B 1 2 3C D E F G H I 8/2/2007 Chapter 12. Tool Kit for Financial Planning and Forecasting Financial Statements 4 MicroDrive's 5 recent financial statements are shown below. 6 7 INCOME STATEMENT 8 (in millions of dollars) 2007 2008 9 10 Sales $2,850.0 $3,000.0 11 Costs except depreciation $2,497.0 $2,616.2 12 Depreciation $90.0 $100.0 13 Total operating costs $2,587.0 $2,716.2 14 EBIT $263.0 $283.8 15 Less Interest $60.0 $88.0 16 Earnings before taxes (EBT) $203.0 $195.8 17 Taxes (40%) $81.2 $78.3 18 NI before preferred dividends $121.8 $117.5 19 Preferred dividends $4.0 $4.0 20 NI available to common $117.8 $113.5 21 22 Dividends to common $53.0 $57.5 23 Add. to retained earnings (DRE) $64.8 $56.0 24 25 Shares of common equity 50 50 26 Dividends per share $1.06 $1.15 27 Price per share $26.00 $23.00 28 29 BALANCE SHEET 30 (in millions of dollars) 31 2007 2008 32 Assets 33 Cash $15.0 $10.0 34 ST Investments $65.0 $0.0 35 Accounts receivable $315.0 $375.0 36 Inventories $415.0 $615.0 37 Total current assets $810.0 $1,000.0 38 Net plant and equipment $870.0 $1,000.0 39 Total assets $1,680.0 $2,000.0 40 41 2007 2008 42 Liabilities and equity 43 Accounts payable $30.0 $60.0 44 Accruals $130.0 $140.0 45 Notes payable $60.0 $110.0 46 Total current liabilities $220.0 $310.0 47 Long-term bonds $580.0 $754.0 48 Total liabilities $800.0 $1,064.0 49 Preferred stock $40.0 $40.0 50 Common stock $130.0 $130.0 51 Retained earnings $710.0 $766.0 52 Total common equity $840.0 $896.0 53 Total liabilities and equity $1,680.0 $2,000.0 54 55 SALES 56 FORECAST (Section 12.2) 57 Strategic planning is one of the core functions of an organization, and it involves the coordination of operating plans with 58 financial plans. While operational plans outline how the firm intends to reach its corporate objectives, financial plans 59 outline the manner in which the firm will obtain the necessary productive assets to operate. Financial planning generally 60 begins with a sales forecast, and that forecast generally starts with a review of the firm's recent history. Here are 61 MicroDrive 62 Inc.'s sales over the past 5 years: 63 Annual Growth 64 65 Sales Rate Ln(Sales) 66 2004 $2,058 7.63 67 2005 2,534 23.1% 7.84 68 2006 2,472 -2.4% 7.81 69 2007 2,850 15.3% 7.96 70 2008 3,000 5.3% 8.01 71 Average = 10.3% 72 THE 73 SALES FORECAST 74 The 75 first step in a sales forecast are several ways to estimate the historical growth rate, ranging from the simple to the complicated. The simplest 76 are to estimate the average annual growth rate and the compound annual growth rate. go to the Options tab (see screen shot below).000 99 100 101 $0 2004 2005 2006 2007 2008 102 103 Year 104 105 106 107 chart shows the regression line.9% (Use the RATE function. check 84 "Display equation on chart" and set the Forecast for 1 unit Forward. 87 88 Annual Sales Net 89 Sales 90 $4. and then specify a projected year. as shown below.) 81 82 We 83 could also use regression analysis to estimate future sales. as we did below.B C D E F G H I 77 78 Average annual growth rate = 10. the easiest way is to use the function Wizard The to 108 create the INTERCEPT and SLOPE functions.000 96 y = 220x . Then select the Chart.000 94 95 $2. 109 110 111 D66:D70 112 C66:C70 113 114 115 116 117 118 119 120 121 Intercept = -438. See below for details. but an even easier way is to use the TREND function. This will print the regression line on the chart and show the 85 forecast 86 for the next year. 140 141 142 D66:D70 143 C66:C70 144 C156 145 146 147 148 149 150 151 .438737 97 98 $1. It then fits the regression line and gives you the This projected 139 value. Add Trendline….000 91 92 93 $3. If you actually want the regression intercept and slope.3% 79 80 Compound annual growth rate = 9. You 138 allows you to specify the past years and sales.737 (Using the INTERCEPT function) 122 123 D66:D70 124 125 C66:C70 126 127 128 129 130 131 132 133 134 135 Slope = 220 (Using the SLOPE function) 136 137 could always use the estimated interecept and slope to project the future sales. go the menu bar and select Chart. The easiest way is to plot the points using the Chart Wizard. 192 193 (1+g) rate using LOGEST = 1. the forecasted 200 value given in the text. and the function finds the "log-based" slope coefficient.60 2004 2005 2006 2007 2008 2009 178 179 180 181 Slope = 8.3 percent.10 y = 0.70 176 177 7.300. depending on the method.1% to 10.7% (Using the SLOPE function) 182 183 To find the growth rate. In this function. which is an estimate of (1+g). 191 the years as the X variable. raise e to the slope (this is eslope) and then subtract 1. we plotted the trendline and the regression equation.B C D E F G H I 152 153 154 155 156 Projected sales for 2009 = 3. 164 165 Natural Log (LN) of Sales 166 167 8. See the chart 163 below.0871x .93 170 8. 197 198 199 Management started with the regression prediction.80 174 175 7.0910358 194 g= 9.1% 186 187 188 189 Instead of doing a full regression with the Y variable being the log of sales. 184 185 g= 9. then modified it based on qualitative data to $3. The slope coefficient is the estimate of the historical sales growth rate.1% 158 159 160 161 compound growth rate is very sensitive to the particular starting and ending dates that are chosen. we could find the slope of the "log" 190 regression directly using the LOGEST function.90 173 7. Management's sales forecast represents a growth rate of 10%.00 171 172 7. One way to smooth this out is to The 162 regress the natural log (LN) of sales versus the years.1% 195 196 The historical growth rates range from 8.20 168 169 8.166.243 (Using the TREND function) 157 Implied growth rate = 8. we simply specify the original sales as the Y variable. 201 202 . 300.067 $20.58 x x D Sales $300.00 D Retained Earnings = = = x x Sales $ 3.00 D Retained Earnings D Sales $300.00 $61.3) 204 We 205can look at the additional funds needed using the AFN equation described in the text. to Sales Ratio 0.0378 $61.58 $200.00 Profit Margin 0.B C D E F G 203 THE AFN FORMULA (Section 12. we substitute gS0 for DS and we substitute S0+gS0 for S1. . At each place We in 231 the equation.6667 $200.0 x x Retention Ratio 0. We then solve for g. This method identifies the additional funds needed as being the difference between the change in assets and 'the 206 cumulative change in spontaneous liabilities and retained earnings.00 227 AFN= $118.00 H I = = = x x 217 218 219 220 221 222 223 224 D Spontaneous Liabilities = = = Spontaneous Liab.493 D Spontaneous D Retained AFN= D Required Assets Liabilities Earnings 225 226 = $20. 207 208 Forecast 209 growth rate in sales = 10% 210 AFN= 211 212 213 214 215 216 D Required Assets D Required Assets D Spontaneous Liabilities Asset to Sales Ratio 0.42 228 229 230can also rearrange the AFN formula to find the growth rate at which no external financing is required. (5) Net plant and equipment (this is reasonable for the long-term.B 232 C D E F G Asset to Sales Ratio H I Spontaneou s Liab. . 238 if MicroDrive's ratios remain constant.21% without needing external financing. (6) Accounts payable.e. in the short246 firm's often have excess capacity. (3) Accounts receivable. the company needs a certain amount of cash on hand. Other items on the financial statements are a direct result of the firm's 248 financial policies (i.21% 236 g for zero AFN= 237 Therefore.e. The actual historical statements are shown above in Rows 7-53. (2) 244 (i. to Sales Ratio 0.. since it does not know exactly when the checks it writes or deposits will Cash 245 clear the bank).. which we discuss below. 239 240 FINANCIAL STATEMENT FORECASTING: THE PERCENT OF SALES METHOD (Section 12. It also assumes term. This forecasting method assumes that many items on the The 243 financial statements are proportional to sales. which we discuss later in this model). Note: If you change the inputs below.667 x 234 = ÷ 0.58133333 235 = ÷ 3. (4) Inventories.4) 241 242 text examines a forecast for a firm using the percentage of sales of method. it assumes that the following items are proportional to sales: (1) Costs.067 g for zero AFN= Profit margin x Retention ratio ÷ - 233 0. you 254 can view a summary of results beginning in Row 374. The The ratios 253 needed for the Pro Forma analysis are shown below.01866 0. dividend policy and capital structure policy). 247 that Depreciation is proportional to Net plant and equipment. MicroDrive can grow at about 3. In particular. and (7) Accruals. 249 250 251 252 next step is to analyze the historical "Pro Forma" ratios.038 0.493 0. 4 $ 92.3 291 NI before preferred dividends $ 117.0 Interest rate x 2008 debt = 289 Earnings before taxes (EBT) $ 195.0 831.0 Previous plus "plug" if needed 308 Accounts receivable 375.561% 4.000% 10.2% x 2009 Sales = 285 Depreciation 100.500% 17.0 321 Preferred stock 40.0 Note: we have used the ROUND function to make the calculations consistent with $ 2.0 296 Dividends per share $ 1. Inc.25 62.6 $ 110.877.2 87.0 $ 2.5 294 295 Shares of common equity 50. Inc.200% 1.429% 262 Accounts Rec.00% x 2009 Sales = 316 Accruals 140.5 292 Preferred dividends 4.616.0 311 Net plant and equipment 1.0 299 300 Table 301 12-3 MicroDrive.111% 33.716.000% 10. you can view a summary of results beginning in Row 374.930% 265 Accounts Pay.0 326 a 327 Required assets b 328 Specified sources of financing 329 Additional funds needed (AFN) 330 Note: H If you change I the inputs below.3 $ 114.0 4.8 $ $ $ $ 50.000.526% 0.0 325 Total liabilities and equity $ 2.6 $ 312.0 $ $ $ $ $ $ 66.667% 10% 40% 8% 9% 11% 10% Forecast 2009 (3) $ 3.333% 12.0 412.50% x 2009 Sales = 310 Total current assets $ 1.0 20.6 $ 87.3 961.526% 266 Accruals / Sales 4.50% x 2009 Sales = 309 Inventories 615.614% 267 268 269 Other Inputs 270 271 Sales Growth Rate 272 Tax rate 273 Dividend growth rate 274 Interest rate on notes payable and short-term investments 275 Interest rate on long-term bonds 276 Coupon rate on preferred stock 277 278 Table 279 12-2 MicroDrive.500% 33.000% 87.B C D E F 255 256 Pro Forma Ratios Actual Historical 257 2007 2008 Average 258 259 Costs / Sales 87.0 130.0 the textbook.333% 1.200% 10.0 1.0 $ 2.667% 4.100.0 Same: no new issue 323 Retained earnings 766. $ 2. / Sales 11.5 2009 DPS x # shares = 298 Additions to retained earnings $ 56.5 $ 1.200.000.0 0.33% x 2009 Sales = 307 ST investments 0.3 Forecast 2009 (3) 11.000% 11.333% 0.: Actual and Projected Income Statements (Millions of Dollars) 280 Actual 281 2008 Forecast basis 282 (1) (2) 283 Sales $ 3.5 the textbook.5 65.345% 10.7 .000% 2.0 154.000.0 Same: no new issue 320 Total liabilities $ 1.0 10% x 2009 Net plant = 286 Total operating costs $ 2.000% 4.: Actual and Projected Balance Sheets (Millions of Dollars) 302 Actual 303 2008 Forecast basis 304 (1) (2) 305 Assets 306 Cash $ 10.15 108% x 2008 DPS = 297 Dividends to common $ 57.561% 20.0 $ 2. to RE = 324 Total common equity $ 896.200.0 Same: no new issue 322 Common stock 130.053% 12. / sales 30.0 Dividend rate x 2008 preferred = 293 NI available to common $ 113.207% 87.7 754.526% 33.0 2.3 2.987.100.200.064% 10.198.410% 260 Depreciation / Net plant & equip.000. Industry Forecast Composite 2009 G 87.0 $ 127.7 40.0 224.172% 261 Cash / Sales 0.0 12.500% 20.500% 11.0 110% x 2008 Sales = 284 Costs except depreciation 2.000% 1.8 $ 219.776% 263 Inventory / Sales 14.0 Previous plus "plug" if needed 318 Total current liabilities $ 310. 676.7 444.614% 87.0 33.8 $ 4.085.33% x 2009 Sales = 312 Total assets $ 2.333% 31.0 319 Long-term bonds 754.333% 2.0 313 314 Liabilities and equity 315 Accounts payable $ 60.0 1.8 $ 131.300.000% 0.053% 2.0 1.2 287 EBIT $ 283. / Sales 1.0 Note: we have used the ROUND function to make the calculations consistent with 0.531% 264 Net plant & equip.000.8 290 Taxes (40%) 78.8 288 Less Interest 88.0 2008 RE + 2009 Add.67% x 2009 Sales = 317 Notes payable 110.064. 10. forecasted common equity.0 H I 334 Required assets include all forecasted operating assets plus the short-term investments from the previous year.0) $ 1.5) $ (66.0 $ 358 Increase in notes payable $ 50.0 $ 6.7 359 Increase in bonds $ 174.0 $ 360 Payment of common and preferred dividends $ (61.0) $ (61.0 365 Cash and securities at end of the year $ 10.0 346 Due to changes in working capital 347 Increase in accounts receivable $ (60.0) $ (37.2 362 363 Net cash flow $ (5.5 $ 131.8 352 353 Long-term investing activities 354 Cash used to acquire fixed assets $ (230.0 $ 14.0 $ 114.5) 348 Increase in inventories $ (200.5) 361 Net cash provided by financing activities $ 227. forecasted long-term bonds.0 $ 11. and the amount of notes payable from the previous year.7 0.8 344 Noncash adjustments 345 Depreciation and amortization $ 100.B C 331 Required additional notes payable 332 Additional short-term investments 333 D E F $ G 114. 31 Actual Forecast 340 (in millions of dollars) 2008 2009 341 (1) (3) 342 Operating Activities 343 Net Income before preferred dividends $ 117.0 364 Cash and securities at beginning of the year $ 15.0 350 Increase in accruals $ 10. forecasted 336 preferred stock. AND AFN . 335 Specified sources of financing include forecasted operating current liabilities.0 $ 10.0 $ 110.0) $ (210. RATIOS.5) 349 Increase in accounts payable $ 30.5) $ 162.5 $ 48. 337 338 339 MicroDrive Statement of Cash Flows for Years Ending Dec.0 351 Net cash provided by operating activities $ (2.0) 355 356 Financing Activities 357 Sale of short-term investments $ 65.0 366 367 368 ANALYSIS 369 OF THE PLAN: FREE CASH FLOW. 0% Profit 397 margin 3.0 Days 394 sales outstanding 45.5) 390 Ratio 391 Analysis Current 392 ratio 3.0% Return 399 on equity 12.8% 3.6 43. while fixed assets were $1. and Key Ratios (Millions of Dollars) H I 375 Preliminary Revised Industry 376 Actual Actual Forecast Forecast Average 377 2007 2008 2009 2009 2008 378 (1) (2) (3) (4) Model 379 Inputs Costs 380 (excluding depreciation) as percent of sales 87.5 1.0 $ 731.4% 40.7% 13.5 4. Forecast Based on Current Values of Inputs in Rows 259-276 2009 87.1% Accounts 381 receivable as percent of sales 12.9 4.8 Debt 396 ratio 53.5% 20.5% 11.4% 15.6 45. AFN.0 Total 395 assets turnover 1.9% 5.9 6. See the worksheet "Scenario Summary.4% 401 402 403 404 405 406 407 408 409 410 411 412 413 414 415 416 417 418 419 420 421 422 423 424 425 426 427 428 429 430 431 432 433 434 435 436 437 438 439 440 441 442 EXCESS 443 CAPACITY ADJUSTMENTS 444 We 445have just stated that assuming current assets to grow at the same rate of sales is not necessarily correct.5% 11.7 2.5% 51.4 $ 211.7% 5.5% .4 114. We can use this information to calculate the firm's full capacity sales and the target fixed assets-tosales ratio. sales for the last year were $3.B C D E F G 370 The 371 following table shows key outputs of the preliminary plan.5 1.6 1.000 million.5% 3.2% 9. let us assume that the firm in our example is not operating at full capacity.0% 87.455 $ 1.2 Inventory 393 turnover 4.000 million.980.6 1. For instance.3% 15.7 Additional 389 funds needed (AFN) $ 114.1% 383 Model 384 Outputs Net 385 operating profit after taxes (NOPAT) $ 170. This 446 means that they could achieve a greater level of production from their fixed assets.8% 10.9% 4.0 9.8% 7.5% 9.3 $ 187. Now.980.5% 11.5 Total 387 operating capital $1.5 54." 373 Table 374 12-4 Model Inputs.5% 12.6% 5.9 45.7% 11.831.5 3.5% $ $ $ $ $ 187.2% 12.0% Return 398 on assets 5.800.4 $ 179.2 Net 386 operating working capital (NOWC) $585 $ 800.0 $ 1.0 7.0% Inventory 382 as percent of sales 20. We used the Scenario Manager to develop the key 372outputs for the revised plan.3% 9.0 1. The same can be said of fixed assets.7 $ (57.0 $ 1.5% 20. let us hypothesize that the firm was only operating at 96 percent of full capacity.4 880.0% Return 400 on invested capital 9.5 Free 388 cash flow (FCF) $ (174. Remember.8% 13.1 4.2% 87.2% 86.0 $ 880.7) $ 7.2 2.1 36.2% 54.5% 16. 000 million. Now.056 I .000 453 2008 Sales $3.We have just stated that assuming current assets to grow at the same rate of sales is not necessarily correct.32 460 461 Required level of FA = $1.000 456 457 Full capacity sales = $3. The same can be said of fixedB assets.000 448 million.300 454 Percentage of capacity 96% 455 2007 Fixed Assets $1. while fixed assets were $1.125 458 459 Target FA/Sales = 0. let us hypothesize that the firm was only operating at 96 percent of full capacity. For instance. at full capacity. This C let us assume D that the firm in Eour example is not operating F G H means 447 that they could achieve a greater level of production from their fixed assets. Remember. sales for the last year were $3. 451 452 2007 Sales $3. We can use this information to calculate the firm's full capacity sales and the target fixed assets-to449 sales 450 ratio. 5 179.7 (57.7 $ Notes: Current Values column represents values of changing cells at time Scenario Summary Report was created.000% 2.333% 0.4 798.000% 0.667% 4.000% 10. 86.800% 16.333% $H$265 2.700% 33.000% 0.500% 20.0 $ 1.000% 10.8 .4 $ NOWC $ 880.667% 20% 40% 8% 9% 11% 10% 230.500% 12.333% 2.000% $H$266 4.4 $ 187.000% $H$261 0.831.667% 10% 40% 8% 9% 11% 10% 211.4 $ AFN $ 114.200% 87.2 731.Scenario Summary Current Values: Preliminary Revised RevisedHiGrowth Changing Cells: $H$259 87. Changing cells for each scenario are highlighted in gray.4 89.333% 33.980.0 $ 880.200% $H$260 10.5) $ $ $ $ $ 86.000% 4.500% $H$264 33.333% 2.333% 11.5 1.500% $H$263 20.0 $ FCF $ 7.000% 4.0 $ TotalCapital $ 1.7 $ 114.998.0 1.0 32.800% 16.333% 11.000% 10.667% $H$271 10% 10% $H$272 40% 40% $H$273 8% 8% $H$274 9% 9% $H$275 11% 11% $H$276 10% 10% Result Cells: NOPAT $ 187.700% 33.333% $H$262 12.4 $ 7.980. Due to its use of the automatic iteration feature. CF3 Ch12 Web 12A Tool Kit.xls . the Web 12A Tool Kit is shown in a separate file. . 500 Sales ($ Millions) y = 0.5055 Accounts Receivable vs.703 R² = 0.35. Sales $400 .000 $3.000 $2.472 409 2.534 398 2. Sales $700 $600 Inventories ($ Millions) $500 $400 $300 $200 $100 $0 $0 $500 $1.500 $3.500 $2.058 $387 2.000 615 3.Tool Kit for Web Extension 12B: Advanced Techniques for Forecasting Financial Statement Accounts REGRESSION APPROACH Relationships between sales and other financial statement accounts are not always proportional.186x . Therefore. Financial Statement Data for MicroDrive ($ Millions) Accounts Receivable $268 298 304 315 375 Year 2004 2005 2006 2007 2008 2009 Sales Inventories $2.300 Inventories vs.000 $1.850 415 3. in some cases it is preferrable to use a regression approach. 23 x coefficient 0. we use the SLOPE and INTERCEPT functions to show the regression coefficients.0966x + 62. we also observe that there is a stronger correlation between sales and receivables.505. Forecasting Inventories Inventories 2008 = = = Intercept -35. than with inventories.000 $3. we observe that our regression estimate is less than the estimate as predicted by the percentage of sales method. However.500 $2. it does give financial managers a reasonable basis for forecasting the target inventory levels. we will repeat this procedure to forecast accounts receivables Forecasting Accounts Receivable Receivables 2008 = = = Intercept 62.8099 Rather than actually run a regression.300 Again.300 This value for inventories is much less than the original value calculated using the percentage of sales method.500 Sales ($ Millions) y = 0. Looking at the "R2" value in the chart. we see that the correlation between sales and inventories in this linear framework is 0.000 $1.$400 Accounts Receivable ($ Millions) $350 $300 $250 $200 $150 $100 $50 $0 $0 $500 $1.000 $2.433 R² = 0. This implies that there is a moderately strong relationship between sales and inventories.186 x Sales 2009 $ 3.703 $578.30 x coefficient 0. While this figure is not a direct indicator of asset requirements. . Now. We see this through the R 2 of 0.097 x Sales 2009 $ 3.500 $3.433 $381.8076. 500 .$3. .500 w the regression coefficients.$3. 62 million . If all ratios stay the same.SECTION 12.330% $450. what is the AFN? Sales growth rate S0 A*/ S0 L*/ S0 Profit margin (M) Retention ratio D Sales S1 AFN 15% $3.666% 6.667% 3.450.000 million 66.783% 49.3 SOLUTIONS TO SELF-TEST 3 Suppose MicroDrive's growth rate in sales is forecast as 15 percent.00 million $3.00 million $205. what is the AFN? .y the same.