Financial Forecasting
financial planning
• Margin patterns
• Key efficiency ratios
• Performance trends
Ratio analysis
Respond to performance
weaknesses
Forecast financial
statements • Requires future cash
flows
• ProForma I/S [Derive • Requires appropriate
retained earnings] growth rates
• ProForma B/S[Derive
funding requirements]
Model for Valuation
Key management
Influence value of
decisions
business
Plan for funding
 managing growth

firms ability to sustain growth depends on:

– forecast revenue growth
– margin management
– dividend policy
– capital expenditure planned
– Net Working Capital (NWC) management

= funding needs
 growth rates
• Internal growth rate
[retention rate x net income]/beginning assets

• Rate of growth without any new external funding (from banks or shareholders for
example), assuming operating ratios remain unchanged.
• Internal growth rate is simply the ratio of new retained earnings to beginning-of-
period assets.

• Sustainable growth rate

[retention rate x net income]/beginning equity

• Assumes new external borrowing in amounts necessary to keep the debt ratio
constant. This new borrowing supports more growth, which is why the sustainable
growth rate is higher than the internal growth rate.
How do you manage growth rates?
• Change leverage
• Change dividend/retention rate
• Improve operating drivers
ingredients of financial planning

• pro forma financial statements

1. economic assumptions
2. growth projections
3. margin extrapolation [key profitability ratios]
4. capex requirements
5. NWC extrapolation [key efficiency ratios]
6. funding requirements [balancing number/plug]
 basic steps in financial planning:
1. Set the sales growth rate [review historic trends]
2. Using a pro-forma income statement, forecast the level of profitability
anticipated by the firm [review historic ratios]
3. Set a dividend policy [to derive retained earnings]
4. Forecast probable level of fixed assets in balance sheet
5. Derive NWC amounts from efficiency ratios
6. Increase equity by retained earnings calculated in step 3
7. Estimate funding requirements balancing a pro-forma balance sheet
8. Check whether issues of seasonality or known future events will create
increased funding requirements
9. Decide on which outside sources of funding will be used – debt or
equity
 factors affecting assumptions
Organizational Characteristics Market and Consumer Behaviour

Market segmentation
Market share Market size
Quality of products New market development
Discretionary cash flow Buyer loyalty
Suppliers

Major changes in availability of

raw materials

Industry Structure Social, Economic and Political

Trends
Rate of technological change
Interest rates
in products or processes
Energy availability
Degrees of product differentiation
Government established and
Industry price/cost structure
legally enforceable regulations
Economies of scale
 financial planning
Using a pro-forma income Income
Sales
statement, forecast the level
of profitability anticipated (Costs)
by the firm (Cost of sales)
(Operating expenses)
(Finance costs)
(Tax)

Profit
Retained Earnings –
Balance Sheet
Dividends
 financial planning

Level of Assets Funding Requirements

Liabilities
Debt – EXTERNAL
Assets:
=
+
Sources of
Fixed Finance
NWC Equity
Share Capital – EXTERNAL
Retained Earnings - INTERNAL
 financial planning
Check whether issues of seasonality or known future events
will create increased funding requirements within the
planning period

Sale
s

Ja June / De Tim
n c e
July