
 43. AFN EQUATION – PROBLEM 03 -
03
QUESTION
Chua Chang & Wu Inc. is planning its operations for next year, and the CEO wants you to forecast the firm's additional
funds needed (AFN). Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the
coming year?

Last year's sales = S0 $200,000 Last year's accounts payable $50,000

Sales growth rate = g 40% Last year's notes payable $15,000
Last year's total assets = A0* $135,000 Last year's accruals $20,000
Last year's profit margin = PM 20.0% Target payout ratio 25.0%
 44. AFN EQUATION – PROBLEM 03 -
03
ANSWER
Last year's sales = S0 200,000
Sales growth rate = g 40%
Forecasted sales = S0 × (1 + g) 280,000
ΔS = change in sales = S1 − S0 = S0 × g 80,000
Last year's total assets = A0* = A0* since full capacity 135,000
Forecasted total assets = A1* = A0* × (1 + g) 189,000
Last year's accounts payable 50,000
Last year's notes payable. Not spontaneous,
so does not enter AFN calculation 15,000
Last year's accruals 20,000
L0* = payables + accruals 70,000
Profit margin = PM 20.0%
Target payout ratio 25.0%
Retention ratio = (1 − Payout) 75.0%

AFN = (A0*/S0)ΔS − (L0*/S0)ΔS − Profit margin × S1 × (1 − Payout)

AFN = 54,000 − 28,000 − 42,000 = −16,000
 45. EXCESS CAPACITY
ADJUSTMENTS
Changes made to the existing asset forecast because the
firm is not operating at full capacity

CAPITAL INTENSITY RATIO – the ratio of assets

required per dollar of assets (A0*/S)
46. EXCESS CAPACITY PROBLEM 04 -
QUESTION
Walter Industries has 5B in sales and 1.7B in fixed assets. Currently
the company’s fixed assets are operating at 90% capacity.
(a) What level of sales would Walter have obtained if it had been
operating at full capacity?
(b) What is Walter’s target fixed assets/sales ratio?
(c) If Walter’s sales increase by 12%, how large of an increase in
fixed assets will the company need to meet its target fixed
assets/sales ratio?
 47. EXCESS CAPACITY PROBLEM 04 -
• ANSWER
Sales = 5,000,000,000; FA = 1,700,000,000; FA are operated at 90% capacity.

• a. Full capacity sales = 5,000,000,000/0.90 = 5,555,555,556.

b. Target FA/S ratio = 1,700,000,000/5,555,555,556 = 30.6%.
• c. Sales increase 12%; FA = ?
• S1 = 5,000,000,000  1.12 = 5,600,000,000.
• No increase in FA up to 5,555,555,556.
• FA = 0.306  (5,600,000,000 – 5,555,555,556)
• = 0.306  (44,444,444)
• = 13,600,000.
48. EXCESS CAPACITY PROBLEM 05 -
QUESTION
Last year Wei Guan Inc. had 350 million of sales, and it had
270 million of fixed assets that were used at 65% of capacity.
In millions, by how much could Wei Guan's sales increase
before it is required to increase its fixed assets?
49. EXCESS CAPACITY PROBLEM 05 -
ANSWER
GIVEN:
Sales 350M
Fixed Assets 270M
% of capacity utilized .65
SOLUTION:
Sales at full capacity (AS/%Capacity) 538,461,538.46
Additional sales without adding FA =
Full capacity sales – Actual sales
538,461,538.46 – 350,000,000.00 = 188,461,538.46
 50. SUSTAINABLE GROWTH RATE

The growth rate a firm can maintain given its capital

structure, ROE, and retention ratio.
 51. SUSTAINABLE GROWTH RATE
PROBLEM 06 - QUESTION
Suppose Weatherford Industries has the following
ratios: A */S = 1.6; L *S = 0.4; profit margin = 0.10
0 0 0 0

and payout ratio = 0.45 or 45%. Sales last year were

100M. Assuming that these ratios will remain constant,
use the AFN equation to determine the maximum
growth rate (sustainable growth rate) Weatherford can
achieve without having to employ nonspontaneous
external funds
 52. SUSTAINABLE GROWTH RATE
PROBLEM 06 - ANSWER
To solve this problem, we define S change in sales and g
as the growth rate in sales, and then we use the three
following equations
S = S0 g
S1 = S0 (1+ g)
AFN = (A0*/S0)S – (L0*/S0)S – M(S1)(1 – Payout)
Set AFN = 0, substitute in known values A */S , L */S , M
0 0 0 0

payout and S and then solve for g

0
 53. SUSTAINABLE GROWTH RATE
PROBLEM 06 - ANSWER
0 = 1.6 (100g) - .4 (100g) - .10 (100 (1 + g)) (1 - .45)
0 = 160g - 40g - 5.5 – 5.5g
114.5g = 5.5
g = 5.5/114.5
g = .048 or 4.8%
g = maximum growth rate without external financing
 54. EXCESS CAPACITY
ADJUSTMENTS 07 - QUESTION
Last year Handorf-Zhu Inc. had 850 million of sales,
and it had 425 million of fixed assets that were used at
only 60% of capacity. What is the maximum sales
growth rate the company could achieve before it had to
increase its fixed assets?
 55. SUSTAINABLE GROWTH RATE
GIVEN: PROBLEM 07 - ANSWER
Sales 850M
Fixed Assets 425M
% of capacity utilized .60
SOLUTION:
Sales at full capacity (AS/%Capacity) 1,416,666,666.67
Additional sales without adding FA =
Full capacity sales – Actual sales
1,416,666,666.67 – 850,000,000.00 = 566,666,666.67
% growth in sales = Additional Sales/Old sales 66.67%
THE END!!!
MODULE 03