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Chapter 4 –Chapter 4 – Financial Forecasting,Financial Forecasting,
Planning, and BudgetingPlanning, and Budgeting
2005, Pearson Prentice Hall
Financial ForecastingFinancial Forecasting
1)1) Project sales revenues and expenses. Project sales revenues and expenses.
2)2) Estimate current assets and fixed Estimate current assets and fixed assets necessary to support projected assets necessary to support projected sales.sales. Percent of sales forecastPercent of sales forecast
Percent of Sales MethodPercent of Sales Method
Suppose this year’s sales will total Suppose this year’s sales will total $32 million$32 million..
Next year, we forecast sales of Next year, we forecast sales of $40 million$40 million..
Net income should be Net income should be 5%5% of sales. of sales. Dividends should be Dividends should be 50%50% of of
earnings.earnings.
This yearThis year % of % of $32m$32m
AssetsAssetsCurrent AssetsCurrent Assets $8m$8m 25%25%Fixed AssetsFixed Assets $16m$16m 50%50% Total AssetsTotal Assets $24m$24mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $4m$4m 12.5%12.5%Accrued ExpensesAccrued Expenses $4m$4m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $15m$15mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $2m$2m EquityEquity $9m$9m Total Liab. & EquityTotal Liab. & Equity $24m$24m
Next yearNext year % of % of $40m$40m
AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings EquityEquity Total Liab. & EquityTotal Liab. & Equity
Predicting Retained EarningsPredicting Retained Earnings
Next year’s projected retained earnings = last Next year’s projected retained earnings = last year’s year’s $2 million$2 million, plus:, plus:
projected net incomeprojected net income cash cash dividendsdividends
salessales sales sales net income net income
$40 million x .05 $40 million x .05 xx (1 - .50)(1 - .50)
= $2 million + $1 million = = $2 million + $1 million = $3 million$3 million
xx xx ( 1 - ) ( 1 - )
Next yearNext year % of % of $40m$40m
AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $3m$3m EquityEquity Total Liab. & EquityTotal Liab. & Equity
Next yearNext year % of % of $40m$40m
AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $3m$3m EquityEquity $10m$10m Total Liab. & EquityTotal Liab. & Equity
Next yearNext year % of % of $40m$40m
AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $3m$3m EquityEquity $10m$10m Total Liab. & EquityTotal Liab. & Equity $27m$27m
Next yearNext year % of % of $40m$40m
AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $3m$3m EquityEquity $10m$10m Total Liab. & EquityTotal Liab. & Equity $27m$27m
How muchDiscretionary
Financing will weNeed?
Next yearNext year % of % of $40m$40m
AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $3m$3m EquityEquity $10m$10m Total Liab. & EquityTotal Liab. & Equity $27m$27m
How muchDiscretionary
Financing will weNeed?
Next yearNext year % of % of $40m$40m
AssetsAssetsCurrent AssetsCurrent Assets $10m$10m 25%25%Fixed AssetsFixed Assets $20m$20m 50%50% Total AssetsTotal Assets $30m$30mLiab. and EquityLiab. and EquityAccounts PayableAccounts Payable $5m$5m 12.5%12.5%Accrued ExpensesAccrued Expenses $5m$5m 12.5%12.5%Notes PayableNotes Payable $1m$1m n/an/aLong Term DebtLong Term Debt $6m$6m n/an/a Total LiabilitiesTotal Liabilities $17m$17mCommon StockCommon Stock $7m$7m n/an/aRetained EarningsRetained Earnings $3m$3m EquityEquity $10m$10m Total Liab. & EquityTotal Liab. & Equity $27m$27m
How muchDiscretionary
Financing will weNeed?
Predicting Discretionary Predicting Discretionary Financing NeedsFinancing Needs
Discretionary Financing Needed =Discretionary Financing Needed =
projectedprojected projectedprojected projectedprojected totaltotal -- total total -- owners’ owners’ assetsassets liabilitiesliabilities equity equity
$30 million - $17 million - $10 million$30 million - $17 million - $10 million
= = $3 million$3 million in discretionary financing in discretionary financing
Sustainable Rate of GrowthSustainable Rate of Growth
g* = ROE (1 - b)g* = ROE (1 - b) wherewhere
b =b = dividend payout ratio dividend payout ratio
(dividends / net income)(dividends / net income)
ROE =ROE = return on equity return on equity
(net income / common equity) or(net income / common equity) or
net income sales assetsnet income sales assets
sales assets common equitysales assets common equityROE = x xROE = x x
BudgetsBudgets
Budgets indicate the Budgets indicate the amountamount and and timingtiming of of future financing needsfuture financing needs..
Budgets provide a basis for taking Budgets provide a basis for taking corrective actioncorrective action if budgeted and if budgeted and actual figures do not match.actual figures do not match.
Budgets provide the basis for Budgets provide the basis for performance evaluationperformance evaluation..