Translates business ideas into concrete short term projections
Details where the firm wants to be at some fture point in time and the resources required to get there
Specifies how much the firm will sell to whom and at what prices
Budgeting
Short term updates of the annual plan - usually covers a calendar quarter
Used in industries in which business conditions change rapidly
Forecasting
Very short term projections of profit and cash flow.
Projects sale revnues and expenses in the planing period
Estimates currrent assets and fixed assets necessary to suppport projected sales
Determine the firms financing needs throughout the planning period
Benefits of Financial Forecasting to Managers
Alows managers to make educated guesses about they future financial condition of the firm
Allows managers to be more effective in monitoring the firms financial affairs and ths lead to increase profits and reduce risk.
When to make financial Forecasts
Major New Investements (capital budgeting, determing profitability)
Routine Operational Requirements (Determing short term financing needed)
Long term financial requirements (determing total assets less existing finance)
5 Sales Forecasting Methods
Percentage of Sales
Cash Budgets
Pro Forma Financial Statements
Computerized financial Forecasting Methods
Regression Analysis
Forecast Current Assets
External Funding Required
Predicting Retained Earnings
Four Steps in Percentage of Sales Method
1. Convert each CA and L that varies with sales to a % of current sales
2. Project level of each A and L by using its % of sales * projected sales (some may remain unchanged if don't vary with sales)
3. Project new RE
4. Project firms need for discretionary financing
Spontaneous Sources of Financing
Trade Credit and other accounts payable that arise spontaneously in the firms day to day operations
Discretionary Sources of Financing
Sources of Financing that require an explicit decision on the part of the firms management every time funds are raised.
Formula: Total Financing Needed
Formula: Addition Financing Needed
Assumptions of Forecasting Financial Variables from Sales Forecasts
1. That most balance sheet accounts are tied directly to sales
2. The current levels of all assets are optimal for the current sales levels.
Definition: Regression Analysis
Regression analysis is the use of techniques for modeling and analyzing several variables, when the focus is on the relationship betwee a dependent and one or more independent variables.
Helps explain how the dependent variable will change in response to a change in the independent variable.
Weaknesses of Forecasting
Assumes the firms past financial condition is an accurate indicator of its future
Accounts can be manipulated to take a certain value desired
Economies of scales can mean that an increase in sales does not require a proportional increase in assets (eg inventory)
Lumpy Assets (eg large scale fixed assets)
Excess Capacity - current level of assets able to generate greater sales
4 Types of Computerized Financial Forecasting and Planning
Deterministic
Sensitivity Analysis
Probabilistic
Optimization
Deterministic Model
Gives a single number forecast of a financial variable or variables without stating anything about its probability of occuring eg budget
Sensitvity Analysis
Consists of rerunning the model to dtermine the effect on the output variables of changes in the input variables eg sales with/without a product
Probabilistic Models
Provides more useful information than other models as it yields output in the form of probability distributions rather than a single estimate
Optimization Models
Determines the values of financial decision variables that optimize some objective function such as profits or costs.