Financial Forcasting & WC Management

Financial Forcasting & WC Management - Financial...

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Working Capital Management This lecture has two parts. The first part discusses various techniques for forecasting future cash flows and the firm’s need for funds. The second part deals with overall management of working capital. I. Financial forecasting is used to estimate the additional financing that may be required in an upcoming period. Pro forma financial statements play an important part in the financial forecasting process. Pro forma financial statements project the results of an assumed or planned event. A. Percentage of sales forecasting assumes that most balance sheet items vary directly with sales and that the firm’s profit margin (Net Income/Sales) is constant. This approach uses the sales forecast to obtain estimates of changes in the other balance sheet accounts. B. Pro forma statements can also be used to determine how much additional financing firms will need in a future period. We are going to use a combination of these two methods to perform our financial forecasting: There are three steps to this process: 1. Determine what balance sheet accounts will change with the sales increase and how much that change will be. Usually all the current assets will change in proportion to the change in sales. Plant and equipment could either change directly with sales or they may increase by a specified amount. Current liabilities that are spontaneous (which means they did not have to be formally contracted to obtain) like accounts payable, wages payable and taxes payable will also increase directly with the sales increase. All other accounts will remain the same until steps 2 and 3. 2. Determine how much of the financing will be provided internally by retained earnings. Increased Forecasted retained = earnings after - Dividends (D) earnings tax (EAT) 1
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The difference between the total amount of financing needed and the amount that will provided by internal financing. This number is referred to as the additional funds needed or AFN: Additional Total Increased financing = financing - retained needed needed earnings 3. Determine how that financing may be obtained given constraints on lending etc. Let's do an example to illustrate this method: Fox Co. 2000 balance sheet is as follows: Cash $ 20 Accounts payable (A/P) $ 50 Accounts receivable (A/R) 100 Notes payable (N/P) 120 Inventory 300 Long-term debt (LTD) 400 600 Common stock (CS) 200 Retained earnings (RE) 250 Total Assets $1020 Total Liabilities & Equity (L&E) $1020 These are the assumptions we will use: -Management believes sales will increase by 20% next year over current level of $1200. The profit margin is 15% and the dividend payout ratio is 50%. -All the assets including P&E will increase directly by the increase in sales. (Remember that some times P&E may increase by a specific amount. For example, management may feel that $200 more of P&E needs to be obtained and then that amount would simply be added to the P&E account). -The only spontaneous current liability of the firm is the accounts payable, so this will increase
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This note was uploaded on 04/20/2011 for the course FIN 4181 taught by Professor Spencer during the Spring '11 term at Dowling.

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Financial Forcasting & WC Management - Financial...

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