Transcript AFN(additional funds needed)

4-1
Financial Planning and Control

Financial Planning
The projection of sales, income, and assets
based on alternative production and marketing
strategies, as well as the determination of the
resources needed to achieve these projections.
Forecasting also is important for production
planning and human resource planning.
Financial Control
The phase in which financial plans are
implemented; control deals with the feedback and
adjustment process required to ensure adherence
to plans and modification of plans because of
unforeseen changes.
4-2
Financial Planning:
• Growth is a key theme behind financial
forecasting. Remember that growth should not be
the underlying goal of a corporation – creating
shareholder value is the appropriate goal. In many
cases, however, shareholder value creation is
enabled through corporate growth.
•The sales forecast predicts a firm’s unit and dollar
sales for some future period; generally based on
recent sales trends plus forecasts of the economic
prospects for the nation, region, industry, etc.
•We want to forecast if we need external funds –
borrowing or a new stock issue
4-3
Percentage of Sales Method
1.
2.
3.
4.
5.
6.
Projected Balance sheet forecasting of AFN
Increased sales requires increased assets that must be
financed. We will discuss the strategy for forecasting
assets.
Increased sales automatically increases spontaneous
liabilities.
Some financing will come from retained earnings.
Depending on the information, we formulate a strategy
for determining RE.
If additional funds are needed we have to choose to
finance with external funds -- debt or stock.
#5 affects #4 -- thus, we sometimes use an iterative
approach to refine the estimate.
4-4
Projected balance sheet
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A = L + OE on a balance sheet
If A = L + OE both at the beginning and end of an
accounting period
– Then A = L + OE
– Which is the fundamental basis for the sources and
uses of funds statements
– In other words the accounting works right
The concern is about acquiring outside capital
– Debt and Equity
• Bond issue or loans
• Stock Issue
External sources take a lead time and planning
Steps to get AFN – simple one-pass
forecast balance sheet method
1.
2.
3.
4.
5.
4-5
Calculate RE with the data given (method
varies)
Increase CA and spontaneous liabilities
proportionately with sales
Increase FA if needed based on capacity
information given
Carry over bonds/bank-loans and stock
Calculate TA - (TL+E) = AFN
 AFN = additional funds needed from
external sources
Hand out simple example
4-6
Two pass method example:
Northwest Chemical: 2001
Sales Projection
(millions of dollars)
$3,000
$2,500
$2,000
$1,500
$1,000
$500
$0
1996
1997
1998
1999
2000
2001
4-7
4-8
Northwest Chemicals
Oregon producer of Ag Chemicals

Prepare financial forecast, main
assumption is a 25% increase in sales
 Want to know how performance/ratios
changes.
 One of the hard items is Additional Funds
Needed
 We will use the percentage of sales method
of forecasting financial statements. This
will give you a thorough feel for the
process of forecasting financial
statements.
4-9
North West Chemical:
Key Ratios
Profit Margin
ROE
DSO
Inv. turnover
F.A. turnover
T.A. turnover
Debt/ assets
TIE
Current ratio
Payout ratio
NWC
2.52%
7.20%
43.2 days
5.00x
4.00x
2.00x
30.00%
6.25x
2.50x
30.00%
Industry
4.00%
15.60%
32.0 days
8.00x
5.00x
2.50x
36.00%
9.40x
3.00x
30.00%
Condition
Poor
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Good
Poor
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O.K.
4-10
Projected Financial Statements
Step 1. Forecast the 2001
Income Statement
Key Assumptions
Implications for
fixed assets
and fixed cost?
 Interest rate = 8% for any debt.
 Operating at full capacity in 2000.
 Each type of asset grows proportionally with
sales.
 Payables and accruals grow proportionally with
sales.
 2000 payout (30%) will be maintained.
 No new common stock will be issued.
 Sales are expected to increase by $500 million.
(%S = 25%)
4-11
NWC: Projected
2001 Income Statement:
Sales
Less: VC
FC
EBIT
Interest
EBT
Taxes (40%)
Net. income
Div. (30%)
Add. to RE
2000
$2,000
1,200
700
$ 100
16
$ 84
34
$ 50
$ 15
$ 35
Factor
x1.25
x1.25
x1.25
Initial Forecast
$2,500
1,500
875
$ 125
16
$ 109
44
$ 65
$ 19
$ 46
4-12
Projected Financial Statements
Step 2. Forecast the 2001
Balance Sheet (Assets)
2000
Factor
Initial Forecast
Cash/sec.
$20
x1.25
$25
Accts. rec.
240
x1.25
300
Inventories
240
x1.25
300
Total CA
$500
Net FA
Total assets
500
$625
x1.25
$1,000
At full capacity, so all assets must
increase in proportion to sales.
625
$1,250
4-13
Projected Financial Statements
Step 2. Forecast the 2001
Balance Sheet (Liability & Equity)
AP/accruals
Notes payable
Total CL
L-T debt
Common stk.
Ret. earnings
Total liab./eq.
2000
Factor
$100 x1.25
100
$200
100
500
200 +46*
$1,000
Initial Forecast
$125
100
$225
100
500
246
$1,071
*From projected income statement.
4-14
Projected Financial Statements
Step 3. Raising the
Additional Funds Needed
 Forecasted
total assets
 Forecasted total claims
 Forecast AFN1
=
=
=
$1,250
$1,071
$ 179
NWC must have the assets to make
forecasted sales. The balance sheet must
balance. So, we must raise $179 externally.
4-15
How will the AFN be financed?
Additional notes payable =
0.5 ($179) = $89.50
Additional L-T debt
=
0.5 ($179) = $89.50
But this financing will add 0.08 ($179) = $14.32
to interest expense, which will lower NI and
retained earnings.
4-16
Projected Financial Statements
Step 4. Financing Feedbacks
The effects on the income statement and
balance sheet of actions taken to finance
forecasted increases in assets.
4-17
NWC: 2001 Adjusted Forecast
of Income Statement
1st Pass Feedback 2nd Pass
Sales
$2,500
$2,500
Less: VC
1,500
1,500
FC
875
875
EBIT
$125
$125
Interest
16
+14
30
EBT
$109
$95
Taxes (40%)
44
38
Net. income
$65
$57
Div. (30%)
$19
$17
Add. to RE
$46
$40
4-18
NWC: 2001 Adjusted Forecast
of Balance Sheet (Assets)
1st Pass Feedback 2nd Pass
Cash/sec.
$25
$25
Accts. rec.
300
300
Inventories
300
300
Total CA
$625
$625
625
625
$1,250
$1,250
Net FA
Total assets
No change in asset requirements.
4-19
NWC: 2001 Adjusted Forecast
of Balance Sheet
(Liabilities & Equity)
1st Pass Feedback 2nd Pass
AP/accruals
$125
$125
Notes payable
100 +89.5
190
Total CL
$225
$315
L-T debt
100 +89.5
189
Common stk.
500
500
Ret. earnings
246
-6
240
Total liab./eq.
$1,071
$1,244
4-20
Results of the
Adjusted Forecast:
 Forecasted
assets = $1,250 (no change)
 Forecasted claims = $1,244 (higher)
 2nd pass AFN
= $
6 (short)
 Cumulative AFN
= $179 + $6 = $185.
 The $6 shortfall came from reduced net
earnings. Additional passes could be
made until assets exactly equal
liabilities/equity. ex: $6 (0.08) = $0.48
interest 3rd pass.
4-21
North West Chemical:
Adjusted Key Ratios
Profit Margin
ROE
DSO (days)
Inv. turnover
F.A. turnover
T.A. turnover
D/A ratio
TIE
Current ratio
Payout ratio
NWC
2000
2001(E)
2.52%
2.27%
7.20%
7.68%
43.2
43.2
5.00x
5.00x
4.00x
4.00x
2.00x
2.00x
30.00%
40.34%
6.25x
4.12%
2.50x
1.99x
30.00%
30.00%
Industry
4.00%
15.60%
32.0
11.00x
5.00x
2.50x
36.00%
9.40x
3.00x
30.00%
Poor
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O.K.
4-22
Analysis of the Forecast:
How does North West
Chemical Compare?
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Not very profitable relative to other
companies in the industry.
Carrying excess inventory and receivables.
Debt ratio projected to move ahead of
average.
Overall, not in good shape and doesn’t
appear to be improving.
4-23
Capacity Issues

Sales last year $500
 Last year at 80% of capacity
 Sales will increase 50%
 What percentage will fixed cost and fixed
assets increase?
4-24
Answer
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Sales last year were .8 times capacity
Sales this year will be 1.5x.8 times capacity
Which is 1.2 times capacity
Therefore capacity needs to be increased by
20%.
Multiply fixed cost and fixed assets by 1.2
4-25
Other Considerations in
Forecasting: Excess Capacity
Suppose in 2000 fixed assets had been
operated at only 75% of capacity:
1.25 x .75 = .9375; will be at 93.75% of capacity
Full Capacity Sales
Actual sales
=
% of capacity usage
$2,000
=
= $2,667.
0.75
4-26
Does NWC need additional
fixed assets?
With the existing fixed assets, sales could
be $2,667. Since sales are forecasted at
only $2,500, no new fixed assets are needed.
How would fixed costs change?
Fixed cost would not increase.
4-27
If NWC had been operating at full
capacity, what would its fixed
assets/sales ratio be?
Actual fixed assets
Target FA / sales =
Full capacity sales
$500
=
= 18.75%
$2,667
With the existing fixed assets, sales could
be $2,667. Since sales are forecasted at
only $2,500, no new fixed assets are needed.
4-28
Projected Financial Statements
Step 2. Forecast the 2001
Balance Sheet (Assets)
2000
Factor
Initial Forecast
Cash/sec.
$20
x1.25
$25
Accts. rec.
240
x1.25
300
Inventories
240
x1.25
300
Total CA
$500
Net FA
Total assets
500
$625
x1.25
$1,000
At full capacity, so all assets must
increase in proportion to sales.
625
$1,250
4-29
How would the excess capacity
situation affect the 2001 AFN?
 The projected increase in fixed assets was
$125, the AFN would decrease by $125.
 Since no new fixed assets will be needed,
AFN will fall by $125.
4-30
NWC: Projected
2001 Income Statement:
Sales
Less: VC
FC
EBIT
Interest
EBT
Taxes (40%)
Net. income
Div. (30%)
Add. to RE
2000
$2,000
1,200
700
$ 100
16
$ 84
34
$ 50
$ 15
$ 35
Factor
x1.25
x1.25
x1.25
Initial Forecast
$2,500
1,500
875
$ 125
16
$ 109
44
$ 65
$ 19
$ 46
4-31
How would the excess capacity
situation affect the 2001 AFN?
 Fixed cost would not increase, increasing
EBIT by $175
 In turn net income and RE would increase,
thus more internal financing and AFN
would be smaller.
4-32
How would excess capacity
affect the forecasted ratios?
 Sales wouldn’t change but assets
would be lower, so turnovers would be
better.
 Less new debt, hence lower interest, so
higher profits, EPS,ROE.
 Debt ratio, TIE would improve.
4-33
2001 Forecasted Ratios:
Profit Margin
ROE
DSO (days)
Inv. turnover
F.A. turnover
T.A. turnover
D/A ratio
TIE
Current ratio
Payout ratio
% of Capacity in 2000
100%
75%
2.27%
2.51%
7.68%
8.44%
43.2
43.2
5.00x
5.00x
4.00x
5.00x
2.00x
2.22x
40.34%
33.71%
4.12%
6.15x
1.99x
2.48x
30.00%
30.00%
Industry
4.00%
15.60%
32.0
8.00x
5.00x
2.50x
36.00%
9.40x
3.00x
30.00%
4-34
Summary: How different factors
affect the AFN forecast.

Dividend payout ratio changes.
If reduced, more RE, reduce AFN.
 Profit margin changes.
If increases, total and retained earnings increase,
reduce AFN.
 Plant capacity changes.
Less capacity used, less need for AFN.
 AP Payment terms increased to 60 days from 30.
Accts. payable would double, increasing
liabilities, reduce AFN.