ACU 07311

Financial Planning
and Forecasting
 Definition of Financial Planning and
Forecasting
• Is a process of setting objectives, assessing
assets and resources, estimating future
financial needs, and making plans to achieve
monetary goals.
• Many elements may be involved in financial
planning, including investing, asset allocation,
and risk management.
 Definition of Financial Planning and
Forecasting…
• It plays a vital role in helping firms as well as individuals get the
most out of their money. May also provide protection against
the unexpected, by helping firms prepare for things such as
unexpected loss of income.
• Budgeting process of the firm is only part of the financial
planning. The budget gives the amount of resources that will be
required in order to achieve the planned objective(s). While a
budget gives resources required, the corporation’s work plan
shows the path to be followed to achieve the objectives.
• Good financial planning (Expected costs Vs projected income) is
essential in order to determine which activities have sufficient
resources and which need additional funding
 Financial Planning Process
• Financial planning is an important aspect of the firm’s
operations because it provides road maps for guiding,
coordinating, and controlling the firm’s actions to achieve
its objectives.
• Two key aspects of the financial planning process are
Cash Planning and Profit Planning. Cash Planning
involves preparation of the firm’s Cash Budget while
Profit Planning involves the preparation of Pro-forma
Financial Statements. Both the cash budget and the pro-
forma financial statements are useful for internal
financial planning.
 Financial Planning Process…
• The financial planning process begins with
long-term or strategic financial plans and
budgets. These in turn, guide the
formulation of short-term or operating
plans and budgets.
• Generally, the short-term plans and
budgets implement the firm’s long-term
strategic objectives.
Short-term Vs Long-term Planning
Long-term (Strategic) Financial Plans
• In most cases, long-term or strategic financial plans
layout a company’s planned financial actions and the
anticipated impact of those actions over periods
ranging from 2 to 10 years. Five-year strategic plans,
which are revised as significant new information
become available, are common in many
organizations. Generally, firms that are subject to
high degrees of uncertainty, relatively short period
cycles, or both tend to use shorter planning horizons.
 Short-term Vs Long-term Planning…
• Long-term financial plans are part of an integrated
strategy that, along with production and marketing
plans, guides the firm toward strategic goals. Those long-
term plans consider proposed outlays for fixed assets,
research and developments activities, marketing and
product development actions, capital structure, and
major sources of financing. Also it may include
termination of existing projects, product lines, lines of
business, repayment or retirement of outstanding debts,
and any planned acquisitions. Such plans tend to be
supported by a series of annual budgets and profit plans.
 Short-term Vs Long-term Planning…
Short-term (Operating) Financial Plans
• Short-term (operating) financial plans specify
short-term financial actions and the anticipated
actions of those actions. These plans often cover a
1 to 2 year period. Key inputs include the sales
forecast and various forms of operating and
financial data. Key outputs from the short-term
operating financial plans include a number of
operating budgets, the cash budget, and pro-
forma financial statements.
 Financial Planning Modes
• Financial planning models are used to
generate predicted values for many other
variables in the financial planning process.
• Many models require the user to specify
some assumptions about the future
(forecasting), so that the predicted values
will be generated basing on the
assumptions specified.
 Financial Planning Modes…
The ingredients of the Financial Planning Model
include the following:
• Sales Forecast
• Pro-forma Financial Statements
• Asset Requirements
• Financial Requirements
• The Plug
• Economic Assumptions
 Financial Planning Modes…
• Sales Forecast – almost all financial plans require an
externally supplied sales forecast. The sales forecast will be
taken as a driver and most other values will be calculated
basing on it. In most cases, the sales forecast will be given
as the growth rate in sales rather than as an explicit sales
figure.
• Pro-forma Financial Statements – a financial plan will have
a forecast SoFP, IS, and statement of cash flows. Pro-forma
financial statements will be prepared basing on the key
projections of key items such as sales. The user will supply
a sales figure, and the model will generate the resulting
income statement and Statement of Financial Position.
 Financial Planning Modes…
• Asset Requirements – the plan will describe projected
capital spending. At minimum the projected SoFP will
contain changes in total fixed assets and net working
capital. These changes are effectively the firm’s total
capital budgets. Proposed capital spending in different
areas must thus be reconciled with the overall increases
contained in the long-range plan.
• Financial Requirements – the plan will include a section
about the necessary financing arrangements. This part of
the plan should discuss dividend policy and debt policy.
Sometimes firms will expect to raise cash by selling new
shares or by borrowing.
 Financial Planning Modes…
• The Plug – after the firm has sales forecast and an estimate of the
required spending on assets, some amount of new financing will
often be necessary because projected sales will exceed projected
total liabilities and equity. Because new financing may be necessary
to cover all of the projected capital spending, a financial plug
variable must be selected. The plug is the designated source or
sources of external financing needed to deal with any shortfall in
financing and thereby bring the SoFP into balance.
• Economic Assumptions – the plan will have to state explicitly the
economic environment in which the firm expects to reside over the
life of the plan. Among the important economic assumption that
will have to be made are the level of interest rates and the firm’s
tax rate.
 Pro-forma Financial Statements
Preparation of Pro-forma Financial Statements
• In the financial planning and forecasting, preparation of pro-
forma financial statements is a crucial component. Pro-forma
financial statements are prepared to show firm’s financial
position and financial performance given a projected growth
in the future. They help to show the financial requirements in
order for the company to operate at the desired predicted
level.
• A most common way of preparing the pro-forma financial
statement is through using the Percentage of Sales Approach.
After having a sales forecast figure (a growth in sales) items in
the IS and SoFP should be separated into two groups, i.e.
those that vary directly with sales and those that do not.
Budget
The Meaning of a Budget
• A budget is a financial plan and a list of all
planned expenses and revenues; it is a plan for
saving, borrowing and spending
(Wikipedia.com). E. Bond (1999) defined
budget as a plan for owners and managers to
achieve their goals for the company during a
specific time period.
Budget…
• Budgets are prepared for various reasons. It helps
to aid the planning of actual operations by
forcing managers to consider how the conditions
might change and what steps should be taken
now and by encouraging managers to consider
problems before they arise. It also helps co-
ordinate the activities of the organization by
compelling managers to examine relationships
between their own operation and those of other
departments.
Budget…
Different budgets are prepared to serve different
purposes. Some categories of budgets include:
• Sales budget – an estimate of future sales,
often broken down into both units and
amounts (shillings). It is used to create
company sales goals.
Budget…
• Production budget – an estimate of the
number of units that must be manufactured to
meet the sales goals. The production budget
also estimates the various costs involved with
manufacturing those units, including labor and
material. Created by product oriented
companies.
Budget…
• Cash budget – a prediction of future cash
receipts and expenditures for a particular time
period. It usually covers a period in the short
term future. The cash flow budget helps the
business determine when income will be
sufficient to cover expenses and when the
company will need to seek outside financing.
Budget…
Cash Budget
• The cash budget is prepared after the operating budgets (sales,
manufacturing expenses or merchandise purchases, selling expenses,
and general and administrative expenses) and the capital expenditures
budget are prepared. The cash budget starts with the beginning cash
balance to which is added the cash inflows to get cash available. Cash
outflows for the period are then subtracted to calculate the cash
balance before financing. If this balance is below the company's
required balance, the financing section shows the borrowings needed.
The financing section also includes debt repayments, including interest
payments. The cash balance before financing is adjusted by the
financing activity to calculate the ending cash balance. The ending cash
balance is the cash balance in the budgeted or pro forma balance
sheet.
Budget…
The importance of a Cash Budget
• As it was said earlier, a budget is a plan. It is a plan for owners and
managers to achieve their goals for the company during a specific
time period. A cash budget is important for a variety of reasons, like;
• It allows a company to make management decisions regarding the
cash position (or cash reserve).
• Managers are kept in a position of knowing the cash flows within the
business; therefore, seasonal fluctuations will be made clear.
• A cash budget also allows a company to evaluate and plan for its
capital needs. The cash budget will help the company to assess its
short – term as well as long – term borrowings.
• A cash budget is a planning tool for management decisions.
 Preparation of a Cash Budget

• In the preparation of a cash budget the

important aspects to consider are time period,
desired cash position, estimated sales and
estimated expenses. The management should
decide the period of time on which a cash
budget will cover, the amount of cash they
wish to keep and the estimation of cash
receipts and payments that will take place
during the time period.
 Preparation of a Cash Budget …
At a minimum, the following categories of expected cash receipts
and expected cash payments should be considered:
Expected Cash Receipts:
• Cash balance
• Cash sales
• Collections of accounts receivable
• Other income
Expected Cash Expenses:
• Raw material (inventory)
• Payroll
Other Direct Expenses:
• Advertising
• Selling expenses
• Administrative expense
• Plant and equipment expenditures
• Other payments