Module 7

Financial Forecasting,
Planning and Control
M. MANAYAO, CPA, MBA
Learning Objectives

1 2 3 4 5
Understand the Explain the Know the Understand the Know and apply the
financial planning
concept and benefits that can elements of a determinants of process using the
perspective of be derived from basic financial a firm’s growth Projected Financial
financial financial planning model. rates. Statement Method
planning. planning. (Percent of Sales
Method)

M. Manayao, CPA, MBA

Introduction
A lack of effective long-range planning is commonly cited reason for
financial distress and failure. Long-range planning is a means of
systematically thinking about the future and anticipating possible
problems before they occur. Planning is said to be a process that at best
helps the firm avoid stumbling into the future backward.

Financial planning formulates the way in which financial goals are to

be achieved. A financial plan is thus, a statement of what is to be done
in the future. Many decisions have a long lead time which means they
take a long time to implement. In an uncertain world, this requires that
decisions made far in advance of their implementation. For instance, if
a firm wants to build a factory in 2018, it might have to begin lining up
contractors and financing in 2016 or even earlier.
M. Manayao, CPA, MBA
 For planning purposes, it is often useful to think of the future
as having a short-run and a long-run. The short-run planning,
in practice, usually covers the coming 12 months while
financial planning over the long-run is takes to be the coming
two to five years. This time period is referred to as the
planning horizon and this is the first dimension of the
planning process that must be established.
The second dimension of the planning process that needs to
be determined is the level of aggregation. Aggregation
Perspective involves the determination of all of the individual projects
together with the investment required that the firm will
of Financial undertake and adding up these investment proposals to
Planning determine the total needed investment which is treated as one
big project.
After the planning horizon and level of aggregation are
established, a financial plan requires inputs in the form of
alternative sets of assumptions about important variables.
This type of planning is particularly important for cyclical
businesses or business firms whose sales are strongly affected
by the overall state of the economy or business cycles.
M. Manayao, CPA, MBA
 Benefits that can be Derived from
Financial Planning
Among the more significant benefits derived from financial planning
are the following:
1. Provides a rational way of planning options or alternatives.
The financial plan allows the firm to develop, analyze and
compare many different business scenarios in an organized and
consisted way. Various investment and financing options can be
explored and their impact on the firm’s shareholders can be
evaluated. Questions concerning the firm’s future lines of
business and optimal financing arrangements are addressed.
Options such as introducing new products or closing plants might
be evaluated.
2. Interactions or linkage between investment proposals are
carefully examined.
The financial plan enables the proponents to show explicitly the
linkages between investment proposals for the different
operating activities of the firm and its available financing choices.
For example, if the firm is planning on expanding or undertaking
new investments and projects, all other relevant variables such as
source, terms and timing of financing are thoroughly examined.
M. Manayao, CPA, MBA
 Benefits that can be Derived from
Financial Planning
3. Possible problems related to the proposal projects are identified
actions to address them are studied.
Financial planning should identify what may happen to the firm if
different events take place. Specifically, it should address what
actions the firm will take if expectations do not materialize and more
generally, if assumptions made today about the future are seriously
in error. Thus, one objective of financial planning is to avoid
surprises and develop contingency plan.
4. Feasibility and internal consistency are ensured.
Financial planning is a way of verifying that the goals and plans made
for specific areas of a firm’s operations are feasible and internally
consistent. The financial plan makes explicit the linkages between
different aspects of a firm’s business such as the market share, return
on equity, financial leverages, and so on. It also imposes a unified
structure for reconciling goals and objectives.
5. Managers are forced to think about goals and establish priorities.
Through financial planning, directions that the firm would take are
established, risks are calculated and educated alternative courses of
M. Manayao, CPA, MBA
action are considered thoroughly.
 Financial planning process will differ from firm to
Financial firm, just as companies differ in size and products.
However, a basic financial planning model will have
Planning the following common elements:

Models a. Economic Environment Assumption

The plan will have to state explicitly the economic
environment in which the firm expects to reside
over the life of the plan. Among the more
important economic assumption that will have to
be made are the inflation rates, level of interest
rates and the firm’s tax rate.
 Sales Forecast
Financial
b.

An externally supplied sales forecast considered

Planning the “driver” shall be the “heart” of all financial
plans. The user of the planning model will supply

Models this value and most other values will be calculated

based on it. Planning will focus on projected future
sales and the assets and financing needed to
support those sales.

Oftentimes, the sales forecast will be given as the

growth rate in sales rather than as an explicit sales
figure. Perfect sales forecast are not possible, of
course, because sales depend on the uncertain
future state of the economy.
 Determinant of Growth Rates
Financial A firm’s ability to sustain growth depends explicitly
Planning on the following factors:
✓ Profit Margin
Models ✓ Dividend Policy
✓ Financial Policy
✓ Total Asset Turnover
 c. Pro-forma Statements
Financial A financial plan will have a forecast statement of financial
position, income statement, statement of cash flows and
Planning statement of stockholders’ equity. These are called pro-
forma or projected statements which will summarize the
different events projected for the future.
Models
d. Asset Requirements
The financial plan will describe projected capital spending.
At a minimum, the projected statement of financial
position will contain changes in total fixed assets and net
working capital. These changes effectively the firm’s total
capital budget. Proposed capital spending in different
areas must be reconciled with the overall increases
contained in the long-range plan.
 e. Financial Requirements
Financial The financial plan will include a section about the necessary
financing arrangements. This part of the plan should
Planning discuss dividend policy and debt policy. Sometimes firms
will expect to raise cash by selling new shares of stock or by
borrowing. In this case, the plan will have to consider what
Models kinds of securities have to be sold and what methods of
issuance are most appropriate.

f. Additional Funds Needed (AFN)

After the firm has a sales forecast and an estimate of the

required spending on assets, some amount of new financing
will often be necessary because projected total assets will
exceed projected total liabilities and equity. In other words,
the statement of financial position will no longer balance.
 The Projected Financial
Statement Method
➢ Any forecast of financial requirements involves (a)
determining how much money the firm will need during
a given period, (b) determining how much money the
firm will generate internally during the same period,
and (c) subtracting the funds generated from the funds
required to determine the external financial
requirements.

➢ The projected financial statement method is

straightforward, one simply projects the asset
requirements for the coming period, then projects the
liabilities and equity that will be generated under
normal operations and subtracts the projected
liabilities/capital from the required assets to estimate
the additional funds needed.
The Projected Financial
Statement Method

Step 1: Forecast the Income Statement.

a. Establish a sales projection.

b. Prepare the production schedule and project
the corresponding production costs: direct
materials, direct labor and overhead.
c. Estimate selling and administrative expenses.
d. Consider financial expenses, if any.
e. Determine the net profit.
The Projected Financial
Statement Method

Step 2: Forecast the Statement of Financial

Position.

a. Project the assets that will be needed to support

projected sales.
b. Project funds that will be spontaneously
generated (through accounts payable and
accruals) and by retained earnings.
c. Project liability and stockholders’ equity accounts
that will not rise spontaneously with sales (e.g.,
notes payable, long-term bonds, preferred stock
and common stock) but may change due to
financing decisions that will be made later.
 Step 2: Forecast the Statement of Financial Position.

d. Determine if additional funds will be needed by using

The the following formula:

Projected
Financial
Statement The additional financing needed will be raised by
Method borrowing from the bank as notes payable, by issuing
long-term bonds, by selling new common stock or by
some combination of these actions.
 Step 3: Raising the Additional Funds Needed.

The financing decision will consider the following factors:

The a. Target capital structure;

Projected b.

c.
Effect of short-term borrowing on its current ratio;
Conditions in the debt and equity markets; or
Financial d. Restrictions imposed by existing debt agreements.

Statement
Method
 Step 4: Consider Financing Feedbacks.
The
Depending on whether additional funds
Projected will be borrowed or will be raised through
common stocks, consideration should be
Financial given on additional interest expense in the
common statement or dividends, thus
Statement decreasing the retained earnings.

Method Apply the iteration process using the

available financing mix until the AFN
would become so small that the forecast
can be considered complete.
 Financial planning involves making projections of
sales, income, and assets based on alternative
production and marketing strategies and then deciding
how to meet the forecasted financial requirements. In
Financial the financial planning process, managers should also
evaluate plans and identify changes in operations that
Planning and would improve results. Financial control moves on to
the implementation phase dealing with the feedback
Control and adjustment process that is required (a) to ensure
that plans are followed, and (b) to modify existing
Process plans in response to changes in the operating
environment. The process begins with the specification
of the corporate goals, after which management lays
out a series of forecasts and budgets for every
significant area of the firm’s activities.

M. Manayao, CPA, MBA

 Financial forecasting analysis begins with projections
of sales revenues and production costs. In standard
business terminology, a budget is a plan which sets
forth the projected expenditures for a certain activity
and explains where the required funds will come from.
Financial Thus, the production budget presents a detailed
analysis of the required investments in materials,
Planning and labor, and plant necessary to support the forecasted
sales level. Each of the major elements of the
production budget is likely to have a sub-budget of its
Control own; thus, there will be a material budget, a personnel
budget and a facilities budget. The marketing staff will
Process also develop selling and advertising budgets. Typically,
these budgets will be set up on a monthly basis, and as
times goes by, actual figures will be compared with
projected figures for the remainder of the year will be
adjusted if it appears that the original projections were
unrealistic.

M. Manayao, CPA, MBA

 Financial During the planning process, the projected levels of
each of the different operating budgets will be
Planning and combined, and from this set of data the firm’s cash flow
will be set forth in its cash budget. If a projected
Control increase in sales leads to a projected cash shortage,
management can make arrangements to obtain the
Process required funds in the least-cost manner.

M. Manayao, CPA, MBA

 Budgeting
Budgeting is the act of preparing
a budget. A budget is a financial
plan of the resources needed to
carry out tasks and meet
financial goals. It is also a
quantitative expression of the
goals the organization wishes to
achieve and the cost of attaining
these goals. The use of budgets to
control a firm’s activities is
known as budgetary control.
M. Manayao, CPA, MBA
Purpose of Budgeting
A budget is a description in quantitative – usually monetary – terms of a
desired future result. The process of preparing the budget requires
management at all levels of focus on the future of the business entity. The
benefits that may be realized from a budgeting program are:

1. Defining broad objectives and goals and formulating strategies to

achieve such objectives.
2. Coordinating the activities of the organization by integrating the plans
of the various parts thereby pulling everyone in the same direction.
3. Allocating resources to those parts of the organization where they can
be used most effectively.
4. Communicating management’s approved plans throughout the
organization.
5. Uncovering and preparing for potential bottleneck in the operations
before they occur.
6. Motivating managers to achieve the desired results.
7. Setting a standard or benchmark for evaluating actual performance.
Advantages of Budgeting
It provides a means of
It forces planning and
It allows a reiterative communicating
exposes situations in which
process to bring the goals organization goals down
plans of subcomponents
of the organization and the through the organization
are inadequate to attain
subcomponents into and sub-unit operational
the total organization’s
agreement. limitations up though the
objectives.
organization.

It provides a basis for

It provides a basis by which
financial planning, sub-unit
activity can be monitored,
coordination, resource
with actual results being
acquisition, inventory
compared to the planned
policy, scheduling and
results.
output distribution.
Limitations of Budgeting

It is difficult to prepare a There may be lack of higher

Budgets tend to oversimplify
detailed budget for an and lower management
the real situation and fail to
organization that has never commitment because of lack
allow for variations in external
existed or for a new division, of understanding of the
factors. They do not reflect
product, or department of an fundamentals of budget
qualitative variables.
existing firm. preparation and utilization.

The budget is only a

representation of future plans
or a means to the goal of
profitable activity and not an Budget reports usually
end in itself. It may interfere emphasizes results, not reasons.
with the supervisor’s style of
leadership and can therefore
stifle initiative.

M. Manayao, CPA, MBA

Types of Budgets

The types of budgets

or the major
composition of the
master budget are:

The Operating The Capital

The Financial Budget
Budget Investment Budget
The following is a
simplified
subclassification of
the above-mentioned
types of budget for a
manufacturing firm:
Steps in Developing a
Master Budget
1. Establish basic goals and long-range plans for the
company. These will serve as guidelines in the
preparation of budget estimates.
2. Prepare a sales forecast for the budget period.
3. Estimate the cost of goods sold and operating expenses.
4. Determine the effect of budgeted operating results on
assets, liabilities and ownership equity accounts. The
cash budget is the largest part of this step, since changes
in many asset and liability accounts will depend upon the
cash flow forecast.

5. Summarize the estimated data in the form of a projected

income statement for the budget period and the projected
statement of financial position as of the end of the budget
period.
Master Budget
Interrelationships
 Problem 1 (page 212)
Sales (23,000 x 115%) 26,450 Net income 7,245
Cost (16,700 x 115%) (19,205) Increase in equity (1,590)
Net income 7,245 AFN 5,655

Assets (15,800 x 1.15) 18,170 Debt (5,200 x 1.15) 5,980

Equity (10,600 x 1.15) 12,190
Total 18,170 T0tal 18,170
 Problem 2 (page 212)
Sales 7,434
Cost (3,890 x 1.18) (4,590)
Net income 2,844

Assets (18,300 x 1.18) 21,594 Debt 12,400

Equity (5,900 + 2,844) 8,744
Total 21,594 Total 21,144
EFN 450
Total 21,594
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