Financial Management: Financial Forecasting
Summary
TLDRIn this financial management course segment, Thomas focuses on financial planning and forecasting, particularly the income statement and balance sheet. Key assumptions for forecasting include projected sales growth, cost of goods sold, operating expenses, interest based on debt balances, and taxes based on tax rates. The balance sheet considerations involve working capital, fixed assets, and company policies on capital issuance, debt, equity, and dividends. An example is provided, demonstrating how to forecast financials using historical data, assumptions, and company policies, with an emphasis on the importance of understanding relationships between financial statement items.
Takeaways
- 📈 Forecasting financials involves making assumptions about the relationships between income statement items and financial information.
- 💹 The foundational figure for forecasting is projected sales growth, which drives the income statement and balance sheet forecasts.
- 🔍 Relationships such as cost of goods sold, operating expenses, and interest to sales are crucial for income statement forecasting.
- 🏦 Interest expense is calculated based on debt balances and prevailing bank interest rates.
- 💼 Tax calculations are based on tax rates and the company's taxable income.
- 💼 Balance sheet forecasting involves assumptions about working capital, cash balances, accounts receivable, inventory, and payables as percentages of sales.
- 🏗️ Capital expenditures depend on the company's capacity level and the need for additional fixed assets to support sales growth.
- 💼 Company policies on capital issuance, debt, equity, and dividends affect balance sheet forecasting.
- 💼 Short-term debt adjustments are made based on cash needs, while long-term debt is influenced by company policy.
- 🔄 The balance sheet must balance, with adjustments to short-term notes payable to ensure equity.
- 🔢 Historical financials and assumptions are used to create a financial forecast, which is a critical tool for financial planning.
Q & A
What is the main topic of the lecture?
-The main topic of the lecture is financial planning and forecasting, specifically focusing on forecasting the income statement and balance sheet for a company.
What foundational figure is essential for developing a financial forecast?
-The foundational figure essential for developing a financial forecast is the projected growth and sales of the company.
How does the relationship of cost of goods sold to sales impact the financial forecast?
-The relationship of cost of goods sold to sales, expressed as a percentage of sales, impacts the financial forecast by determining the cost structure as sales grow.
What factors influence interest expense in the financial forecast?
-Interest expense in the financial forecast is influenced by debt balances and bank interest rates.
Why might a company experience a decrease in interest expense despite significant sales growth?
-A company might experience a decrease in interest expense despite significant sales growth if the debt balance decreases, as interest expense is driven by the debt balance.
How does the balance sheet relate to the income statement in financial forecasting?
-The balance sheet relates to the income statement in financial forecasting by showing how the company's assets, liabilities, and equity are expected to change in response to projected sales growth and other financial activities.
What is the role of working capital in the balance sheet forecast?
-Working capital, which includes cash, accounts receivable, inventory, and payables, generally relates to sales and is forecasted as a percentage of sales in the balance sheet.
Why might a company need to increase its fixed assets?
-A company might need to increase its fixed assets if it is at full capacity and plans to grow sales beyond the existing capacity, as additional fixed assets are required to support increased production or sales.
How does company policy affect the balance sheet forecast?
-Company policy affects the balance sheet forecast by influencing decisions regarding new capital issuance, debt and equity structures, and dividend payments.
What is the significance of the dividend payout ratio in financial forecasting?
-The dividend payout ratio, which is the relationship of dividends paid as a percentage of net income, is significant in financial forecasting as it indicates how much of the company's earnings are distributed to shareholders and how much is retained for growth or other purposes.
How is the interest rate for interest expense estimated in the absence of provided rates?
-In the absence of provided interest rates, the interest rate for interest expense is estimated by dividing the interest expense from the income statement by the total of short-term and long-term notes payable.
What assumption is made regarding the timing of changes in short-term notes payable in the financial forecast?
-The assumption made regarding the timing of changes in short-term notes payable in the financial forecast is that any increase occurs at the very last day of the year, simplifying the calculation of interest expense.
Outlines
📈 Financial Planning and Forecasting Overview
Thomas introduces the topic of financial planning and forecasting, focusing on the income statement and balance sheet. He emphasizes the importance of projected sales growth as the foundational figure for forecasting. Assumptions about the relationships between income statement items and other financial data are discussed, including cost of goods sold, operating expenses, interest based on debt balances and bank interest rates, and taxes based on tax rates. The potential for sales growth with a decrease in interest expense due to reduced debt is highlighted. Thomas also mentions the relationship between balance sheet items like working capital, cash balance, accounts receivable, inventory, and payables to sales. Capital expenditures are discussed in the context of company capacity and the need for additional fixed assets. Company policies on capital issuance, debt, equity, and dividends are also considered in the forecasting process.
🔍 Detailed Forecasting Process and Assumptions
This paragraph delves into the detailed process of forecasting financial statements. Thomas explains the need to estimate interest rates by analyzing historical financial statements and applying these rates to new debt balances. He discusses the calculation of taxes based on a percentage of earnings before taxes and the use of the same tax rate for projections. Dividends are also considered, with a focus on maintaining the dividend payout ratio. The centrality of annual sales growth to the forecasting process is reiterated, with a 20% growth rate used as an example. Thomas also discusses how balance sheet items like cash, accounts receivable, inventory, and fixed assets are driven by sales growth. The necessity to increase fixed assets when sales and fixed asset utilization are at 100% is highlighted. Liabilities and equity are also examined, with a focus on how accounts payable move with sales and the handling of short-term notes payable to balance the balance sheet. Company policy on issuing new debt and not issuing new equity is mentioned, with retained earnings calculated based on beginning balance, net income, and dividends.
🏫 In-Class Calculations and Final Thoughts
Thomas invites students to work through the calculations on their own as a preparation for the in-class activity, where they will work through the financial forecasting process together. He assures that they will cover the calculations in detail to ensure understanding. The paragraph concludes with a look forward to seeing the students in class, indicating an interactive and collaborative learning environment.
Mindmap
Keywords
💡Financial Planning and Forecasting
💡Income Statement
💡Balance Sheet
💡Sales Growth
💡Cost of Goods Sold (COGS)
💡Operating Expenses
💡Interest Expense
💡Capital Expenditures
💡Working Capital
💡Dividends
💡Fixed Asset Utilization
Highlights
Today's topic is financial planning and forecasting, focusing on forecasting the income statement and balance sheet for a company.
Forecasting the income statement involves making assumptions about the relationships of its items to other financial information.
Projected sales growth is a foundational figure for developing financial forecasts.
Understanding the relationship of cost of goods sold to sales is crucial for forecasting.
Operating expenses and interest are forecasted based on their respective relationships to sales and debt balances.
It's possible for a company to have sales growth and a decrease in interest expense if debt balance decreases.
Sales growth could lead to a decrease in taxes due to high expenses resulting in low taxable income.
Balance sheet forecasting involves assumptions about working capital, cash balance, and capital expenditures.
Fixed assets may need to increase if sales growth exceeds current capacity.
Company policies on capital issuance, debt, equity, and dividends payments influence balance sheet forecasting.
Short-term debt adjustments are made based on cash flow needs and operations.
The example provided includes a 2016 income statement, dividend payment, and projected sales growth for 2017.
Fixed asset utilization at 100% indicates a need for increased fixed assets to support sales growth.
Company policy includes issuing new debt and maintaining the dividend payout ratio in 2017.
Forecasting involves calculating cost of sales, SGA expenses, and depreciation based on historical percentages and assumptions.
Interest expense is estimated by dividing the interest expense by the total debt balances.
Historical tax rates are used to forecast taxes on the income statement.
Dividends are forecasted using the dividend payout ratio based on net income.
The central forecast figure is the annual sales growth of 20%.
Accounts receivable, inventory, and accounts payable are forecasted as percentages of sales.
Short-term notes payable is adjusted to balance the balance sheet, reflecting cash flow needs.
Long-term notes payable is influenced by company policy on new debt issuance.
Retained earnings are calculated based on beginning balance, net income, and dividends for the forecast year.
The lecture will work through the calculations in detail to ensure understanding of financial forecasting.
Transcripts
hi I'm Thomas welcome back to the course
financial management
today's topic is financial planning and
forecasting
we'll look at forecasting the income
statement and balance sheet for a
company and with those two financial
statements it's also possible to
forecast the cash flow statement
although we will focus on the income
statement and balance sheet for this
lecture in forecasting the income
statement we have certain assumptions
that we're making regarding the
relationships of income statement items
to other financial information of the
company first we need to know what is
the projected growth and sales that
that's really the foundational figure to
develop our forecast we also need to
know relationships to sale we need to
know the relationship of cost of goods
sold to sales or as a percentage of
sales same for operating expenses
interest will be based on debt balances
and whatever the bank interest rates are
and taxes will be based on tax rates so
it is possible a company could have
significant sales growth but a decrease
in interest expense because interest
expense is driven by debt balance and
it's possible that while sales goes up
the debt balance goes down it's also
possible that sales could go up and
taxes could go down because of high
expenses resulting in a low taxable
income number assumptions relating to
the balance sheet working capital or
cash balance along with our working
capital accounts receivables inventory
and payables generally relate to sales
and we will look at those as a
percentage of sales and capital
expenditures may or may not need to be
incurred depending on the company's
capacity level if we are at full
capacity we can't produce any more or
sell any more without additional fixed
assets then the sales go up our fixed
assets also need to increase but if we
have capacity and we're not growing our
sales beyond the
existing capacity then we don't need any
new buildings or machines etc and
company policy relating to the balance
sheet companies generally have policies
regarding new capital issuance debt and
equity as well as dividends payments now
in calculating our forecast we will
ultimately see that from the short-term
debt standpoint we're either going to
need extra cash and we will borrow we
will increase short-term debt or we'll
have excess cash beyond what we need for
our operations and we will pay down
short-term debt but from the standpoint
of what we'll consider more of a
permanent kind of debt I don't mean
forever
it could even be short term short term
or long term but it's more of a notes
payable as opposed to let's say a short
term line of credit from a bank notes
payable would be based on company policy
at the end of our calculations we'll see
we have excess or a shortage of cash and
we will even that out with a line of
credit from the bank now here's an
example we have our 2016 income
statement with some additional
information what the dividend payment
was for the 2016 or the dividend payment
during 2016
and now our annual sales growth that
were projecting for the following year
for 2017 and going forward we have our
2016 balance sheet with some additional
information our fixed asset utilization
is currently 100 percent so if we grow
sales which our projection was to grow
sales by 20% then we're going to need it
to increased increase fixed assets as
well in order to increase sales company
policy we plan on issuing new debt of a
hundred and ten dollars in 2017 there
will be no new equity issued and the
dividend payout ratio is no change that
doesn't mean the dividend payout in
dollars does not change that means the
dividend payout ratio the relationship
of dividends paid as a percentage of net
income will
change so looking back let's talk about
some of the relationships you'll want to
understand cost of sales as a percentage
of sales $520 is what percentage of $800
and next year we'll use the same
percentage to calculate costs of sales
on a bigger grown sales number we'll do
the same thing with SGA expense we could
also call that operating expense
depreciation expense we are going to let
the assumptions drive that number if we
increase our fixed assets then we will
increase the annual depreciation expense
by the same number and if we don't
increase our fixed assets then we will
leave depreciation expenses the same
number
interest expense what we need to do is
we need to look at one slide forward our
debt notice that we have short term
notes payable and long term notes
payable now we're not provided with an
interest rate we can estimate the
interest rate by dividing the interest
expense again going back to the income
statement dividing interest expense by
the total of short-term notes payable in
a long term notes payable that will give
us an estimate of interest rate and
that's the interest rate that we will
use for our interest expense in 2017 and
our taxes on the income statement these
taxes were based on some percentage of
earnings before taxes the line directly
above so you calculate the historic tax
rate and use the same tax rate in your
projection dividends were seventy
dollars that is some percentage of the
ninety-five dollars in net income you
want to use the same percentage the same
dividend payout ratio in 2017 and again
our sales growth the central number to
this forecast both the income statement
and the balance sheet is annual sales
growth of 20% and now again to the
balance sheet and maybe still going back
and forth cash accounts receivable
inventory all three of those will be
driven by sales growth as sales goes up
these three should go
fixed assets needs to increase not
always but again looking to the right we
see our fixed asset utilization is
currently 100 percent and we're growing
sales we can only do that with more
fixed assets so we need to increase our
fixed assets balance moving to
liabilities and equity accounts payable
will also move with sales that's a
working capital account as sales
increases accounts payable increases our
short-term notes payable this is a
number that we will finalize at the end
of our forecast we're going to change
this number either an increase or a
decrease to make the balance sheet
balance an increase would mean we had a
cash shortfall and we need to borrow a
decrease would mean excess cash and we
were able to pay down some short-term
debt looking to the bottom section long
term notes payable notice on the right
our company policy this coming year 2017
we will issue new debt let's put that
into the long term category of $110 we
will not issue any new equity so common
stock won't change and retained earnings
you will need to calculate based on the
beginning balance here of 220 plus 2017
net income minus 2017
dividends so once you've factored all
those numbers into your forecast you
will have a new income statement and a
new balance sheet will see the solution
on the following slides but in our
lecture we're going to work through this
activity together you can certainly take
a look now and you can even try and work
through the calculations on your own
that will give you great preparation for
our activity in class but we will work
through these calculations in detail
together during our lecture now looking
at the solution income statement and
balance sheet notice a couple of
particular items number one the two
numbers in yellow interest expense 37
dollars
remember interest expenses based on debt
balance so I must be calculating that
number based
some interest rate and I had to estimate
that interest rate for my historical
financial statements and I apply that
interest rate to my new debt balance now
when I say the new debt balance what I
mean there is looking at what the
short-term notes payable was plus the
long-term notes payable factoring in the
increase in 2017 immediately before
completing the model and what I mean by
that is if we look to the right in the
balance sheet we have another number
highlighted and also in red to really
emphasize this is a key number in our
model short-term notes payable has
increased it's now one hundred fifty six
dollars
we're making the assumption that that
increase was at the very last day of the
year and that the short-term notes
payable before that was the same balance
as it was at the end of 2016 in other
words in calculating our interest
expense we've got several moving parts
so we're making some simplifying
assumptions by assuming that short-term
notes payable doesn't increase until the
very last day of the year and so we
calculate and the other assumption we're
making is that the increase in long term
notes payable happened on the first day
of the year so again you can work
through the calculations to see if you
get the same numbers and we will do
these calculations together in class to
make sure you understand how to take a
set of historical financials some
assumptions and create your financial
forecast we'll do that together
I look forward to seeing you in class
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