FINANCIAL

PLANNING AND
FORECASTING
 Financial Statement Analysis

Analysis means establishing a meaningful relationship

between various items of the two financial statements with
each other in such a way that a conclusion is drawn. By
financial statements we mean two statements :
• (i) Profit and loss Account or Income Statement
• (ii) Balance Sheet or Position Statement
Analysis of financial statements is an attempt to
assess the efficiency and performance of an
enterprise. Thus, the analysis and interpretation
of financial statements is very essential to
measure the efficiency, profitability, financial
soundness and future prospects of the business
units
 Financial planning process

Step 1 – Assess your financial situation

Step 2 – Create a budget
Step 3 – Set your financial goals
Step 4 – Know your risk tolerance
Step 5 – Work out and implement a basic financial plan
Step 6 – Regularly review and adjust your financial plan
Strategy and Policy
Policies are general statements or understandings which guide
managers thinking in decision making. They ensure that decisions
fall within certain boundaries. They usually do not require action but
are intended to guide managers in their commitment to the decision
they ultimately make. The essence of policy is discretion.
Strategy on the other hand, concerns the direction in which human
and material resources will be applied in order to increase the
chance of achieving selected objectives.
 Strategic Planning Process
• Inputs • Internal Environment
• Enterprise Profile • Alternative Strategies
• Orientation of Top • Evaluation and Choice of
Managers Strategies
• Purpose and Objectives • Consistency and
• External Environment contingency
Budgeting is the process of identifying,
gathering, summarizing, and communicating
financial and nonfinancial information about an
organization's future activities.
 Budgeting technique
Depending on how you set up your budget, you can
forecast overall income and expense, net profit or loss,
overhead costs or the performance of individual functions.
You can forecast for an entire year or use real-time data to
project results. Create different budgets, or different
reports within a master budget, to effectively forecast the
performance of your small business.
Master Budget
The easiest way to forecast the performance of your
business is to create a master budget based on the
company's recent performance. Forecast your final budget
using your recent performance numbers and agreed-upon
projections such as (1) Real-Time Projections, (1) Overhead
Projections and (3) Multiple Scenarios.
Payback period method - As the name suggests, this method refers to the period in which
the proposal will generate cash to recover the initial investment made.
Accounting rate of return method (ARR) - This method helps to overcome the
disadvantages of the payback period method. The rate of return is expressed as a percentage
of the earnings of the investment in a particular project
Discounted cash flow method - The discounted cash flow technique calculates the cash
inflow and outflow through the life of an asset
Net present Value (NPV) Method - In this technique the cash inflow that is expected at
different periods of time is discounted at a particular rate.
Internal Rate of Return (IRR) - This is defined as the rate at which the net present value
of the investment is zero. The discounted cash inflow is equal to the discounted cash outflow
Profitability Index - It is the ratio of the present value of future cash benefits, at the
required rate of return to the initial cash outflow of the investment
 Forecast
A forecast is a prediction of what is going to happen as a
result of a given set of circumstances. The dictionary
meaning of ‘forecast’ is ‘prediction, provision against
future, calculation of probable events, foresight, prevision’.
In business sense it is defined as ‘the calculation of
probable events’.
 Financial Forecasting Techniques
1. Days Sales Method - It is a traditional technique used
to forecast the sales by calculating the number of days sales
and establishing its relation with the balance sheet items to
arrive at the forecasted balance sheet. This technique is
useful for forecasting funds requirement of a firm.
 Financial Forecasting Techniques
2. Percentage of Sales Method - It is another commonly
used method in estimating financial requirements of the
firm basing on forecast of sales. Any change in sales is
likely to have impact on various individual items of assets
and liabilities of the balance sheet of a firm.
 Financial Forecasting Techniques
3. Simple Linear Regression Method - Simple linear
regression is concerned with bivariate distributions, that is
distributions of two variables. Simple regression analysis
provides estimates of values of the dependent variable
from values of independent variable. The device used to
accomplish this estimation procedure is the regression line.
 Financial Forecasting Techniques
4. Multiple Regression Method - Multiple regression
analysis is further application and extension of the simple
regression method for multiple variables. This method is
applied when behaviour of one variable is dependent on
more than one factor. In this method of financial
forecasting it is assumed that sales are a function of several
variables.
 Financial Forecasting Techniques
5. Projected Funds Flow Statement - The funds flow
statement presents the details of financial resources that
are available during the accounting period and the ways in
which those resources are applied in the business. It is a
statement of sources and application of funds analyzing
the changes taking place between two balance sheet dates.
 Financial Forecasting Techniques
6. Projected Cash Flow Statement - It is a detailed projected
statement of income realized in cash and cash expenditure
incorporating both revenue and capital items. Projected cash flow
statement focus on the cash inflow and outflow of various items
represented in the Income statement and Balance sheet. The
projected cash flow statement shows the cash flows arising from the
operating activities, investing activities and financing activities. A
projected cash flow statement is used in forecasting the financial
requirements of the firm.
 Financial Forecasting Techniques
7. Projected Income Statement and Balance Sheet -
The projected income statement is prepared on the basis
of forecast of sales and anticipated expenses for the period
under estimation. The projected balance sheet is also drawn
based on the future estimation of raising or repayment
long-term funds and acquisition or disposal of fixed assets
and estimation working capital items with reference to the
estimated sales.
 Pro Forma Financial Statement
Are the complete set of financial reports issued by an
entity, incorporating assumptions or hypothetical
conditions about events that may have occurred in the
past or which may occur in the future.
 Break-even Analysis
Refers to the point in which total cost and total revenue
are equal. A break even point analysis is used to
determine the number of units or dollars of revenue
needed to cover total costs (fixed and variable costs).
 Break Even Point
• The break-even point refers to the revenues needed to cover a
company's total amount of fixed and variable expenses during a
specified period of time. The revenues could be stated in dollars
(or other currencies), in units, hours of services provided, etc.

• Breakeven point is the price level at which the market price of a

security is equal to the original cost. For options trading, the
breakeven point is the market price that an underlying asset must
reach for an option buyer to avoid a loss if they exercise the option.
 Operating and Financial Leverage

The use of fixed operating costs by the firm.

Degree of Operating Leverage -- The percentage change in a firm’s

operating profit (EBIT) resulting from a 1 percent change in output
(sales).

DOL at Q units of output(or sales) = Percentage change in operating

profit (EBIT)/Percentage change in output(or sales)
 Operating Leverage
Interpretation of Degree of Operating Leverage
• DOL is a quantitative measure of the “sensitivity” of a firm’s
operating profit to a change in the firm’s sales
• The closer that a firm operates to its break-even point, the higher is
the absolute value of its DOL
• When comparing firms, the firm with the highest DOL is the firm
that will be most “sensitive” to a change in sales
Financial Leverage

• the use of fixed financing costs by the firm

• used as a means of increasing the return to common
shareholders
 Financial Leverage

Degree of Financial Leverage

• the percentage change in a firm’s earnings per share (EPS)
resulting from a 1 percent change in operating profit

DFL at EBIT of X dollars = Percentage change in earnings per

share (EPS) / Percentage change in operating profit (EBIT)