Chapter 3 And Chapter 4-Financial Forecasting

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Proforma Statements

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-are principal means by which operating managers can predict the financial implications of their decisions.
-are predictions of what a companys future need for external funding and a great way to test the feasibility of current operating plans.
-are often based on percent of sales forecasts that assume many balance sheet and income statement entries vary in constant proportion to sales.

Front 2

Proforma statements involve four steps

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-Review of past financial statements to identify quantities that have varied in proportion to sales historically.
-careful projection of future sales.
-testing the sensitivity of forecast results to variations in projected sales.

Front 3

Pro Forma Statements

Back 3

generate forecasts that are strictly applicable only on the forecast date and thus require care when dealing with seasonal businesses.
-contain a circularity involving interest expense and total debt outstanding, which can be easily handled with a computer spreadsheet set to enable iterative calculation.

Front 4

Cash Flow Forecast

Back 4

Project external funding required as the difference between anticipated sources and uses of cash over the forecast period.

Front 5

Cash Budgets

Back 5

-project the change in cash balance over the forecast period as the difference between anticipated cash receipts and disbursements.

Front 6

Three ways to cope with uncertainty in financial forecasts are

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sensitivity analysis: change one uncertain input at a time and observe how the forecast responds.

Front 7

Scenario Analysis

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make coordinated changes in several inputs to mirror the occurrence of a particular scenario, such as loss of a major customer, or a major recession.

Front 8

Simulation

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assign probability distributions to a number of uncertain inputs and use a computer to generate a distribution of possible outcomes.

Front 9

Planning Process

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3 continuing cycles
-strategic planning cycle in which senior management is most active.
-an operational cycle in which divisional managers translate qualitative strategic goals into concrete plans.
-a budgeting cycle that essentially puts a price tag on the operational plans.
-relies on the techniques of financial forecasting and planning to an increasing degree in each cycle.

Front 10

sustainable growth rate

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-reminds managers that more growth is not always a blessing and that companies can literally "grow broke."
-Is the maximum rate at which a firm can increase sales without raising new equity or increasing it financial leverage.
-assumes company debt increases in proportion to equity.

Front 11

Sustainable Growth Rate (includes four ratios) (define each one)

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-Profit Margin
-Retention Ratio
-Asset Turnover
-Financial Leverage, defined as assets divided by beginning of period equity

Front 12

Sustainable Growth Rate

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-equals the firms retention ratio times return on beginning of period equity.
-declines with inflation whenever managers and creditors do not understand the effects of inflation on historical-cost financial statements.

Front 13

Sustainable Growth Rate

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Declines with inflation whenever managers and creditors do not understand the effects of inflation on historical-cost financial statements.

Front 14

Actual sales growth above a firms sustainable growth rate

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firm needs money

Front 15

Actual Sales Growth

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Old net sales-new net sales/old net sales

Front 16

Actual sales growth above a firms sustainable growth rate

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Can be managed by:
-increasing financial leverage
-reducing the dividend payout
-Pruning away marginal activities, products or customers.
-Outsourcing some or all of production
-Increasing prices
-Merging with a "cash cow."
-Selling new equity.

Front 17

Actual sales growth below a firms sustainable growth rate

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-produces excess cash that can enhance a firms appeal as a takeover target.

-Forces management to find productive uses for the excess cash, such as
-reducing financial leverage
-returning the money to shareholders
-cutting prices
-"Buying growth" by acquiring rapidly growing firms in need of cash.

Front 18

New equity financing

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-has on average been a use of cash to American companies for most of the past 25 years, meaning firms have retired more equity than they have issued.

Front 19

New equity

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-is an important source of cash to a number of smaller, rapidly growing companies with exciting prospects.