Company Marketing Forecasting

Techniques Finance Essay

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As the purpose of the company manager is to make their company more profitable
and valuable so manager must take a right decision to identify, evaluate and
implement as well as estimate the benefits of potential projects that meet or exceed
investor expectations. It also estimates that how changes in capital structure,
dividend policy and working capital policy will influence shareholder value. How ever
the value creation is impossible unless company do appropriate forecasting for the
future.
Financial planning process is a crucial part so there are following forecasting
techniques which help manager in decision making
One of the most appropriate forecasting method in capital budgeting is estimating
future cash flow for a project that enable cost and revenue forecasting for an
organisation as well.
Capital budgeting tools evaluate expected future cash flows in relation to cash put out
today.

Cash flow forecasts

It is very important task for forecasting cast and revenue for an organisation the final
result we obtain are really only as good as the accuracy of our estimate. Because cash,
not income is central to all decisions of the firm. We express what every benefits we
expect from a project in term of cash flows rather than income. The firm invests cash
now in the hope of receiving returns in a greater amount in the future. Only cash
receipts can be re invested in the firm or paid to stock holders in the form of
dividends. In capital budgeting good guys may get credit, but effecting managers get
cash. In setting up cash flows for analysis a computer spread sheet program is
invaluable, It allow one to change assumptions and quickly produce a new cash
stream.

Incremental cash flows

For each investment proposal we need to provide information on expected future
cash flows on and after text bases. In addition information must be provided on an
incremental bases so that we analyze only the difference between the cash flow the
firm with and without the project for example if a firm contemplates a new product
that is likely too compete with existing product it is not appropriate to express cash
flow in term of the estimated sales of the new product. We must take into account
some probable cannibalization.

Sales forecasts
The sales forecasting normally starts with a review of sales during the past five to ten
years. Through these past five years historic sales firm can predict its future growth.
Once sales have been forecasted, company must forecast future balance sheets and
income statements.

Analyze the Historical Ratios

The objective of historic data is to forecast the future or pro forma financial
statement. The percent of sale method assume that costs in a given year will be some
specified percentage of that year's sales. Thus company begin their analysis by
calculating the ratio of costs to sales for several past years.

Income Statement forecast

For making any decision to invest in any project company forecasts the income
statement for the coming year. Income statement forecast is needed to estimate both
income and the addition to retained earnings.

Balance Sheet forecast

The asset shown in the balance sheet must increase if sales are to increase. So on the
basis of assets, sales, inventory and receivables ratio analysis company manager
make decision for future projects.
Financial forecasting generally starts with a forecast of the company sales in terms of
both units and dollars (Ref: Eugene F. Brigham, Michael C. Ehrhardt - 2008 Business & Economics - 1071 page, Accessed on 15th May 2010)

Either the projected or pro forma, financial statement method can be used to forecast
financial requirements. The financial statement method is more reliable and it's also
provides ratios that can be used to evaluate alternatives business plans.
A firm can determine the additional fund needed by estimating the amount of new
asset necessary to support the forecasted level of sales and then subtracting from that
amount the spontaneous funds that will be generated from operation. The firm can
then plan how to raise the additional funds needed most efficiently.
Adjustment must be made if economies of scale exist in the use of assets, if excess
capacity exists or asset must be added in lumpy increments.
Linear regression and excess capacity adjustment can be used to forecast asset
requirements in situation where assets are not expected to grow at the same rate as
sales.

Different sources of Funds available to a Carlin

& Light for new Power plant project
Businesses, individuals and government often need to raise capital to invest in
specific projects. For example, suppose Carlin power & Light (CP&L) forecasts an
increase in the demand for electricity in North Carolina and the company decides to
build a new power plant. Because at the moment CP&L certainly not have the 1
billion to pay for the plant, Carlin & light will have to raise this capital in the financial
market. Although equity, debt and preferred stock are the major sources of funds for
the company to raised a capital.

Ability to borrow
A liquid position is not only way to provide for flexibility and thereby protect against
uncertainty. If the CP&L has the ability to borrow on comparatively short notice, it
may relatively flexible. This ability to borrow can be in the form of a line of credit or a
revolving credit from a bank or financial institution.

Bonds
Bond is another option for the CP&L to raise a capital for the investment in new
project. In financial term a bond is a debt security in which the authorized issuer
owes the holders a debt and, it's depend upon the terms of the bond, some bonds
obliged to pay a certain amount of interest until the time of its maturity. A bond is a

kind of formal contract to payback borrowed money with interest at fixed intervals.
So issuing bond can be the one of source for the company to raise capital.

Leasing
Leasing as an alternative to outright purchase, minimize cash outgoing and maximize
the tax advantages. The lease can include such charges as maintenance, which
enables the company to know, in advance, the total costs for the year. At the end of
the lease period the company can return the asset, exercise its option to buy or
negotiate a new lease on new equipment. Leasing mean that company can always
have the most up-to-date equipment. The company may never own the good
outright. However, if it wants to keep the equipment, it must take out a new lease or
buy.

Alternatively organization can sell an asset to a financial institution and lease it back
from them. This is termed sales and lease back. The advantage here is that the
company receives an injection of cash and can spread the repayments over a number
of years.

Note payable
CP&L can use note payable method to raise a capital for its project. A promissory
note, referred to as a note payable. Or can say commonly as just a NOTE, it is a
contract where one party makes an unconditional promise in writing to pay a sum of
money to the other party or can say company (payee) either at a fixed or
determinable future time or on demand of the payee, under specific terms and
conditions.

Common stock
Common stock is another way to raised fund in form of CP&L equity ownership. It is
a type of security.
In case of common stock holders of common stock are able to influence the
corporation through votes on establishing corporate objectives and policy, stock
splits, and electing the company's board of directors. Some holders of common stock
also receive preventative rights, which enable them to keep their proportional
ownership in a company. There is no fixed dividend will be paid to common stock

holders and so their returns are undecided, dependent on earnings, company

reinvestment, and proficiency of the market to value and sell stock.

Task 2
Different Appraisal Methods for Investment
Net present value as a superior method of investment appraisal.

Net present value

NPV is a precursor of how much value an investment or project adds to the firm.
With a specific project, if return value is a positive value, then project is in the status
of discounted cash inflow in the time of time. But if NPV comes in a negative value,
the project is in the status of discounted cash outflow of time. Some time with
positive value of NPV risk could be accepted
A present value is the value now invested for the cash flow it could be negative value
or positive value. The value of each cash flow is needed to be adjusted for risk and the
time value of money for a project.
A net present value (NPV) considers all cash flows that including initial cash flows
for example the cost of purchasing of an asset, whereas a present value does not. The
simple present value is useful where the negative cash flow is an initial one-off, as
when buying a security.
A discount rate allied like this
NPV = CF0 + CF1/(1+r) + CF2/(1+r)2 + CF3/(1+r)3 ...
Where CF 1 is the cash flow the investor receives in the first year, CF2 the cash flow
the investor receives in the second year etc.
and r is the discount rate.( Ref: moneyterms.co.uk accessed on 11th May 2010)
The series will typically end in a visual display unit value, which is a rough estimate
of the value at that point. It is usual for this to be adequately far in the future to have
only a minor effect on the NPV, so as rough estimate, usually based on a estimation
ratio, that is acceptable.

Periods other than a year could be used, but the discount rate needs to be adjusted.
Assuming we start from an annual discount rate then to adjust to another period we
would use, to get a rate i, given annual rate r, for a period x, where x is a fraction or
a multiple of the number of years:
i + 1 = (r + 1)x
To use discount rates that vary over time (so r1 is the rate in the first period, r2 = rate
in the second period etc.) we would have to resort to a more basic form of the
calculation:
NPV = CF0 + CF1/(1+r1) + CF2/((1+r1) -(1+r2)) + CF3/((1+r1) -(1+r2) (1+r3)) ...
This would be tedious to calculate by hand but is fairly easy to implement in a
spreadsheet

Strengths
It will give the accurate decision advice assuming a perfect capital market. It will also
give right ranking for mutually exclusive projects.
NPV gives an absolute value.
NPV allows for the time value for the cash flows.

Weaknesses
It is very difficult to identify the correct discount rate in the given project.
NPV as method of investment assessment requires the decision criteria to be
specified before the appraisal can be undertaken

In contrast of NPV there are other three methods of investment appraisal

Pay back
Internal rate of return

Accounting rate of return

Pay Back
In business and financial side refers to the period of time required for the return on
an investment to "pay back" the sum of the original investment.
Payback period which dealings the time required for the cash inflows to equal the
original expense. It measures risk, not return.
It will give you exact period to pay back Loan or finance, Difference between Cash
inflows and Outflows are also outlined
The payback period is both theoretically simple and easy to calculate. It is also a
seriously unsound method of evaluating investments.
The payback period is the time in use to recover the initial investment or initial
capital. So a 1m investment that will make a profit of 200,000 a year has a
payback period of five years. Investments with a short-term payback period are
favored to those with a long period. Most companies using payback period as a
regular will have a maximum acceptable period.
The payback period has a number of serious flaws/Demerits:
It attaches no value to cash flows after the end of the payback period.
It makes no adjustments for risk.
It is not directly related to wealth maximization as NPV is.
It ignores the time value of money
The cut off period is arbitrary.
To compensate for some of these deficiencies, one can adjust the cash flow by
discounting the cash flow using the WACC and then calculating the payback period.
This only really adjusts for the time value of money and it therefore does not address
the other deficiencies of the payback period.
One justification for the use of the payback period is that it is conservative, as it
values only short term returns which can be foreseen with reasonable certainty.

However this argument does not really stand up to scrutiny; the NPV also adjusts for
the uncertainty of future cash flows and does so correctly.

Strengths
Simple to compute
Provides some information on the risk of the investment
Provides a crude measure of liquidity

Weaknesses
It is not for very long financing, It doesn't deal with Time value of money so many
times companies have to pay more than they actually acquire, Pay back period has
limitations with Inflation as well, rise of inflation can cause serious damage to
organization's finance. Interest rates are also not entirely covered, however we can
calculate interest rate over pay back period, but it has some limitations. It makes no
adjustment for risk as well.

INTERNAL RATE OF RETURN

The internal rate of return that is called (IRR) is a rate of return that is used in
capital budgeting as a tool to calculate and compare the profitability of investment in
the project. It is also called the discounted cash flow rate of return or simply the rate
of return that is called ROR
The Internal Rate of Return is the discount rate that generates a zero net present
value for a sequence of future cash flows. This basically means that IRR is the rate of
return that makes the amount of present value of future cash flows and the final
market value of a project that equal its current market value.
Internal Rate of Return provides a simple 'hurdle rate', whereby any project should
be avoided if the cost of capital exceeds this rate. Usually a financial calculator has to
be used to calculate this IRR, though it can also be mathematically calculated using
the following formula
Internal Rate of Return is the flip side of Net Present Value (NPV), where NPV is the
discounted value of a stream of cash flows, generated from an investment. IRR thus

computes the break-even rate of return showing the discount rate, below which an
investment results in a positive NPV.

It calculates Break-even, IRR calculates an alternative cost of capital including an

appropriate risk premium. (Ref: www.scribd.com/doc/.../Capital-Budgeting-ofCanteen-Wala accessed on 15th May 2010)

Strengths
Academicians have long predictable the superiority of net present value (NPV) over
internal rate of return (IRR), yet financial managers carry on to use IRR as a capital
budgeting measure.

Weakness
IRR cannot not be use to rate mutually exclusive projects, mutually exclusive are
those where you have to choose one project not both. The IRR also cannot be use in
the usual manner for projects that start with an initial positive cash inflow, like
Deposit in Fixed account by Customer, intermediate cash flows are never reinvested
or considered at the project's IRR, thus making IRR little edgy as compared to NPV

Accounting Rate of Return

In finance, and accounting, it measures the excess or shortfall of. Input the cash
flows and a discount rate or discount curve and outputting
The accounting rate of return (ARR) is a very simple (in fact overly simple) rate of
return:
Average profit average investment
As a percentage. Where average means arithmetic mean
The profit number used is operating profit usually from a particular project).
The average investment is the book value asset tied up. This is important as the profit
figure used is after depreciation and amortization the means that value of assets used
should also be after depreciation and amortization as well.

ARR is most often used internally when selecting projects. It can also be used to
measure the performance of projects and subsidiaries within an organization. It is
rarely used by investors, and should not be used at all, because:
Cash flows are more important to investors, and ARR is based on numbers that
include non-cash items.
ARR does not take into account the time value of money the value of cash flows does
not diminish with time as is the case with NPV
It does not adjust for the greater risk to longer term forecasts.
There are better alternatives which are not significantly more difficult to calculate.
The accounting rate of return is conceptually similar to pay back, and its flaws, in
particular, are similar. A very important difference is that it tends to favour higher
risk decisions (because future profits are insufficiently discounted for risk, as well as
for time value), whereas use of the payback period leads to overly conservative
decisions.
Because ARR does not take into account the time value of money, and because it is
wholly unadjusted for non-cash items, any method of selecting investments based on
it is necessarily seriously flawed. Its only advantage is that it is very easy to calculate.
It is fairly easy to construct (realistic) examples where it will lead to different choices
from NPV, and the NPV led decision is clearly correct.

Strengths
Considers the time value of money
Considers the risk of the project's cash flows (through the cost of capital)

Weaknesses
No concrete decision criteria that indicate whether the investment increases the
firm's value
Requires an estimate of the cost of capital in order to calculate the payback
Ignores cash flows beyond the discounted payback period

Recommendations
An efficient understanding of present value concepts is of great support in the
understanding of a wide range of areas of business decision making. The concepts
are particularly important in managerial decision making, since many decisions
made today affect the firm's cash flows over future time periods for any project.
In this report I have only discussed how to take the timing of the cash flows into
concern.
Risk and tax considerations must still be defined before the real-world decision
maker has a tool that can be successfully applied. In addition, there are may be many
qualitative factors that management wants to think before accepting or rejecting an
investment. One another important thing is that NPV helps management in decision
making for the approval and rejection of the project.

Task 3
Part (a)
RATIO ANALYSIS
Financial ratio analysis is the computation and comparison of ratios which are
derived from the information of the company's financial statements. We calculated
different ratio's to analyze company's financial position. Ratios are shown below
Calculation of ratios for both years of Amber Lights Ltd, a high street fashion store

RETURN ON CAPITAL EMPLOYED

Capital employed is in general measured as fixed assets add current assets subtract
Current liabilities and represents the long term investment in the business, or
owner's capital plus long term liabilities. Return on capital employed is frequently
regarded as the best measure of profitability.

Formula
= Net profit before tax & interest/ Capital employed
Capital employed= total asset - current liabilities

LAST YEAR
THIS YEAR
= 22,000/144,000
0.152778
= 35,000/142,000
0.246479

Interpretation:
Note that the profit before interest is used, because the loan capital compensated by
that interest is included in capital employed. Amber Light Ltd ROC for last year is
15% which is very low not dramatically good because a low return on capital
employed (assets used) is caused by either a low profit margin or a low asset turnover
or both, but this year it has been increased by 24% which shows the increase in
profitability of a company.

RETURN ON ORDINARY SHAREHOLDERS'

FUNDS
Return on ordinary shareholders funds represent whether or not a company is
generating satisfactory profits in relation to the resources invested in it by
shareholders

Formula
= Net profit after taxation & preference dividend / (ordinary share capital + reserves)

LAST YEAR
THIS YEAR
= 14,000/(16,000+25,000)
14,000/41,000
0.341463

= 16,000/(16,000+25,000)
16,000/41,000
0.390244

Interpretation:
Return on ordinary shareholder funds in last year was 0.341463 but it shows increase
for this year by 0.390244 which is positive sign for the company. But if we see the
over all percentage of the company that means company may not generating
adequate profit as compare to resource been invested

GROSS PROFIT MARGINE

GPM is the amount remaining after paying for the cost of good sold. Having low
GPM may result from low prices, high cost of material, and high cost of labour, bad
product mix or a combination of these factors.

Formula
= Gross profit / sales

LAST YEAR
THIS YEAR
= 92,000/350,000
0.262857
= 110,000/420,000
0.261905

Interpretation:
The Gross profit margin reveals the percentage of each pound left over after the
business has paid for its goods.

Amber Light Limited gross profit in last year was 0.262857 but it has been slightly
decreased by 0.261905 how ever the decrease in gross profit ratio indicates business
might bearing high cost or may company issued some off sales on credit .

NET PROFIT MARGIN

Net Profit Margin ratio of net income to net sales is called the profit margin. It
defines the profitability generated from revenue and hence is an important measure
of operating performance

Formula
= Net profit before tax & interest/ Sales

LAST YEAR
THIS YEAR
=22,000/350,000
0.062857
=35000/420,000
0.083333

Interpretation:
Profitability ratio of Amber light Ltd Company shows increase in trend that shows
earning power of the business is strong and also indicates that company's pricing
cost structure and production efficiency.

CURRENT RATIO
Current ration ratio is obtained by dividing the 'Total Current Assets' of Amber &
light Company by its 'Total Current Liabilities'. The ratio indicates as a test of
liquidity for a company. It expresses the 'working capital' relationship of current
assets available to meet the company's current obligations.

Formula

= Total current asset / Total current liabilities

LAST YEAR
THIS YEAR
=110,000/50,000
2.2
=136,000/92,000
1.478261

Interpretation
Amber light Ltd Company has 2.2 of Current Assets this year and 1.478261 last year
to meet $1.00 of its Current Liability

ACID TEST RATIO

This ratio is obtained by Total Quick Assets of a company divided by its 'Total
Current Liabilities. Sometimes a company is carrying heavy inventory as part of its
current assets, which might be outdated or slow moving. Thus deducting inventory
from current assets and then doing the liquidity test is measured by this ratio. The
ratio is considered as an acid test of liquidity for an organization. It defines the true
working capital relationship of its cash, A/R, prepaid and notes receivables available
to meet the organization current obligations.

Formula
=Cash + Government securities + receivables / Total current liabilities

LAST YEAR
THIS YEAR
=(4,000+62,000+0)/50,000
66,000/50,000

1.32
=(1,000+72,000+0)/92,000
73,000/92,000
0.793478

Interpretation:
It is a stringent test of liquidity. It is found by separating the most liquid current
assets by current liquidity. Quick ratio of Amber light Company shows slight
decrease of 0.793478 in this year as in last year it was 1.32 so, ratio has been
decreased this year that Shows Company has low efficiency to meet its short term
obligations from most liquid assets.

AVERAGE STOCK TURNOVER PEIOD

Average stock turnover period Measures the number of times a company converts its
stock into sales during the year. When investigative this ratio it should be borne in
mind that different companies will have varying levels of stock turnover depending
on what they produce and the industry they operate in.

Formula
=Cost of good sold / Average stock

LAST YEAR
THIS YEAR
=258,000/44,000
5.863636
=310,000/63,000
4.920635

Interpretation:

In last year the inventories turn over were 5.8 or approximately 6 times which means
Increasing inventory turns reduces holding cost. The organization spends very less
amount of money on rent, utilities, insurance, maintenance, theft and other costs of
maintaining a stock of good to be sold but in this year there is slightly decrease in
inventory turn over which is 4.9 times which may result to overstocking.

Part (b)
Financial ratio analysis helps an organization to evaluate their employee
performance, credit policies and also over all performance and efficiency of the
company.
After doing ratio analysis of the company it tell us that how company is improving its
performance gradually. Some of its ratios shows sudden increase in certain areas like
return on capital employed which has increased in this year from 15% to 25% that
shows the increase in profitability of a company. Its mean company is optimum
utilising their asset to earn more profit.
In other words if we looked at ratio analysis of last year and this year which indicates
that over all company performed well in this year that's mean company is efficiently
utilising its asset and other resources they have minimised their liabilities. But
overall the result of this year is better than the previous one.

Limitations of ratios
Following are the limitations of ratio analysis.
The first and important limitation of the ratio category is Accounting information
that means the different accounting policies which may misrepresent inter company
comparisons. And secondly, through inventive accounting some accounts of the
company are adjusted therefore, ratio analysis can give false explanations to the
users.
The second limitation of ratio is Information problems. The limitations problem in
information are there because ratios are not ultimate measures, invalid information
is presented in the financial statements, historical costs is not good for decision
making, and ratios give general interpretations.

Third form of limitation is Comparison of performance over the time. These

limitations can caused by ratio analysis because of price changes, technology
changes, changes in accounting policy and impact of organization size
Many ratios are calculated on the basis of the balance sheet figures of the company.
These figures are as on the balance-sheet date only and may not be suggestive of the
year round position.
It can present current and past trends, but not future trends.
Impact of inflation is not properly reflected the ratios analysis , as many figures are
taken at historical for of data that is several years old.
The ratios are only as good or bad as the essential information used to calculate
them.

Recommendations:
In business strategy we emphasised on the role of the business environment in
shaping strategic thinking and decision-making.
The external environment in which a business is operating can creates a lot of
opportunities which a business can exploit, as well as threats that could damage a
business as well. However, to be in a position to take advantage of opportunities or
react to threats, a business needs to have the right resources and capabilities in place.
After analysing The Amber LIGHTS LTD financial statement we recommend that
company must focus on the resource auditing to identify the resources available to a
business as well as best utilisation of the resources. Some of these can be owned e.g.
plant, building and machinery, retail outlets whereas other resources can be obtained
through partnerships, mergers or simply supplier arrangements with other
businesses.
The resource auditing analysis helps to define the capabilities for AMBER LIGHTS
LTD. An most important objective of a strategic auditing is to make sure that the
business portfolio is strong and that business units requiring investment and
management attention are highlighted.
REFRENCES
www.google.com (accessed on 3rd May 2010)

www.investopedia.com (accessed on 9th June 2010)

www.solutionmatrix.com (accessed on 12th June 2010)
www.wikipedia.com (accessed on 7th June 2010)
Van Horn J. (12th Edition) Financial management and policy (accessed on 1st May
2010)
F.Birgham et C. Ehrhardt (10th Edition) Financial Management Theory and Practice
(accessed on 5th May 2010)