Chapter 14Short-term Financial PlanningChapter ObjectivesFinancial ForecastingSales ForecastPercent of Sales MethodSpontaneous FinancingDiscretionary Financing (DFN)Calculation of DFNPowerPoint PresentationDFN RelationshipsExternal Financing Needs (EFN)DFN and EFNSustainable Rate of GrowthROESlide 16Limitations of the Percent of Sales Forecast MethodBudget FunctionsCash BudgetChapter 14Chapter 14Short-term Financial PlanningShort-term Financial PlanningChapter ObjectivesChapter ObjectivesPercent of sales method to forecast financing requirementsSustainable rate of growthLimitations of the percent of sales methodCash budgetsFinancial ForecastingFinancial ForecastingProcess of attempting to estimate a firm’s future financing requirementsSteps:1. Project the firm’s sales revenues and expenses over the planning period2. Estimate the levels of investment in current and fixed assets that are necessary to support the projected sales3. Determine the firm’s financing needs throughout the planning periodSales ForecastSales ForecastThe key ingredient in a firm’s planning process is the sales forecastReflects:1. Past trend in sales2. Anticipated eventsPercent of Sales MethodPercent of Sales MethodEstimating the level of an expense, asset, or liability for a future period as a percentage of the sales forecast.The percentages used can come from recent financial statements or from averages over past yearsSpontaneous FinancingSpontaneous FinancingThe trade credit and other accounts payable that arise spontaneously in the firm’s day-to-day operations.Normally vary directly with the level of salesAccounts Payable and Accrued ExpensesDiscretionary Financing (DFN)Discretionary Financing (DFN)Require explicit decisions on the part of the firm’s management every time funds are raised. Do not normally vary directly with the level of salesNotes Payable, long-term debt, common stock, paid in capitalCalculation of DFNCalculation of DFNFour step process (Using percentage of sales method)1. Covert each asset and liability account that varies directly with firm sales to a percentage of the current year’s sales–Current Assets/Sales2. Project the level of each asset and liability account in the balance sheet using its percentage of sale multiplied by projected sales or by leaving the account balance unchanged when the account does not vary with the level of sales–Projected current assets = projected sales X (current assets/sales)3. Project the addition to retained earnings available to help finance the firm’s operations. This equals projected net income for the period less planned common stock dividends.Projected addition to retained earnings = projected sales X Net income X {1-(cash dividends Sales Net Income)}4. Project the firm’s DFN as the projected level of total assets less projected liabilities and owners’ equityDFN = Projected total assets – projected total liabilities – projected owners’ equityDFN RelationshipsDFN RelationshipsDFN = Predicted change in total assets – Predicted change in spontaneous liabilities – Predicted change in retained earningsExternal Financing Needs External Financing Needs (EFN)(EFN)All the firm’s needs for financing beyond the funds provided internally through the retention of earningsEFN = Predicted change in total assets – Predicted change in retained earningsDFN and EFNDFN and EFNDFN = Predicted change in total assets – Predicted change in spontaneous liabilities – Predicted change in retained earningsEFN = Predicted change in total assets – Predicted change in retained earningsDifference between DFN and EFN is the inclusion/exclusion of spontaneous liabilitiesSustainable Rate of GrowthSustainable Rate of GrowthThe rate at which a firm’s sales can grow if it wants to maintain its present financial ratios and does not want to resort to the sale of new equity shares.Sustainable rate of Growth (g) = ROE (1-b)ROE is return on equity or net income / common equityb is dividend payout ratio or dividends/net income(1-b) = plowback ratio or the fraction of earnings that are reinvested or plowed back into the firmROEROEReturn on equityNet income / common equityROE = (net income / sales) X (sales/assets) X (total assets/common equity)or NPM X Asset turnover X capital structureSustainable Rate of GrowthSustainable Rate of GrowthFirm NPM Asset Leverage Plowback Sustainableturnover ratio rate of growthA 15% 1.00 1.2 50% 9.0%B 15% 1.00 1.2 100% 18.0%C 15% 1.00 1.5 100% 22.5%Limitations of the Percent of Limitations of the Percent of Sales Forecast MethodSales Forecast MethodMethod provides reasonable estimates of financing requirements only when asset requirements and financing sources can be accurately forecast as a constant percent of salesEconomies of scale are sometimes realized from investing in certain types of assetsSome assets are lumpy assets or assets that must be purchased in large, nondivisible componentsBudget FunctionsBudget FunctionsA budget is a forecast of future eventsPerform three functions:–Indicate the amount and timing of a firm’s needs for future financing–Provide the basis for taking corrective action in the event of variances–Provide the basis for performance evaluation and controlCash BudgetCash BudgetDetailed plan of future cash flowsComposed of four elements:–Cash Receipts–Cash Disbursement–Net change in cash for the period–New financing