Financial Forecasting and Planning

Financial Forecasting and Planning

Financial planning estimates a company’s future funding needs and helps coordinate decisions about growth, assets, cash flow, and financing.

Planning Horizons

• Strategic plan: Describes how the company intends to earn money in the future and guides its other plans.
• Long-term financial plan: Typically covers 3–5 years and projects the income statement and balance sheet.
• Short-term financial plan: Covers one year or less and focuses on detailed cash-flow planning, often using a cash budget.

Long-Term Planning Process

1. Forecast sales. Use historical sales trends and anticipate events that could materially affect demand or growth.
2. Prepare pro forma financial statements. Project the income statement and balance sheet. One common approach is the percentage-of-sales method, which estimates selected costs, assets, and liabilities as percentages of sales.
3. Estimate funding needs. Compare the assets required to support forecast sales with projected financing sources to identify any additional funding required.

Example: Percentage-of-Sales Forecast

The example assumes:

• 2016 sales of $10 million
• 2017 sales growth of 20%
• Net income equal to 5% of sales
• 50% of earnings retained and 50% paid as dividends

Projected results:

• 2017 sales: $12 million ($10 million × 1.20)
• 2017 net income: $600,000 ($12 million × 5%)
• Retained earnings added: $300,000 ($600,000 × 50%)

Applying 2016 balance-sheet ratios to projected sales gives:

Item Percentage of sales Projected amount Current assets 20% $2.4 million Net fixed assets 40% $4.8 million Accounts payable 10% $1.2 million Accrued expenses 10% $1.2 million

Total assets required are $7.2 million. Assuming notes payable, long-term debt, and paid-in equity remain unchanged, projected financing sources total $6.7 million. The resulting discretionary funding need (DFN) is $500,000.

Funding Framework

• Spontaneous funding sources change automatically with sales, such as accounts payable and accrued expenses.
• Discretionary funding sources require management decisions, such as taking on debt, issuing shares, or changing dividend policy and retained earnings.

The calculation is:

DFN = required assets − projected financing sources $7.2 million − $6.7 million = $0.5 million

Management could cover the gap through short- or long-term borrowing, issuing shares, or other financing decisions.

Practical Takeaway

Use the forecast to translate a sales-growth target into required assets and financing. Revisit assumptions—especially sales growth, asset-to-sales ratios, and dividend policy—because they directly affect the funding gap.

Presenter and source: Bambang Sutrisno, Bambang Sutrisno YouTube channel.