Business FinanceMichael Dimond

Michael DimondSchool of Business Administration

Module H: Forecasting for Financial Management• Financial planning process• Building pro forma financial statements• Analyzing & using pro forma financials

• You can skip P4-7 & P4-8 in the homework (cash receipts & cash disbursements)

• You can skip P4-19 & P4-20 in the homework (comprehensive pro forma statement problems)

Michael DimondSchool of Business Administration

Financial Planning Process

• Plans are developed according to purpose• Strategic Plan - long term (e.g. 5-year)

• Necessarily less specific than operating plan• Tied to strategic goals• Strategic plan guides CapEx budget

• Operating Plan - short term (e.g. 1-year)• Based on forecasts of sales & capacity• Operating Plan (O.P.) provides operating budget & cash budget• Used with pro forma financial statements to predict profit & cash flow

• Plans are adjusted as needed• Strategic plan usually updated annually (or sooner, if events warrant)

• Operating plan usually updated quarterly

Michael DimondSchool of Business Administration

Pro Forma Financial Statements

• Pro forma = “in the form of”• Pro forma financials use the form of a balance sheet and income statement to

present forecast information and support financial planning & analysis (FP&A)

• Profit is the foundation of cash flow (see 4.1 Analyzing the firm's cash flow)• Cash flow is usually forecast through budgets: Capital budget, cash budget,

operating budget, etc.

• Profit comes from operations• Pro forma income statement

• Assets support operations• Pro forma balance sheet

• Pro forma financials are based on past performance and adjusted for expectations• Common-size financials

• Marketing forecasts

• Capacity analysis

• CapEx budgets

Michael DimondSchool of Business Administration

Preparing the Pro Forma Income Statement• Start with sales forecast

• Volume x Price = Revenue

• Estimate direct costs• Volume x Variable Cost per Unit = Total Variable Costs

OR

• COGS as % of Sales (from common size income statement)

• Estimating other costs• Percent-of-sales method uses data from common-size income statement

• Not everything grows at the same rate as sales (e.g. Depreciation)

Michael DimondSchool of Business Administration

Preparing the Pro Forma Balance Sheet• Three approaches

• Percent-of-sales method• Simplest method: All line items are estimated as a percent of sales• Not necessarily accurate for all items (e.g. PP&E)

• Judgmental Approach• Estimate specific line items• Determine imbalance (i.e. does A=L+SE?)• “Plug” the imbalance with external funds (debt or equity brought into the firm)

• External funds figure is frequently abbreviated EFR, EFN, AFR, AFN

• Total Asset Turnover suggest what total assets should be• TAT = Sales/Total Assets, :. Sales/TAT = Total Assets Forecasted• Estimate line item values based on common-size balance sheet• Consider how stable the common-size B/S has been over past years

Michael DimondSchool of Business Administration

Evaluating Pro Forma Financials

• Forecasts are not certain• Check the arithmetic & the internal logic• Common-size financials (vertical analysis)• Rates of growth of line items (horizontal analysis)• Ratio analysis (what questions do you need to answer?)• Examine OCF & FCF compared to history

• How would you value a company based on pro forma financial information?

Michael DimondSchool of Business Administration

Example: Sources & Uses of cash

Michael DimondSchool of Business Administration

Example: Pro Forma IS with assumptions

Michael DimondSchool of Business Administration

Spreadsheet Assignment #3: Smithfield Forecast• Assume Smithfield Foods, when acquired, will have sales

growth of 15% next year. Forecast their Income Statement and Balance Sheet based on the Percent of Sales method.