COM240 Management FinanceProcessing

Java Python COM240 Management Finance

#12: Financial Forecasting

Financial Forecasting

• The Percentage of Sales Method - Part 1

• Overview

• Six Steps of the % of Sales Forecast

1.    Decide Key Assumptions

2.    Forecast the Income Statement

• The Percentage of Sales Method - Part 2

3.    Forecast Working Capital

4.    Forecast Balance Sheet

5.    Forecast Statement of Cash Flows

6.    Financial Ratios and Sensitivity Analysis

Overview

• Learn how financial managers create a forecast of the 3 financial statements using historical relationships

• Called the “ Percentage of Sales Method” because westart with a sales forecast then build other items as a “% of Sales”

•  Booth, Cleary and Rakita (BCR) is confusing so we will  stick with these slides (and Excel spreadsheet) to explain it.

• A financial forecast is great tool for understanding future financing needs

• Called External Financial Requirements (EFR)

• Generate proforma forecasts of Income Statement, Balance Sheet and Statement of Cash Flows

• Retained Earnings from Income Statement increases Common Equity on Balance Sheet

• Find out how much cash needed to run business

• Cash will be “ plug” that balances Balance Sheet

•  Verify it using Statement of Cash Flows

Assets = Liabilities + Equity

(Assetsex. casℎ) + casℎ = Liabilities + Equity

90 + casℎ = 40 + 60

casℎ = 10

Six Steps of the % of Sales Forecast

1. Decide key assumptions

• For forecast, we need assumptions about:

• Sales growth and profit margins

• Cost of debt and quantity of debt => used to forecast interest expense

• Working Capital: A/R, Inventory, A/P

• Other Current Assets and Current Liabilities

• Tax rate and dividend payout ratio

• Depreciation and CAPEX

• Easiest way is to calculate historical ratios over the past 3 to 5 years and look at averages and trends.

• Common-size financial statements are helpful for identifying relationships and patterns.

• Examples of key assumptions:

• Sales growth declines steadily from 10% to 2%

• Margins and Working Capital ratios are unchanged.

• CAPEX declines overtime until equal to Depreciation.

YEAR FORECAST ASSUMPTIONS	0	1	2	3	4	5
Sales growth and margins
Sales growth (y-o-y)	n.a.	10.0%	8.0%	6.0%	4.0%	2.0%
COGS % Sales	70.0%	70.0%	70.0%	70.0%	70.0%	70.0%
SGA % Sales	10.0%	10.0%	10.0%	10.0%	10.0%	10.0%
Depreciation % Sales	5.0%	5.0%	5.0%	5.0%	5.0%	5.0%
Capital expenditures % Sales	10.0%	9.0%	8.0%	COM240 Management FinanceProcessing 7.0%	6.0%	5.0%
Interest expense, taxes and dividends
Cost of debt (% per annum)	6.0%	6.0%	6.0%	6.0%	6.0%	6.0%
Tax rate (%)	20.0%	20.0%	20.0%	20.0%	20.0%	20.0%
Dividend payout ratio (%)	10.0%	10.0%	10.0%	10.0%	10.0%	10.0%
Productivity (Working capital)
Days of Receivables = AR / (Revenue/365)	25	25	25	25	25	25
Days of Inventory = Inventory / (COGS/365)	90	90	90	90	90	90
Days of Payables = AP / (COGS/365)	45	45	45	45	45	45
Cash Conversion Cycle = Days AR + Days Inv - Days AP	70	70	70	70	70	70

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