Financial Statements Forecasting

3 Primary Financial Statements

Income statementBalance sheetConsolidated statement of cash flowsOther decision-making measures:

Financial ratios Common size statementsFree cash flow projections & valuation

Financial Analysis

Assess the strengths and weaknesses of the firm’s current conditionRatio analysisBreak-even analysisOperating and financial leverage analysis

Generate pro forma financial statements to identify strategies to improve the condition and assess future risks

4

Growth and the Need for Financing

Growth is frequently associated with cash Faster growth more profits more cash This is incorrect! Growth and profits do not always

generate sufficient cash flow to cover the assets needed for growth!

Growth needs to be managed and planned Firms often fail when the needs of expansion

overwhelm the available resources for expansion

5

Flow of a Sales-Driven Model

6

Sustainable Growth in the Rapid Growth Phase

“It takes money to make money" phase Increased sales require more assets of all

types Internal sources may not generate enough

cash Retained earnings Increase in spontaneous liabilities

May need to raise capital externally Debt Equity

7

Calculating the Discretionary Financing Needed

Compile changes in assets Left side of balance sheet Cash Current Assets

Inventories & Account Receivables Long-term assets

Net Fixed Assets Goodwill

Subtract forecasted Total Liabilities and Equity from Total Assets to determine Discretionary Funds Needed (DFN)

8

Achieving Equilibrium

When Discretionary Funds Needed is PositiveRaise external financing

Increase debt Issue more stock

Reduce cash &/or marketable security stock balances

Decrease dividends

9

Achieving Equilibrium

When Discretionary Funds Needed is NegativeDecrease external capital:

Repurchase sharesPay off debt

Hold excess cash &/or marketable security balances

Increase dividends

The “Plug”

The balance-sheet items which will “plug” or balance the balance sheet model so that Total Assets equals Total Liabilities & Equity

Models the assumption of how the firm finances itself: Cash & marketable securities Debt Equity Dividends

11

Testing the model for perverse effects

Questions: When assumptions change what happens to the plug values? Does it make sense?

Example: Problems associated with using dividends as a plug May not have adequate cash balances to pay the dividends that

are calculated Negative dividends can be calculated when the firm experiences

a loss Dividends may not distribute excess cash that the firm wishes to

reduce Solution involves using =max(Calculated Dividend,0)

12

Equilibrium checks

Balance SheetDiscretionary Funds Needed must equal 0

Statement of Cash FlowsNet increase in cash from Consolidated

Statement of Cash Flows less changes in cash & marketable

securities in Balance Sheet>> must equal 0