FINANCIAL PLANNING

 The process of mapping out the future cash flow and outflows of the firm.

 To estimate the future financing requirements in advance of when the financing will be needed.

TWO TYPES OF PLANNING:

• STRATEGIC PLANNING

- It is a long range in nature and deals with the overall direction of the firm.

• OPERATIONAL PLANNING

- It is designed to be a blueprint detailing where the firm wants to be at some future point in time
and what resources are needed to get it there.

 Long term – typically done over 5-year planning horizon

 Short tem – typically conducted over a 12-18 month window.

OVERVIEW OF THE CORPORATE PLANNING PROCESS

FINANCIAL FORECASTING
Forecasting is a technique that uses historical data as inputs to make informed estimates that are
predictive in determining the direction of future trends. Businesses utilize forecasting to determine how to
allocate their budgets or plan for anticipated expenses for an upcoming period of time.

Facts:

● Main Assumption: PAST PATTERN REPEATS ITSELF INTO THE FUTURE

● Forecasts are rarely perfect

● The science and art of forecasting try to minimize, but not to eliminate, forecast errors. Forecast
errors mean the difference between actual and forecasted values

● Forecasts for a group of products are usually more accurate than these for individual products; a
shorter period tend to be more accurate.
 ● The longer the forecast horizon, the less accurate the forecast will be

STEPS IN THE FORECASTING PROCESS

TYPES OF FORECASTING

Qualitative forecasting methods, often called judgmental methods, are methods in which the forecast is
made subjectively by the forecaster. They are educated guesses by forecasters or experts based on
intuition, knowledge, and experience.

Quantitative forecasting is a statistical technique for making projections about the future which uses
numerical facts and prior experience to predict upcoming events.

Examples of Quantitative Forecasting Methods:

 Naive Forecasting. Estimating technique in which the last period's actuals are used as this
period's forecast, without adjusting them or attempting to establish causal factors. It is used only
for comparison with the forecasts generated by the better (sophisticated) techniques.
  A moving average is a technique to get an overall idea of the trends in a data set; it is an average of
any subset of numbers. The moving average is extremely useful for forecasting long-term trends.
You can calculate it for any period of time.
 The Trend Projection Method is the most classical method of business forecasting, which is
concerned with the movement of variables through time. This method requires a long time-series
data.
 Exponential smoothing refers to the use of an exponentially weighted moving average (EWMA) to
“smooth” a time series. If you have some time series xt, you can define a new time series st that is
a smoothed version of xt.

st=αxt+(1−α)st−1

Forecasting Financial Variables

 Traditional financial forecasting takes the sales forecast as a given and projects its impact on the
firm’s various expenses, assets, and liabilities.

 Most common method used for making these projections is the percent of sales method.

Percentage of sales forecasting method

 It permits a company to forecast the amount of financing it will need for a given increase in sales.
This method is simple and can provide information useful in preparing pro forma financial
statements and in estimating future funds needs.

 The method assumes that:

1. Present asset level are optimal with respect to the present sales.

2. Most Items on the balance sheet increase in proportion to the increase in sales.

Pro forma financial statements

• Pro forma financial statements helps forecast a firm’s asset requirements needed to
support the forecast of revenues (step 1)

• The most common technique is percent of sales method that expresses expenses, assets,
liabilities for a future period as a percentage of sales

Steps in Financial Forecasting

1. CONSTRUCT A SALES FORECAST

Sales forecast is generally based on:

 Past trend in sales

 The influence of any anticipated events that might materially affect that trend.

 Example: Expected increase in sales is 25%

2. PREPARE A PRO FORMA FINANCIAL STATEMENT

 Pro forma – income statement

PRO FORMA BALANCE SHEET

3. ADDITIONAL FUNDS NEEDED

 The amount of external financing a firm must seek in order to change the asset base as necessary
to support a different level of sales
 AFN = Necessary increase in asset – Spontaneous increase in liabilities – Projected increase in
retained earnings.
 4. DECIDE HOW TO RAISE FUNDS

 Borrow on short term basis

 Borrow on a long term basis
 Sell additional common stocks
 Cut dividends

FORECASTED PRO FORMA – BALANCE SHEET

5. SEE EFFECTS OF PLAN ON RATIOS

Retained earnings:

 Retained earning forecasting is important so that any shortfall in cash could be identified and the
amount of external financing necessary for the business could also be assessed.
 Retained earnings can be estimated using the following formula

Expected Estimated retained earnings

= estimated sales x profit margin x plowback ratio
 Plow back ratio=1-pay out ratio
 Pay out ratio=dividend/net income
 Profit margin=net income/sales
GENERAL ASSUMPTIONS:

 Current Assets:
- Generally grow in proportion to Sales.
 Fixed Assets:
Do not always grow in proportion to Sales. Ask if you need to expand property, office
or factory space, machinery in order to achieve your Sales target.
 Current Liabilities:
- Also called Spontaneous Financing. Generally grow in proportion to Sale
 Long Term Liabilities:
- Also, called Discretionary Financing does not grow in proportion to Sales
Discretionary Financing = estimated total assets estimated total liabilities estimated total equity.
- Discretionary Financing will depend on the decision of the management.

ACTUAL EXAMPLE OF PROFORMA FINANCIAL STATEMENT ( SAN MIGUEL BREWERY )

SALES FORECAST:

*Naïve Forecasting will be used as a method for this example.

Sales will remain at 16.57% at 2018

PRO FORMA INCOME STATEMENT

 PRO FORMA BALANCE SHEET

NEGATIVE AFN

 AFN implies that the firm can actually expect to generate more money internally from the increase
in sales than its needs to support the high level of sales
 OVERVIEW OF BUDGETING
 Simply pro forma financial statements that detail a firm’s financial forecast. They show the
company’s cash will be spent on labor, materials, and capital goods and indicate how cash will be
obtained.
 Used to plan, coordinate and control a firm’s operation.

CASH BUDGETING
 It is the primary tool for financial forecasting and planning. It contains a detailed plan of the future
cash flow estimates and is comprised of four elements or segments.
- Cash Receipts
- Cash Disbursements
- Net Change in cash for the period
- New financing needs
 A cash budget is the projection of the company’s cash receipts and disbursement over some future
period of time. Typically, a cash budget is prepared on an annual basis and subdivided into months.
 Useful in determining the amount of short term funds the firm may need to borrow to cover any
projected cash shortages.
 Also indicates the periods when the firm may have cash surpluses.

CASH BUDGET PREPARATION

1. Estimation of cash receipts

2. Scheduling of disbursement
3. Determination of a desired cash balance at the beginning of each month

ESTIMATION OF CASH RECEIPTS

 ASSUMPTIONS:
 On the average, 10% of total sales in any given month are cash sales.
 The remaining 90% are credit sales
- 30% of credit sales are collected during the month
- 70% are collected during the following month

SCHEDULING OF DISBURSEMENT

The key determinants of a firm’s schedule of payables are the level of purchases per period and
the terms given by suppliers.
 Midwestern's purchases are estimated to be 55% of next month
 Purchase new equipment in February which will cost 70,000; this also contribute to the
expected need for short-term loan.
 DETERMINATION OF A DESIRED CASH BALANCE AT THE BEGINNING OF EACH MONTH

 The projected cash balance at the beginning of each month is equal to the projected cash balance
at the end of the previous month.
 Assumption:
 50,000 is the minimum cash balance for the first quarter of 2017.
 THE STATEMENT OF CASH FLOWS

 It shows the effects of a company’s operating, investing, and financing activities on its cash balance.
 It provides a more complete indication of the sources ( and uses ) of a firm’s cash resources over
time

PRO FORMA STATEMENT OF CASH FLOWS

 It can be used to determine how much additional financing a company will need in some future
period

Assumptions:
 Operating Activities – based on sales and cost projections for the coming year, management
forecast that net cash provided by operations will be $21,000,000
 Investing Activities – Expansion of its warehouse and opening of two new stores will require a
capital expenditure of $25,000,000 during the coming year. Unlike the previous year, no asset sales
are expected during 2018
 Financing Activities – In order to support the higher level of sales in 2018, the company estimates
that it will have to increase its cash and cash equivalents by $1,500,000, i.e from $5,200,000 at
beginning of 2017 to $6,700,000 at the end of the year.

Reference: CONTEMPORARY FINANCIAL MANAGEMENT BY: MCGUIGAN , KRETLOW AND MOYER

TOPIC: FINANCIAL FORECASTING, PLANNING AND BUDGETING

REPORTED BY: ARA MAY A. ALANGCAO

SBCA MBA
DATE REPORTED: SEPTEMBER 8, 2018