10
CHAPTER
Prospective Analysis
Short-Term Forecasting
Objective and Users
Main objective is analysis of liquidity
- Sufficient cash to effectively operate
- Ability to service short-term debt
Liquidity is of interest to both internal and external
users
- Managers (cash for operations)
- Creditors (loan safeguards)
- Investors (return implications)
- Auditors (going concern analysis)
- Numerous others…
Short-Term Forecasting
Cash Flow Relations
Basic facts,
- Cash refers to cash and cash equivalents
- Cash is the most liquid of assets
- Nearly all transactions have an immediate or
eventual impact on cash
- Some users consider receivables and
inventories liquid assets given their
nearness to cash
Short-Term Forecasting
Cash Flow Relations
Cash inflows and out flows are interrelated
Cash flows are related to accruals and income
Cash flows are subjected to managerial discretion
Sales is the driver of operating cash flows
- Cash forecasts
depends on the quality of
the sales forecast
- Most cash flows relate to
and depend on sales
1
2 4
3
Sales forecasting requires analysis of,
Directions and trends in sales
Market share
Industry and economic conditions
Productive and financial capacity
Competitive factors
Short-Term Forecasting
Forecasting Sales
Objectives,
? Verifies reasonableness of short-term
forecasts
? Assesses feasibility of short-term
forecasts
Short-Term Forecasting
Pro Forma Analysis
Focus on construction of pro forma financial statements
- Prepare pro forma income statement
- Prepare pro forma balance sheet
- Financial ratios derived from pro forma statements
- Assess pro forma ratios for reasonableness and
feasibility
- Compare key relations to past
relations
- Unexpected variations must be
reviewed for possible revisions
Short-Term Forecasting
Pro Forma Analysis
Short-Term Forecasting
Pro Forma Analysis--Illustration
Estimates of Sales and Cash Collections
For Months January–June,Year 1
January February March April May June
Sales $100,000 $125,000 $150,000 $175,000 $200,000 $250,000
Collections of sales,
1st month— 40% $ 40,000 $ 50,000 $ 60,000 $ 70,000 $ 80,000 $100,000
2nd month— 30% 30,000 37,500 45,000 52,500 60,000
3rd month— 20% 20,000 25,000 30,000 35,000
4th month— 5% 5,000 6,250 7,500
Total cash collections
$ 40,000 $ 80,000 $117,500 $145,000 $168,750 $ 202,500
Write-offs— 5% 5,000 6,250 7,500
Short-Term Forecasting
Pro Forma Analysis--Illustration
Expense Estimates
For Months January–June,Year 1
Materials 30% of sales Labor 25% of sales
Manufacturing overhead,
Variable 10% of sales
Fixed $8,000 per month
(includes $1,000
depreciation per
month)
Selling expenses 10% of sales,
General and administrative expenses,
Variable 8% of sales
Fixed $7,000 per month
Short-Term Forecasting
Pro Forma Analysis--Illustration
Estimates of Material Purchases and Cash Payments
For Months January–June,Year 1
January February March April May June
Materials purchases*
$ 40,000 $ 38,000 $ 43,000 $ 56,000 $ 58,000 $ 79,000
Payments,
1st month— 50% $ 20,000 $ 19,000 $ 21,500 $ 28,000 $ 29,000 $ 39,500
2nd month— 50% 20,000 19,000 21,500 28,000 29,000
Total payments $ 20,000 $ 39,000 $ 40,500 $ 49,500 $ 57,000 $ 68,500
*These reconcile with material costs and changes in inventories,
Short-Term Forecasting
Pro Forma Analysis--Illustration
IT technologies,inc,
Cash Forecast
For Months January–June,Year 1
January February March April May June Six-Month Totals
Cash balance—beginning $ 15,000 $ 20,000 $ 25,750 $ 27,250 $ 30,580 $ 30,895 $ 15,000
Add cash receipts for,
Cash collections (Exh,9.1) 40,000 80,000 117,500 145,000 168,750 202,500 753,750
Sale of real estate? 8,000 50,000 58,000
Sale of bonds? 47,500 60,000 107,500
Sale of equipment? 25,000 25,000
Total cash available $ 55,000 $ 100,000 $143,250 $ 219,750 $ 267,330 $ 308,395 $ 959,250
Less disbursements for,
Material (Exh,9.3) $ 20,000 $ 39,000 $ 40,500 $ 49,500 $ 57,000 $ 68,500 $ 274,500
Labor? 25,000 31,250 37,500 43,750 50,000 62,500 250,000
Fixed overhead? 7,000 7,000 7,000 7,000 7,000 7,000 42,000
Variable overhead? 10,000 12,500 15,000 17,500 20,000 25,000 100,000
Selling expenses? 10,000 12,500 15,000 17,500 20,000 25,000 100,000
General and administrative? 15,000 17,000 19,000 21,000 23,000 27,000 122,000
Taxes§ 19,000 19,000
Purchase of fixed assets? 1,000 1,000 1,000 1,000 1,000 5,000
Total cash disbursements 87,000 120,250 135,000 157,250 178,000 235,000 912,500
Tentative cash balance (deficit)
$ (32,000) $ (20,250) 8,250 $ 62,500 $ 89,330 $ 73,395 $ 46,750
Minimum cash required? 20,000 25,000 27,000 30,000 30,000 30,000
Borrowing required $ 52,000 $ 46,000 $ 19,000 — — — $ 117,000
Repayment of loan $ 30,000 $ 58,000 $ 29,000 (117,000)
Interest paid on balance* 1,920,435,145 2,500
Ending cash balance $ 20,000 $ 25,750 $ 27,250 $ 30,580 $ 30,895 $ 44,250 $ 44,250
Loan balance $ 52,000 $ 98,000 $ 117,000 $ 87,000 $ 29,000 — —
* Interest is computed at the rate of ? percent per month and paid at month-end,Any loan is taken out at the beginning of a month,
? Estimates computed using information from Exhibit 10.2,
? Treasurer’s expectations taken from information given,
§ Taxes total a 40 percent combined state and federal rate,Taxes of $19,000 are paid in June,with the balance accrued,
Short-Term Forecasting
Pro Forma Analysis--Illustration
IT TECHNOLOGIES,INC,
Pro Forma Income Statement
For Six Months Ending June 30,Year 1
Source of Estimate
Sales $ 1,000,000 Forecasted sales
Cost of sales,
Materials 300,000 Exhibit 10.2
Labor 250,000 Exhibit 10.2
Overhead 148,000 Exhibit 10.2
698,000
Gross profit 302,000
Selling Expense 100,000 Exhibit 10.2
Bad debts expense 18,750 Exhibit 10.1
General and administrative expense 122,000 Exhibit 10.2
240,750
Operating income 61,250
Gain on sale of equipmen 25,000
Interest expense (2,500) Exhibit 10.4 note
Income before taxes 83,750
Income taxes (40% rate) 33,500
Net income $50,250
Short-Term Forecasting
Pro Forma Analysis--Illustration
IT TECHNOLOGIES,INC,
Balance Sheets
Actual Pro Forma
January 1,Year 1 June 30,Year 1
Assets
Current assets,
Cash $15,000 $ 44,250
Accounts receivable (net) 6,500 234,000
Inventories raw materials 57,000 71,000
Total current assets $ 78,500 $ 349,250
Real estate $58,000 —
Fixed assets 206,400 $ 201,400
Accumulated depreciation (36,400) (17,400)
Net fixed assets 228,000 184,000
Other assets 3,000 3,000
Deferred debt expenses — 2,500
Total assets $309,500 $ 538,750
Liabilities and Equity Capital
Current Liabilities,
Accounts payable $ 2,000 $ 41,500
Notes payable 28,500 43,500
Accrued taxes — 14,500
Total current liabilities $ 30,500 $ 99,500
Long-term debt $ 15,000 $ 125,000
Common stock 168,000 168,000
Retained earnings 96,000 146,250
279,000 439,250
Total liabilities and equity capital $309,500 $ 538,750
[Long-term (>2-3 years) pro forma analysis using
financial statements is unreliable]
Long-term cash forecasting of cash flows involves
two steps,
1,Analyze prior periods’ cash
flow statements
2,Use available information to
forecast cash sources and uses
Long-Term Forecasting
Two-Step Process
Long-Term Forecasting
Analysis of Prior Cash Flows--Step 1
Focus on prior periods’ statements of cash flows
?Emphasize recent performance
?Review several prior years
?Business activities involve multiyear horizons
?Consider ―cumulative year‖ statements
Long-Term Forecasting
Analysis of Prior Cash Flows--Step 1
Means to analyze prior periods’ cash flow statements
i,Identify past major sources and uses of cash
ii,Prepare a common-size analysis of the statement of cash flows
iii.Total major sources and uses of cash over several years
iv,Evaluate results and seek answers to questions such as,
? Are asset replacements financed from internal or external
funds?
? What are the financing sources of expansion and business
acquisitions?
? Is the company dependent on external financing?
? What are the company’s investing demands and opportunities?
? What are the requirements and forms of financing?
? Are managerial policies (such as dividends) sensitive to cash
flows?
Long-Term Forecasting
Analysis of Prior Cash Flows--Illustration
CAMPBELL SOUP COMPANY Statements of Cash Flows
For Years 6 to 11 ($ millions) Year 11 Year 10 Year 9 Year 8 Year 7 Year 6 Total
Cash flows from operating activities,
Net earnings $ 401.5 $ 4.4 $ 13.1 $ 274.1 $ 247.3 $ 223.2 $ 1,163.6
To reconcile net earnings to net cash provided by operating activities,
Depreciation and amortization 208.6 200.9 192.3 170.9 144.6 126.8 1,044.1
Divestitures and restructuring provisions — 339.1 343.0 17.6 — — 699.7
Deferred taxes 35.5 3.9 (67.8) 13.4 45.7 29.0 59.7
Other,net 63.2 18.6 37.3 43.0 28.0 16.6 206.7
Cumulative effect of accounting change — — — (32.5) — — (32.5)
(Increase) decrease in accounts receivable 17.1 (60.4) (46.8) (104.3) (36.3) (3.6) (234.3)
(Increase) decrease in inventories 48.7 10.7 (113.2) 54.2 (3.9) 23.1 19.6
Net change in other current assets and liab,30.6 (68.8) (0.6) 30.2 42.9 48.7 83.0
Net cash provided by operating activities $ 805.2 $ 448.4 $ 357.3 $ 466.6 $ 468.3 $ 463.8 $ 3,009.6
Cash flows from investing activities,
Purchases of plant assets $ (361.1) $ (387.6) $ (284.1) $ (245.3) $ (303.7) $ (235.3) $ (1,817.1)
Sale of plant assets 43.2 34.9 39.8 22.6 — 29.8 170.3
Businesses acquired (180.1) (41.6) (135.8) (471.9) (7.3) (20.0) (856.7)
Sale of businesses 67.4 21.7 4.9 23.5 20.8 — 138.3
Increase in other assets (57.8) (18.6) (107.0) (40.3) (50.1) (18.0) (291.8)
Net change in other temp,investments 9.7 3.7 9.0 249.2 (60.7) (144.1) 66.8
Net cash used in investing activities $ (478.7) $ (387.5) $ (473.2) $ (462.2) $ (401.0) $ (387.6) $ (2,590.2)
Cash flows from financing activities,
Long-term borrowings $ 402.8 $ 12.6 $ 126.5 $ 103.0 $ 4.8 $ 203.9 $ 853.6
Repayments of long-term borrowings (129.9) (22.5) (53.6) (22.9) (23.9) (164.7) (417.5)
Increase (decrease) in s-t borrowings* (137.9) (2.7) 108.2 8.4 (20.7) 4.6 (40.1)
Other short-term borrowings 117.3 153.7 227.1 77.0 89.3 72.9 737.3
Repayments of other s-t borrowings (206.4) (89.8) (192.3) (87.6) (66.3) (88.5) (730.9)
Dividends paid (137.5) (124.3) (86.7) (104.6) (91.7) (104.6) (649.4)
Treasury stock purchases (175.6) (41.1) (8.1) (29.3) — — (254.1)
Treasury stock issued 47.7 12.4 18.5 0.9 1.6 4.0? 85.1
Other,net (0.1) (0.1) 23.5 2.3 18.6 17.9 62.1
Net cash provided (used in) financing $ (219.6) $ (101.8) $ 163.1 $ (52.8) $ (88.3) $ (54.5) $ (353.9)
Effect of exchange rate change on cash $ (8.7) $ 0.7 $ (12.1) $ (10.8) $ (7.1) $ (3.7) $ (41.7)
Net incr,(decr.) in cash & equivalents 98.2 (40.2) 35.1 (59.2) (28.1) 18.0 23.8
Cash and equivalents at beginning of year 80.7 120.9 85.8 145.0 173.1 155.1 760.6
Cash and equivalents at end of year $ 178.9 $ 80.7 $ 120.9 $ 85.8 $ 145.0 $ 173.1 $ 784.4
* With less than three month maturities,
? 2.8 issued for a pooling of interest,
Long-Term Forecasting
Analysis of Prior Cash Flows--Illustration
CAMPBELL SOUP COMPANY
Summary of Cash Inflows and Outflows*
For Years 6 to 11
Year 11 Year 10 Year 9 Year 8 Year 7 Year 6 Total
Operating activities $ 805.2 $ 448.4 $ 357.3 $ 466.6 $ 468.3 $ 463.8 $ 3,009.6
Investing activities (478.7) (387.5) (473.2) (462.2) (401.0) (387.6) (2,590.2)
Financing activities (219.6) (101.8) (163.1) (52.8) (88.3) (54.5) (353.9)
Increase (decrease) in cash
98.2 (40.2) 35.1 (59.2) (28.1) 18.0 23.8
Long-Term Forecasting
Analysis of Prior Cash Flows--Illustration
CAMPBELL SOUP COMPANY
Common-Size Statements of Cash Flows* For Years 6 to 11
Year 11 Year 10 Year 9 Year 8 Year 7 Year 6 Total
Cash flows from operating activities,
Net earnings 26.89% 0.54% 1.15% 25.14% 38.42% 27.88% 21.54%
To reconcile net earnings to net cash provided by operating activities,
Depreciation and amortization 13.97 24.58 16.82 15.67 22.47 15.84 19.33
Divestitures and restructuring provisions — 41.49 30.00 1.61 — — 12.95
Deferred taxes 2.38 0.48 (5.93) 1.23 7.10 3.62 1.11
Other,net 4.23 2.28 3.26 3.94 4.35 2.07 3.83
Cumulative effect of accounting change — — — (2.98) — — (0.60)
(Increase) decrease in accounts receivable 1.15 (7.39) (4.09) (9.57) (5.64) (0.45) (4.34)
(Increase) decrease in inventories 3.26 1.31 (9.90) 4.97 (0.61) 2.89 0.36
Net change in other current assets and liab 2.05 (8.42) (0.05) 2.77 6.67 6.08 1.54
Net cash provided by operating activities 53.92% 54.86% 31.25% 42.80% 72.76% 57.94% 55.72%
Cash flows from investing activities,
Purchase of plant assets (24.18)% (47.42)% (24.85)% (22.50)% (47.19)% (29.39)% (33.64)%
Sale of plant assets 2.89 4.27 3.48 2.07 — 3.72 3.15
Businesses acquired (12.06) (5.09) (11.88) (43.28) (1.13) (2.50) (15.86)
Sale of businesses 4.51 2.66 0.43 2.16 3.23 — 2.56
Increase in other assets (3.87) (2.28) (9.36) (3.70) (7.78) (2.25) (5.40)
Net change in other temp,investments 0.65 0.45 0.79 22.86 (9.43) (18.00) 1.24
Net cash used in investing activities (32.06)% (47.41)% (41.39)% (42.39)% (62.31)% (48.42)% (47.95)%
Cash flows from financing activities,
Long-term borrowings 26.97% 1.54% 11.07% 9.45% 0.75% 25.47% 15.80%
Repayments of long-term borrowings (8.70) (2.75) (4.69) (2.10) (3.71) (20.57) (7.73)
Increase (decrease) in s-t borrowings (9.23) (0.33) 9.46 0.77 (3.22) 0.57 (0.74)
Other short-term borrowings 7.86 18.81 19.87 7.06 13.88 9.11 13.65
Repayments of other s-t borrowings (13.82) (10.99) (16.82) (8.03) (10.30) (11.06) (13.53)
Dividends paid (9.21) (15.21) (7.58) (9.59) (14.25) (13.07) (12.02)
Treasury stock purchases (11.76) (5.03) (0.71) (2.69) — — (4.70)
Treasury stock issued 3.19 1.52 1.62 0.08 0.25 0.50 1.58
Other,net (0.01) (0.01) 2.06 0.21 2.89 2.24 1.15
Net cash provided (used in) financing (14.71)% (12.46)% 14.27% (4.84)% (13.72)% (6.81)% (6.55)%
Effect of exchange rate change on cash (0.58)% 0.09% (1.06)% (0.99)% (1.10)% (0.46)% (0.77)%
Net incr,(decr.) in cash & equivalents 6.58 (4.92) 3.07 (5.43) (4.37) 2.25 0.44
* Common-size percentages are based on total cash inflows = 100%,For Year 11 the 100 percent is composed of,CFO (53.92) + Sale of plant assets (2.89) + Sale of bus,(4.51) + Decrease in temp,invest,(0.65) + LT borrowings (26.97) + ST borrowings (7.86) + Treas,st,issued (3.19),
Long-Term Forecasting
Analysis of Prior Cash Flows--Step 1
Inferences from Analysis of Cash Flows helps assess,
? Quality of management’s decisions
- across time
- for results of operations and financial position
- in response to opportunities and adversities
? Where management committed resources
? Additional sources of cash
? Where management reduced investments
? Investment of discretionary cash flows
? Where claims against a company are reduced
? Disposition of earnings
? Level,composition,pattern,and stability of operating
cash flows
Long-Term Forecasting
Forecasting Cash Sources and Uses -- Step 2
The statement of cash flows is a good analytical structure for long-term
forecasting
Specific steps include,
Net income forecasts need adjusting for noncash items such as
depreciation,depletion,deferred income taxes,and nonremitted earnings
of subsidiaries and investees for reliable estimates of operating cash
flows
Forecasts of operating working capital are obtained by estimating
required levels of working capital components like receivables,
inventories,and payables
Estimates of cash sources from items such as asset disposals,
investment sales,and issuance of stock and bonds are required
Capital expenditure forecasts are based on current operations
adjusted for productive capacity,forecasts of activity implied
by profit projections,and estimates of asset replacement costs
Estimates of debt retirements and dividend payments
are required
Long-Term Forecasting
Forecasting Cash Sources and Uses -- Step 2 Illustration
CAMPBELL SOUP COMP ANY
Forecasted Statements of Cash Flows ($ millions)
Year 13 Year 12
Cash flows from operating activities,
Net earnings(a) $ 540.0 $ 480.0
To reconcile net earnings to net cash from operations,
Depreciation and amortization(b) 331.1 294.3
Deferred taxes(c) 30.0 26.7
Other,net(d) 65.5 58.3
(Increase) decrease in accounts receivable(e) (38.2) (12.4)
(Increase) decrease in inventories(f) (51.2) (16.6)
Net change in other current assets and liabilities(g) 85.9 27.9
Net cash provided by operating activities $ 963.1 $ 858.2
Cash flows from investing activities,
Purchases of plant assets(h) $ (443.1) $ (400.0)
Sale of plant assets (est.)(i) 31.5 28.4
Businesses acquired (est.)(i) (85.3) (77.0)
Sale of businesses (est.)(i) 25.5 23.0
Increase in other assets (est.)(i) (53.9) (48.6)
Net change in other short-term investments (est.)(i) 12.3 11.1
Net cash used in investing activities $ (513.0) $ (463.1)
Cash flows from financing activities,
Long-term borrowings (est.) $ 132.0 $ 142.3
Repayments of long-term borrowings(j) (218.9) (227.7)
Increase (decrease) in short-term borrowings(k) (200.3) (95.7)
Other short-term borrowings (est.) 131.2 122.9
Repayments of other short-term borrowings (est.)(l) (140.4) (200.0)
Dividends paid (est.) (108.8) (108.2)
Treasury stock purchases (est.) (49.4) (42.4)
Treasury stock issued (est.) 15.6 14.2
Other,net (est.) 9.1 10.4
Net cash provided (used in) financing activities $ (429.9) $ (384.2)
Effect of exchange rate changes on cash (est.) $ (7.5) $ (6.7)
Net increase (decrease) in cash and cash equivalents(m) 12.7 4.2
Cash and cash equivalents at the beginning of year(m) 183.1 178.9
Cash and cash equivalents at the end of year(m) $ 195.8 $ 183.1
Notes,
See textbook for all assumptions and estimations,
Long-Term Forecasting
Forecasting Cash Sources and Uses -- Step 2 Illustration
Key assumptions and estimations for Campbell Illustration ($ mil.),
1,Sales forecasts are $6,350 in Year 12 and $6,800 in Year 13,
2,Forecast of net income for Year 12 is taken from our Year 12 forecasted income statement
(see Exhibit CC.16),Forecast of net income for Year 13 is 7.9 percent of forecast sales,
3,Net income for Years 9 and 10 is used in our forecasting procedures before the net effects of
divestitures,restructurings,and unusual charges totaling $260.8 in Year 9 and $301.6 in Year
10,
4,Forecasts of depreciation and amortization for Years 12 and 13 are based on their relation to
net income--using the relation of average depreciation and amortization for Years 9 through
11 to the average net income over the same period,
5,Deferred income taxes in Year 12 are estimated using the relation of total deferred taxes to
total net income for Years 10 and 11,It changes in Year 13 by the percent change in Year 13
forecasted net income relative to Year 12 forecasted net income,
6,Forecast of ―Other,net‖ in Year 12 reflects the relation of ―Other,net‖ to net income from
Years 9 through 11,Its forecast changes in Year 13 by the percent change in Year 13
forecasted net income relative to Year 12 forecasted net income,
7,Operating working capital items like accounts receivable,inventory,and payables (excluding
cash and temporary investments) for Years 12 and 13 are forecasted as follows,
a,Compute the percent relation between operating working capital items and sales for Year
11,
b,Multiply the percent relation in (a) by forecasted sales in Years 12 and 13,
8,Forecasts of cash and temporary investments reflect their relation to forecasted sales in
Years 12 and 13 using the relation of cash and temporary investments to sales from Year 11,
Long-Term Forecasting
Forecasting Cash Sources and Uses -- Step 2
What-If Forecasting of Cash Flows helps,
? Assess the impact of unexpected changes or
adversities
? Estimate a company’s defensive posture and
capabilities
? Assess a company’s financial flexibility
? Predict resources available to pursue
opportunities
? Assess the effects of events on
cash sources and uses
? Formulate managerial strategies
to changing business conditions
? Assess risk exposures
Cash Flow Ratios
Cash Flow Adequacy
Cash flow adequacy ratio reflects a company’s ability to
generate sufficient cash from operations to cover capital
expenditures,investments in inventories,and cash dividends
Ratio = 1 indicates the company exactly covered these cash
needs without a need for external financing
Ratio <1 (>1) suggests internal cash sources
are not (more than) sufficient to maintain
dividends and operating growth
d iv id e n d sc a s h a n d a d d i t io n s,in v e n t o r y e s,e x p e n d it u r c a p it a l of s u my e a r -F iv e
o p e r a t io n s f r o mc a s h of s u my e a r -F iv e
Cash Flow Ratios
Cash Reinvestment Ratio
The cash reinvestment ratio is a measure of the percent of
investment in assets representing operating cash retained
and reinvested in the company for both replacing assets and
growth in operations
Ratio in the area of 7%-11% is satisfactory
c a p it a l W o r k in g+a s s e t sO t h e r +I n v e s t m e n t+p la n t G r o s s
D iv id e n d sf lo wc a s h O p e r a t in g ?
CHAPTER
Prospective Analysis
Short-Term Forecasting
Objective and Users
Main objective is analysis of liquidity
- Sufficient cash to effectively operate
- Ability to service short-term debt
Liquidity is of interest to both internal and external
users
- Managers (cash for operations)
- Creditors (loan safeguards)
- Investors (return implications)
- Auditors (going concern analysis)
- Numerous others…
Short-Term Forecasting
Cash Flow Relations
Basic facts,
- Cash refers to cash and cash equivalents
- Cash is the most liquid of assets
- Nearly all transactions have an immediate or
eventual impact on cash
- Some users consider receivables and
inventories liquid assets given their
nearness to cash
Short-Term Forecasting
Cash Flow Relations
Cash inflows and out flows are interrelated
Cash flows are related to accruals and income
Cash flows are subjected to managerial discretion
Sales is the driver of operating cash flows
- Cash forecasts
depends on the quality of
the sales forecast
- Most cash flows relate to
and depend on sales
1
2 4
3
Sales forecasting requires analysis of,
Directions and trends in sales
Market share
Industry and economic conditions
Productive and financial capacity
Competitive factors
Short-Term Forecasting
Forecasting Sales
Objectives,
? Verifies reasonableness of short-term
forecasts
? Assesses feasibility of short-term
forecasts
Short-Term Forecasting
Pro Forma Analysis
Focus on construction of pro forma financial statements
- Prepare pro forma income statement
- Prepare pro forma balance sheet
- Financial ratios derived from pro forma statements
- Assess pro forma ratios for reasonableness and
feasibility
- Compare key relations to past
relations
- Unexpected variations must be
reviewed for possible revisions
Short-Term Forecasting
Pro Forma Analysis
Short-Term Forecasting
Pro Forma Analysis--Illustration
Estimates of Sales and Cash Collections
For Months January–June,Year 1
January February March April May June
Sales $100,000 $125,000 $150,000 $175,000 $200,000 $250,000
Collections of sales,
1st month— 40% $ 40,000 $ 50,000 $ 60,000 $ 70,000 $ 80,000 $100,000
2nd month— 30% 30,000 37,500 45,000 52,500 60,000
3rd month— 20% 20,000 25,000 30,000 35,000
4th month— 5% 5,000 6,250 7,500
Total cash collections
$ 40,000 $ 80,000 $117,500 $145,000 $168,750 $ 202,500
Write-offs— 5% 5,000 6,250 7,500
Short-Term Forecasting
Pro Forma Analysis--Illustration
Expense Estimates
For Months January–June,Year 1
Materials 30% of sales Labor 25% of sales
Manufacturing overhead,
Variable 10% of sales
Fixed $8,000 per month
(includes $1,000
depreciation per
month)
Selling expenses 10% of sales,
General and administrative expenses,
Variable 8% of sales
Fixed $7,000 per month
Short-Term Forecasting
Pro Forma Analysis--Illustration
Estimates of Material Purchases and Cash Payments
For Months January–June,Year 1
January February March April May June
Materials purchases*
$ 40,000 $ 38,000 $ 43,000 $ 56,000 $ 58,000 $ 79,000
Payments,
1st month— 50% $ 20,000 $ 19,000 $ 21,500 $ 28,000 $ 29,000 $ 39,500
2nd month— 50% 20,000 19,000 21,500 28,000 29,000
Total payments $ 20,000 $ 39,000 $ 40,500 $ 49,500 $ 57,000 $ 68,500
*These reconcile with material costs and changes in inventories,
Short-Term Forecasting
Pro Forma Analysis--Illustration
IT technologies,inc,
Cash Forecast
For Months January–June,Year 1
January February March April May June Six-Month Totals
Cash balance—beginning $ 15,000 $ 20,000 $ 25,750 $ 27,250 $ 30,580 $ 30,895 $ 15,000
Add cash receipts for,
Cash collections (Exh,9.1) 40,000 80,000 117,500 145,000 168,750 202,500 753,750
Sale of real estate? 8,000 50,000 58,000
Sale of bonds? 47,500 60,000 107,500
Sale of equipment? 25,000 25,000
Total cash available $ 55,000 $ 100,000 $143,250 $ 219,750 $ 267,330 $ 308,395 $ 959,250
Less disbursements for,
Material (Exh,9.3) $ 20,000 $ 39,000 $ 40,500 $ 49,500 $ 57,000 $ 68,500 $ 274,500
Labor? 25,000 31,250 37,500 43,750 50,000 62,500 250,000
Fixed overhead? 7,000 7,000 7,000 7,000 7,000 7,000 42,000
Variable overhead? 10,000 12,500 15,000 17,500 20,000 25,000 100,000
Selling expenses? 10,000 12,500 15,000 17,500 20,000 25,000 100,000
General and administrative? 15,000 17,000 19,000 21,000 23,000 27,000 122,000
Taxes§ 19,000 19,000
Purchase of fixed assets? 1,000 1,000 1,000 1,000 1,000 5,000
Total cash disbursements 87,000 120,250 135,000 157,250 178,000 235,000 912,500
Tentative cash balance (deficit)
$ (32,000) $ (20,250) 8,250 $ 62,500 $ 89,330 $ 73,395 $ 46,750
Minimum cash required? 20,000 25,000 27,000 30,000 30,000 30,000
Borrowing required $ 52,000 $ 46,000 $ 19,000 — — — $ 117,000
Repayment of loan $ 30,000 $ 58,000 $ 29,000 (117,000)
Interest paid on balance* 1,920,435,145 2,500
Ending cash balance $ 20,000 $ 25,750 $ 27,250 $ 30,580 $ 30,895 $ 44,250 $ 44,250
Loan balance $ 52,000 $ 98,000 $ 117,000 $ 87,000 $ 29,000 — —
* Interest is computed at the rate of ? percent per month and paid at month-end,Any loan is taken out at the beginning of a month,
? Estimates computed using information from Exhibit 10.2,
? Treasurer’s expectations taken from information given,
§ Taxes total a 40 percent combined state and federal rate,Taxes of $19,000 are paid in June,with the balance accrued,
Short-Term Forecasting
Pro Forma Analysis--Illustration
IT TECHNOLOGIES,INC,
Pro Forma Income Statement
For Six Months Ending June 30,Year 1
Source of Estimate
Sales $ 1,000,000 Forecasted sales
Cost of sales,
Materials 300,000 Exhibit 10.2
Labor 250,000 Exhibit 10.2
Overhead 148,000 Exhibit 10.2
698,000
Gross profit 302,000
Selling Expense 100,000 Exhibit 10.2
Bad debts expense 18,750 Exhibit 10.1
General and administrative expense 122,000 Exhibit 10.2
240,750
Operating income 61,250
Gain on sale of equipmen 25,000
Interest expense (2,500) Exhibit 10.4 note
Income before taxes 83,750
Income taxes (40% rate) 33,500
Net income $50,250
Short-Term Forecasting
Pro Forma Analysis--Illustration
IT TECHNOLOGIES,INC,
Balance Sheets
Actual Pro Forma
January 1,Year 1 June 30,Year 1
Assets
Current assets,
Cash $15,000 $ 44,250
Accounts receivable (net) 6,500 234,000
Inventories raw materials 57,000 71,000
Total current assets $ 78,500 $ 349,250
Real estate $58,000 —
Fixed assets 206,400 $ 201,400
Accumulated depreciation (36,400) (17,400)
Net fixed assets 228,000 184,000
Other assets 3,000 3,000
Deferred debt expenses — 2,500
Total assets $309,500 $ 538,750
Liabilities and Equity Capital
Current Liabilities,
Accounts payable $ 2,000 $ 41,500
Notes payable 28,500 43,500
Accrued taxes — 14,500
Total current liabilities $ 30,500 $ 99,500
Long-term debt $ 15,000 $ 125,000
Common stock 168,000 168,000
Retained earnings 96,000 146,250
279,000 439,250
Total liabilities and equity capital $309,500 $ 538,750
[Long-term (>2-3 years) pro forma analysis using
financial statements is unreliable]
Long-term cash forecasting of cash flows involves
two steps,
1,Analyze prior periods’ cash
flow statements
2,Use available information to
forecast cash sources and uses
Long-Term Forecasting
Two-Step Process
Long-Term Forecasting
Analysis of Prior Cash Flows--Step 1
Focus on prior periods’ statements of cash flows
?Emphasize recent performance
?Review several prior years
?Business activities involve multiyear horizons
?Consider ―cumulative year‖ statements
Long-Term Forecasting
Analysis of Prior Cash Flows--Step 1
Means to analyze prior periods’ cash flow statements
i,Identify past major sources and uses of cash
ii,Prepare a common-size analysis of the statement of cash flows
iii.Total major sources and uses of cash over several years
iv,Evaluate results and seek answers to questions such as,
? Are asset replacements financed from internal or external
funds?
? What are the financing sources of expansion and business
acquisitions?
? Is the company dependent on external financing?
? What are the company’s investing demands and opportunities?
? What are the requirements and forms of financing?
? Are managerial policies (such as dividends) sensitive to cash
flows?
Long-Term Forecasting
Analysis of Prior Cash Flows--Illustration
CAMPBELL SOUP COMPANY Statements of Cash Flows
For Years 6 to 11 ($ millions) Year 11 Year 10 Year 9 Year 8 Year 7 Year 6 Total
Cash flows from operating activities,
Net earnings $ 401.5 $ 4.4 $ 13.1 $ 274.1 $ 247.3 $ 223.2 $ 1,163.6
To reconcile net earnings to net cash provided by operating activities,
Depreciation and amortization 208.6 200.9 192.3 170.9 144.6 126.8 1,044.1
Divestitures and restructuring provisions — 339.1 343.0 17.6 — — 699.7
Deferred taxes 35.5 3.9 (67.8) 13.4 45.7 29.0 59.7
Other,net 63.2 18.6 37.3 43.0 28.0 16.6 206.7
Cumulative effect of accounting change — — — (32.5) — — (32.5)
(Increase) decrease in accounts receivable 17.1 (60.4) (46.8) (104.3) (36.3) (3.6) (234.3)
(Increase) decrease in inventories 48.7 10.7 (113.2) 54.2 (3.9) 23.1 19.6
Net change in other current assets and liab,30.6 (68.8) (0.6) 30.2 42.9 48.7 83.0
Net cash provided by operating activities $ 805.2 $ 448.4 $ 357.3 $ 466.6 $ 468.3 $ 463.8 $ 3,009.6
Cash flows from investing activities,
Purchases of plant assets $ (361.1) $ (387.6) $ (284.1) $ (245.3) $ (303.7) $ (235.3) $ (1,817.1)
Sale of plant assets 43.2 34.9 39.8 22.6 — 29.8 170.3
Businesses acquired (180.1) (41.6) (135.8) (471.9) (7.3) (20.0) (856.7)
Sale of businesses 67.4 21.7 4.9 23.5 20.8 — 138.3
Increase in other assets (57.8) (18.6) (107.0) (40.3) (50.1) (18.0) (291.8)
Net change in other temp,investments 9.7 3.7 9.0 249.2 (60.7) (144.1) 66.8
Net cash used in investing activities $ (478.7) $ (387.5) $ (473.2) $ (462.2) $ (401.0) $ (387.6) $ (2,590.2)
Cash flows from financing activities,
Long-term borrowings $ 402.8 $ 12.6 $ 126.5 $ 103.0 $ 4.8 $ 203.9 $ 853.6
Repayments of long-term borrowings (129.9) (22.5) (53.6) (22.9) (23.9) (164.7) (417.5)
Increase (decrease) in s-t borrowings* (137.9) (2.7) 108.2 8.4 (20.7) 4.6 (40.1)
Other short-term borrowings 117.3 153.7 227.1 77.0 89.3 72.9 737.3
Repayments of other s-t borrowings (206.4) (89.8) (192.3) (87.6) (66.3) (88.5) (730.9)
Dividends paid (137.5) (124.3) (86.7) (104.6) (91.7) (104.6) (649.4)
Treasury stock purchases (175.6) (41.1) (8.1) (29.3) — — (254.1)
Treasury stock issued 47.7 12.4 18.5 0.9 1.6 4.0? 85.1
Other,net (0.1) (0.1) 23.5 2.3 18.6 17.9 62.1
Net cash provided (used in) financing $ (219.6) $ (101.8) $ 163.1 $ (52.8) $ (88.3) $ (54.5) $ (353.9)
Effect of exchange rate change on cash $ (8.7) $ 0.7 $ (12.1) $ (10.8) $ (7.1) $ (3.7) $ (41.7)
Net incr,(decr.) in cash & equivalents 98.2 (40.2) 35.1 (59.2) (28.1) 18.0 23.8
Cash and equivalents at beginning of year 80.7 120.9 85.8 145.0 173.1 155.1 760.6
Cash and equivalents at end of year $ 178.9 $ 80.7 $ 120.9 $ 85.8 $ 145.0 $ 173.1 $ 784.4
* With less than three month maturities,
? 2.8 issued for a pooling of interest,
Long-Term Forecasting
Analysis of Prior Cash Flows--Illustration
CAMPBELL SOUP COMPANY
Summary of Cash Inflows and Outflows*
For Years 6 to 11
Year 11 Year 10 Year 9 Year 8 Year 7 Year 6 Total
Operating activities $ 805.2 $ 448.4 $ 357.3 $ 466.6 $ 468.3 $ 463.8 $ 3,009.6
Investing activities (478.7) (387.5) (473.2) (462.2) (401.0) (387.6) (2,590.2)
Financing activities (219.6) (101.8) (163.1) (52.8) (88.3) (54.5) (353.9)
Increase (decrease) in cash
98.2 (40.2) 35.1 (59.2) (28.1) 18.0 23.8
Long-Term Forecasting
Analysis of Prior Cash Flows--Illustration
CAMPBELL SOUP COMPANY
Common-Size Statements of Cash Flows* For Years 6 to 11
Year 11 Year 10 Year 9 Year 8 Year 7 Year 6 Total
Cash flows from operating activities,
Net earnings 26.89% 0.54% 1.15% 25.14% 38.42% 27.88% 21.54%
To reconcile net earnings to net cash provided by operating activities,
Depreciation and amortization 13.97 24.58 16.82 15.67 22.47 15.84 19.33
Divestitures and restructuring provisions — 41.49 30.00 1.61 — — 12.95
Deferred taxes 2.38 0.48 (5.93) 1.23 7.10 3.62 1.11
Other,net 4.23 2.28 3.26 3.94 4.35 2.07 3.83
Cumulative effect of accounting change — — — (2.98) — — (0.60)
(Increase) decrease in accounts receivable 1.15 (7.39) (4.09) (9.57) (5.64) (0.45) (4.34)
(Increase) decrease in inventories 3.26 1.31 (9.90) 4.97 (0.61) 2.89 0.36
Net change in other current assets and liab 2.05 (8.42) (0.05) 2.77 6.67 6.08 1.54
Net cash provided by operating activities 53.92% 54.86% 31.25% 42.80% 72.76% 57.94% 55.72%
Cash flows from investing activities,
Purchase of plant assets (24.18)% (47.42)% (24.85)% (22.50)% (47.19)% (29.39)% (33.64)%
Sale of plant assets 2.89 4.27 3.48 2.07 — 3.72 3.15
Businesses acquired (12.06) (5.09) (11.88) (43.28) (1.13) (2.50) (15.86)
Sale of businesses 4.51 2.66 0.43 2.16 3.23 — 2.56
Increase in other assets (3.87) (2.28) (9.36) (3.70) (7.78) (2.25) (5.40)
Net change in other temp,investments 0.65 0.45 0.79 22.86 (9.43) (18.00) 1.24
Net cash used in investing activities (32.06)% (47.41)% (41.39)% (42.39)% (62.31)% (48.42)% (47.95)%
Cash flows from financing activities,
Long-term borrowings 26.97% 1.54% 11.07% 9.45% 0.75% 25.47% 15.80%
Repayments of long-term borrowings (8.70) (2.75) (4.69) (2.10) (3.71) (20.57) (7.73)
Increase (decrease) in s-t borrowings (9.23) (0.33) 9.46 0.77 (3.22) 0.57 (0.74)
Other short-term borrowings 7.86 18.81 19.87 7.06 13.88 9.11 13.65
Repayments of other s-t borrowings (13.82) (10.99) (16.82) (8.03) (10.30) (11.06) (13.53)
Dividends paid (9.21) (15.21) (7.58) (9.59) (14.25) (13.07) (12.02)
Treasury stock purchases (11.76) (5.03) (0.71) (2.69) — — (4.70)
Treasury stock issued 3.19 1.52 1.62 0.08 0.25 0.50 1.58
Other,net (0.01) (0.01) 2.06 0.21 2.89 2.24 1.15
Net cash provided (used in) financing (14.71)% (12.46)% 14.27% (4.84)% (13.72)% (6.81)% (6.55)%
Effect of exchange rate change on cash (0.58)% 0.09% (1.06)% (0.99)% (1.10)% (0.46)% (0.77)%
Net incr,(decr.) in cash & equivalents 6.58 (4.92) 3.07 (5.43) (4.37) 2.25 0.44
* Common-size percentages are based on total cash inflows = 100%,For Year 11 the 100 percent is composed of,CFO (53.92) + Sale of plant assets (2.89) + Sale of bus,(4.51) + Decrease in temp,invest,(0.65) + LT borrowings (26.97) + ST borrowings (7.86) + Treas,st,issued (3.19),
Long-Term Forecasting
Analysis of Prior Cash Flows--Step 1
Inferences from Analysis of Cash Flows helps assess,
? Quality of management’s decisions
- across time
- for results of operations and financial position
- in response to opportunities and adversities
? Where management committed resources
? Additional sources of cash
? Where management reduced investments
? Investment of discretionary cash flows
? Where claims against a company are reduced
? Disposition of earnings
? Level,composition,pattern,and stability of operating
cash flows
Long-Term Forecasting
Forecasting Cash Sources and Uses -- Step 2
The statement of cash flows is a good analytical structure for long-term
forecasting
Specific steps include,
Net income forecasts need adjusting for noncash items such as
depreciation,depletion,deferred income taxes,and nonremitted earnings
of subsidiaries and investees for reliable estimates of operating cash
flows
Forecasts of operating working capital are obtained by estimating
required levels of working capital components like receivables,
inventories,and payables
Estimates of cash sources from items such as asset disposals,
investment sales,and issuance of stock and bonds are required
Capital expenditure forecasts are based on current operations
adjusted for productive capacity,forecasts of activity implied
by profit projections,and estimates of asset replacement costs
Estimates of debt retirements and dividend payments
are required
Long-Term Forecasting
Forecasting Cash Sources and Uses -- Step 2 Illustration
CAMPBELL SOUP COMP ANY
Forecasted Statements of Cash Flows ($ millions)
Year 13 Year 12
Cash flows from operating activities,
Net earnings(a) $ 540.0 $ 480.0
To reconcile net earnings to net cash from operations,
Depreciation and amortization(b) 331.1 294.3
Deferred taxes(c) 30.0 26.7
Other,net(d) 65.5 58.3
(Increase) decrease in accounts receivable(e) (38.2) (12.4)
(Increase) decrease in inventories(f) (51.2) (16.6)
Net change in other current assets and liabilities(g) 85.9 27.9
Net cash provided by operating activities $ 963.1 $ 858.2
Cash flows from investing activities,
Purchases of plant assets(h) $ (443.1) $ (400.0)
Sale of plant assets (est.)(i) 31.5 28.4
Businesses acquired (est.)(i) (85.3) (77.0)
Sale of businesses (est.)(i) 25.5 23.0
Increase in other assets (est.)(i) (53.9) (48.6)
Net change in other short-term investments (est.)(i) 12.3 11.1
Net cash used in investing activities $ (513.0) $ (463.1)
Cash flows from financing activities,
Long-term borrowings (est.) $ 132.0 $ 142.3
Repayments of long-term borrowings(j) (218.9) (227.7)
Increase (decrease) in short-term borrowings(k) (200.3) (95.7)
Other short-term borrowings (est.) 131.2 122.9
Repayments of other short-term borrowings (est.)(l) (140.4) (200.0)
Dividends paid (est.) (108.8) (108.2)
Treasury stock purchases (est.) (49.4) (42.4)
Treasury stock issued (est.) 15.6 14.2
Other,net (est.) 9.1 10.4
Net cash provided (used in) financing activities $ (429.9) $ (384.2)
Effect of exchange rate changes on cash (est.) $ (7.5) $ (6.7)
Net increase (decrease) in cash and cash equivalents(m) 12.7 4.2
Cash and cash equivalents at the beginning of year(m) 183.1 178.9
Cash and cash equivalents at the end of year(m) $ 195.8 $ 183.1
Notes,
See textbook for all assumptions and estimations,
Long-Term Forecasting
Forecasting Cash Sources and Uses -- Step 2 Illustration
Key assumptions and estimations for Campbell Illustration ($ mil.),
1,Sales forecasts are $6,350 in Year 12 and $6,800 in Year 13,
2,Forecast of net income for Year 12 is taken from our Year 12 forecasted income statement
(see Exhibit CC.16),Forecast of net income for Year 13 is 7.9 percent of forecast sales,
3,Net income for Years 9 and 10 is used in our forecasting procedures before the net effects of
divestitures,restructurings,and unusual charges totaling $260.8 in Year 9 and $301.6 in Year
10,
4,Forecasts of depreciation and amortization for Years 12 and 13 are based on their relation to
net income--using the relation of average depreciation and amortization for Years 9 through
11 to the average net income over the same period,
5,Deferred income taxes in Year 12 are estimated using the relation of total deferred taxes to
total net income for Years 10 and 11,It changes in Year 13 by the percent change in Year 13
forecasted net income relative to Year 12 forecasted net income,
6,Forecast of ―Other,net‖ in Year 12 reflects the relation of ―Other,net‖ to net income from
Years 9 through 11,Its forecast changes in Year 13 by the percent change in Year 13
forecasted net income relative to Year 12 forecasted net income,
7,Operating working capital items like accounts receivable,inventory,and payables (excluding
cash and temporary investments) for Years 12 and 13 are forecasted as follows,
a,Compute the percent relation between operating working capital items and sales for Year
11,
b,Multiply the percent relation in (a) by forecasted sales in Years 12 and 13,
8,Forecasts of cash and temporary investments reflect their relation to forecasted sales in
Years 12 and 13 using the relation of cash and temporary investments to sales from Year 11,
Long-Term Forecasting
Forecasting Cash Sources and Uses -- Step 2
What-If Forecasting of Cash Flows helps,
? Assess the impact of unexpected changes or
adversities
? Estimate a company’s defensive posture and
capabilities
? Assess a company’s financial flexibility
? Predict resources available to pursue
opportunities
? Assess the effects of events on
cash sources and uses
? Formulate managerial strategies
to changing business conditions
? Assess risk exposures
Cash Flow Ratios
Cash Flow Adequacy
Cash flow adequacy ratio reflects a company’s ability to
generate sufficient cash from operations to cover capital
expenditures,investments in inventories,and cash dividends
Ratio = 1 indicates the company exactly covered these cash
needs without a need for external financing
Ratio <1 (>1) suggests internal cash sources
are not (more than) sufficient to maintain
dividends and operating growth
d iv id e n d sc a s h a n d a d d i t io n s,in v e n t o r y e s,e x p e n d it u r c a p it a l of s u my e a r -F iv e
o p e r a t io n s f r o mc a s h of s u my e a r -F iv e
Cash Flow Ratios
Cash Reinvestment Ratio
The cash reinvestment ratio is a measure of the percent of
investment in assets representing operating cash retained
and reinvested in the company for both replacing assets and
growth in operations
Ratio in the area of 7%-11% is satisfactory
c a p it a l W o r k in g+a s s e t sO t h e r +I n v e s t m e n t+p la n t G r o s s
D iv id e n d sf lo wc a s h O p e r a t in g ?
