Transcript Financial Forecasting and Corporate Valuation

Financial Forecasting
and Short-term
Financing
Forecasting and
Pro Forma Analysis
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Timing of financial needs
Amount of financial needs
Flow of funds
Check the covenants
Pro forma Income
Pro forma
Statement
Balance Sheet
Depreciation
Capital Expenditures
Plug Figure
Financing Options
Change in Net Plant
& Equipment
Short-Term Debt
Long-Term Debt
Sales
Forecast
Working Capital
Accounts
Net Income
Dividend Policy
Change in Retained
Earnings
External
Financing
Required
Steps in Financial Forecasting
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Forecast sales
Project the assets needed to support
sales
Project internally generated funds
Project outside funds needed
Decide how to raise funds
See effects of plan on ratios and stock
price
Sales Forecast
Seasonal changes
Business cycle
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Market segment
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Recession
Expansion
High growth
Contraction
Inflation
2001 Balance Sheet (Millions of $)
Cash & sec.
$20
Accounts rec.
240
Inventories
240
Total CA
$500
Net fixed
Assets
Total assets
Accts. pay. &
accruals
$100
Notes payable
100
Total CL
$200
L-T debt
100
Common stk
500
Retained
500
$1000
Earnings
Total claims
200
$1000
2001 Income Statement (Millions of $)
Sales
$2,000.00
Less: COGS (60%)
SGA costs
1,200.00
700.00
EBIT
$100.00
Interest
16.00
EBT
$84.00
Taxes (40%)
33.60
Net income
$50.40
Dividends (30%)
$15.12
Add’n to RE
35.28
AFN (Additional Funds Needed)
Key Assumptions
 Operating at full capacity in 2001.
 Each type of asset grows proportionally with
sales.
 Payables and accruals grow proportionally with
sales.
 2001 profit margin (2.52%) and payout (30%) will
be maintained.
 Sales are expected to increase by $500 million.
(%ΔS = 25%)
AFN (Additional Funds Needed)
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AFN= (A*/S0) ΔS - (L*/S0) ΔS - M(S1)(1 - d)
= ($1,000/$2,000)($500) - ($100/$2,000)($500) 0.0252($2,500)(1 - 0.3)
= $180.9 million.
Projecting Pro Forma Statements with the
Percent of Sales Method:
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Project sales based on forecasted growth rate in sales
Forecast some items as a percent of the forecasted sales
Costs
Cash
Accounts receivable
Items as percent of sales
Inventories
Net fixed assets
Accounts payable and accruals
Choose other items
Debt (which determines interest)
Dividends (which determines retained earnings)
Common stock
Percent of Sales: Inputs
2001
2002
Actual
Proj.
COGS/Sales
60%
60%
SGA/Sales
35%
35%
Cash/Sales
1%
1%
Acct. rec./Sales
12%
12%
Inv./Sales
12%
12%
Net FA/Sales
25%
25%
5%
5%
AP & accr./Sales
Other Inputs
Percent growth in sales
25%
Growth factor in sales (g)
1.25
Interest rate on debt
8%
Tax rate
40%
Dividend payout rate
30%
2002 1st Pass Income Statement
2002
Sales
2001
Factor
1st Pass
$2,000
g=1.25
$2,500
Pct=60%
1,500
Pct=35%
875
Less: COGS
SGA
EBIT
Interest
EBT
$125
16
16
$109
Taxes (40%)
44
Net. Income
$65
Div. (30%)
$19
Add. to RE
$46
2002 1st Pass Balance Sheet (Assets)
Forecasted assets are a percent of sales.
2002 Sales = $2,500
2002
Factor
1st Pass
Cash
Pct= 1%
$25
Accts. rec.
Pct=12%
300
Inventories
Pct=12%
300
Total CA
Net FA
Total assets
$625
Pct=25%
$625
$1250
2002 1st Pass Balance Sheet (Claims)
2002 Sales = $2,500
2002
2001
AP/accruals
Notes payable
Factor
1st Pass
Pct=5%
$125
100
100
Total CL
$225
L-T debt
100
100
Common stk.
500
500
Ret. earnings
200
Total claims
+46*
246
$1,071
What are the additional funds needed (AFN)?
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Forecasted total assets
Forecasted total claims
Forecast AFN
= $1,250
= $1,071
= $ 179
NWC must have the assets to make
forecasted sales. The balance sheets
must balance. So, we must raise $179
externally
How will the AFN be financed?
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Additional notes payable= 0.5 ($179) =
$89.50  $90.
Additional L-T debt= 0.5 ($179) = $89.50
 $89.
But this financing will add 0.08($179) =
$14.32 to interest expense, which will
lower NI and retained earnings.
2002 2nd Pass Income Statement
1st Pass
Feedback
2nd Pass
Sales
$2,500
$2,500
Less: COGS
$1,500
$1,500
875
875
$125
$125
SGA
EBIT
Interest
EBT
16
+14
30
$109
$95
Taxes (40%)
44
38
Net income
$65
$57
Div (30%)
$19
$17
Add. to RE
$46
$40
2002 2nd Pass Balance Sheet (Assets)
1st Pass
AFN
2nd Pass
Cash
$25
$25
Accts. rec.
300
300
Inventories
300
300
Total CA
$625
$625
Net FA
625
625
Total assets
$1,250
$1,250
2002 2nd Pass Balance Sheet (Claims)
1st Pass
AP/accruals
$125
Notes payable
100
Total CL
Feedback
$125
+90
$225
L-T debt
100
Common stk.
500
Ret. earnings
246
Total claims
$1,071
2nd Pass
190
$315
+89
189
500
-6
240
$1,244
Results After the Second Pass
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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 the $6
reduction in retained earnings. Additional
passes could be made until assets exactly
equal claims.
Financial Forecasting and Firm Capacity
Balance Sheet ($ in Millions)
Assets
1999 Liabilities and Owners'
Equity
Current Assets
1999
Current Liabilities
Cash
200
Accounts Payable
400
Accounts Receivable
400
Notes Payable
400
Inventory
600
Total Current Liabilities 800
Total Current Assets
1200
Long-Term Liabilities
Fixed Assets
Net Fixed Assets
Total Assets
800
2000
Long-Term Debt
500
Total Long-Term Liabilities
500
Owners' Equity
Common Stock ($1 Par)
300
Retained Earnings
400
Total Owners' Equity
700
Liab. and Owners' Equity
2000
Income Statement ($ in Millions), 1999
Sales
1200
Cost of Goods Sold
900
Taxable Income
300
Taxes
Net Income
Dividends
Addition to Retained Earnings
90
210
70
140
Full Capacity
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The equation used to calculate EFN when fixed
assets are being utilized at full capacity is given
below.
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S0 = Current Sales,
S1 = Forecasted Sales = S0(1 + g),
g = the forecasted growth rate is Sales,
A*0 = Assets (at time 0) which vary directly with
Sales,
L*0 = Liabilities (at time 0) which vary directly with
Sales,
PM = Profit Margin = (Net Income)/(Sales), and
b = Retention Ratio = (Addition to Retained
Earnings)/(Net Income).
Full Capacity Example
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Given that Fixed Assets are being utilized at full
capacity and the forecasted growth rate in Sales is
25%.
Forecasted Sales: S1 = 1200(1 + .25) = $1500
Excess Capacity
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If the firm has excess capacity in its Fixed Assets then the Fixed
Assets may not have to increase in order to support the forecasted
sales level. Moreover, if the Fixed Assets do need to increase in
order to support the forecasted sales level, then they will not have to
increase by as much as would be required if they were being used at
full capacity.
If Forecasted Sales are less than Full Capacity Sales, then fixed
assets do not need to increase to support the forecasted sales level.
On the other hand, if Forecasted Sales are greater than Full Capacity
Sales, then Fixed Assets will have to increase.
Case 1: S1 Less Than SFC
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Given that Fixed Assets are currently being utilized at
60% of capacity and the forecasted growth rate in Sales
is 25%.
S1 = 1200(1 + .25) = $1500
SFC = 1200/.60 = $2000
Forecasted Sales are less than Full Capacity Sales the EFN can
be found in one step. Here A*0 is equal to Total Current Assets
which equals $1200.
Case 2: S1 Greater Than SFC
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When the Forecasted Sales are greater than Full
Capacity Sales, EFN can be determined in two steps.
The first step, EFN1, finds the EFN needed to get to
Full Capacity Sales. The second step, EFN2, finds the
additional EFN to get from Full Capacity Sales to the
Forecasted Sales.
The total EFN is simply EFN1 plus EFN2.
Excess Capacity Example: S1 > SFC
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Given that Fixed Assets are currently being utilized at
90% of capacity and the forecasted growth rate in
Sales is 25%.
S1 = 1200(1 + .25) = $1500
SFC = 1200/.90 = $1333.33
Tracing Cash and Net Working Capital
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Current Assets are cash and other assets that are expected
to be converted to cash with the year.
 Cash
 Marketable securities
 Accounts receivable
 Inventory
Current Liabilities are obligations that are expected to
require cash payment within the year.
 Accounts payable
 Accrued wages
 Taxes
The Operating Cycle and the Cash Cycle
Raw material
purchased
Finished goods sold
Cash
received
Order
Stock
Placed Arrives
Inventory period
Accounts receivable period
Time
Accounts payable period
Firm receives invoice
Cash paid for materials
Operating cycle
Cash cycle
Operating Cycle, Inventory
turnover, and A/R turnover
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Inventory turnover = Sales / Average Inventory,
or COGS / Average Inventory
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Accounts Receivable turnover = Sales / AR
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[Days A/R outstanding = 360 / Accounts Receivable
turnover]
Payable turnover = Purchase (or COGS) / AP
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[Inventory Conversion = 365 / Inventory turnover]
[Days A/P outstanding = 360 / Payable turnover]
Operating Cycle = Inventory Conversion + Days
A/R outstanding
The Operating Cycle and the Cash Cycle
Cash cycle = Operating cycle –
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Accounts
payable
period
In practice, the inventory period, the accounts
receivable period, and the accounts payable
period are measured by days in inventory, days
in receivables and days in payables.
Dell’s Working Capital Policy
DSI
DSO
DPO
CCC
31
42
33
40
Improvement
-18
-5
+21
-44
1997
13
37
54
-4
1996
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Q4
Q4
Dell’s daily sales was about $20M per day. Dell was
able to reduce the need of short term financing
$800M. Assuming a 6% short term cost of capital,
Dell was able to created $48M more pre tax earnings.
You find the following information from a
firm’s financial statements, please calculate
its cash (conversion) period?
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Beginning Inventory
Purchase
Ending Inventory
Accounts Receivable
Sales
Accounts Payable
$ 400,000
$2,600,000
$ 600,000
$ 800,000
$3,600,000
$ 600,000
Cost of Goods Sold  $400,000  $2,600,000  $600,000 
Inventory turnover =
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 4.8
$400,000
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$600,000
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Average Inventory
2
360
360
Inventory Conversion=
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 75 days
Inventory Turnover 4.8
Sales $3,600,000
A/R turnover =
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 4.5
A/R
$800,000
360
360
A/R Days=
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 80 days
A/R Turnover 4.5
Purchases $2,600,000
A/P turnover =
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 4.33
A/P
$600,000
360
360
A/P Days=
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 83 days
A/P Turnover 4.33
Operating Cycle = Inventory Conversion + A/R Days
Cash Cycle = Operating cycle – A/P days
Operating Cycle = 75 + 80 = 155 days
Cash Cycle = 155 days – 83 days = 72 days
Short term financing:
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Advantages:
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Could be obtained quicker.
The amount raised can be flexible.
Usually cheaper. (comparing with long-term finance)
Disadvantages
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High solvency risk: need to be repaid in a short
period.
High refinance risk: face highly volatile short-term
interest rates.
Short-term financing strategies
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Moderate Approach: matching maturities.
Finance long term assets and permanent
current assets with long term financing; finance
transitory current assets with short term.
Aggressive Approach: Finance part of
permanent assets and all transitory assets with
short term financing.
Conservative Approach: Finance part of
transitory current assets with long-term financing.
The Short-Term Financial Plan
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The most common way to finance a temporary cash
deficit to arrange a short-term loan.
Unsecured Loans
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Secured Loans
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Line of credit down at the bank
Accounts receivable financing can be either assigned
or factored.
Inventory loans use inventory as collateral.
Other Sources
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Banker’s acceptances
Commercial paper.