FOF IM CHAPTER 14 - 6th

FOF IM CHAPTER 14 - 6th - CHAPTER 14 Financial Forecasting,...

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CHAPTER 14 Financial Forecasting, Planning, and Budgeting CHAPTER ORIENTATION This chapter is divided into two sections. The first section includes an overview of the role played by forecasting in the firm’s planning process. The second section focuses on the construction of detailed financial plans, including budgets and pro forma financial statements for future periods of the firm’s operations. A budget is a forecast of future events and provides the basis for taking corrective action and can also be used for performance evaluation. The cash budget and pro forma financial statements provide the necessary information to determine estimates of future financing requirements of the firm. These estimates are the key elements in our discussion of financial planning and budgeting. CHAPTER OUTLINE I. Financial forecasting and planning A. The need for forecasting in financial management arises whenever the future financing needs of the firm are being estimated. There are three basic steps involved in predicting financing requirements. 1. Project the firm’s sales revenues and expenses over the planning period. 2. Estimate the levels of investment in current and fixed assets which are necessary to support the projected sales level. 3. Determine the financing needs of the firm throughout the planning period. B. The key ingredient in the firm’s planning process is the sales forecast. This forecast should reflect (l) any past trend in sales that is expected to continue and (2) the effects of any events which are expected to have a material effect on the firm’s sales during the forecast period. C. The traditional problem faced in financial forecasting begins with the sales forecast and involves making forecasts of the impact of predicted sales on the firm’s various expenses, assets, and liabilities. There are a number of techniques that can be used to make these forecasts: 177
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1. The percent of sales method involves projecting the financial variable as a percent of projected sales. 2. A slightly more refined technique involves the use of a scatter diagram in which the financial variable is plotted against corresponding levels of sales (or another predictor variable). A line is then visually fitted to the scatter plot and is used to predict the financial variable. 3. Regression analysis represents a method for mathematically "fitting" a line to a scatter plot. The resulting equation can then be used to predict the level of the subject financial variable. The regression method can be used whenever there is a single "predictor" variable (referred to as the independent variable , e.g., firm sales) and a single "predicted" variable (referred to as the dependent variable , e.g., firm inventories).
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This note was uploaded on 01/29/2009 for the course FIN 301 taught by Professor Selassie during the Spring '09 term at Oakwood University.

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FOF IM CHAPTER 14 - 6th - CHAPTER 14 Financial Forecasting,...

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