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$280
For 19x2:
67
FINANCIAL ANALYSIS
CHAP. 21
earnings available to common stockholders
Return on common stock equity =
5.
average stockholdersâ€™ equity
10.4%
$124
=
For 19x1 estimated:
$1,195
$100
= 8.8%
For 19x2:
($1,195 + $1,075)/2
net credit sales
Accounts receivable turnover =
6.
average accounts receivable
  9.6 (every 38 days)
$1â€™920
For 19x1 estimated:
$200
$2,230
= 9.91 (every 37 days)
For 19x2:
($200 + $250)/2
Based on the trend analysis for 19x1 and 19x2, the companyâ€™s financial condition has deteriorated
(c)
to some degree in this period, and there is going to be a serious liquidity problem as is evidenced by
the decline in the current ratio and the decline of net working capital.
In addition, the companyâ€™s interest coverage has declined and large amounts of debt are coming
due in the near future. The statement of changes in financial position shows that a large portion of
capital expenditures were financed through longterm debt.
Chapter 3
Financial Forecasting, Planning, and Budgeting
3,l FINANCIAL FORECASTING
Financial forecasting, an essential element of planning, is the basis for budgeting activities and
estimating future financing needs. Financial forecasts begin with forecasting sales and their related
expenses. The basic steps involved in projecting financing needs are:
Project the firmâ€™s sales. Most other forecasts (budgets) follow the sales forecast. The statistical
methods of forecasting sales include:
( a ) Timeseries analysis
( 6 ) Exponential smoothing
( c ) Regression analysis
( d ) BoxJenkins method
(These methods are discussed in other disciplines such as managerial economics and statistics
and are not covered here.)
Project variables such as expenses.
Estimate the level of investment in current and fixed assets that is required to support the
projected sales.
Calculate the firmâ€™s financing needs.
32 PERCENTOFSALES METHOD OF FINANCIAL FORECASTING
.
When constructing a financial forecast, the sales forecast is used traditionally to estimate various
expenses, assets, and liabilities. The most widely used method for making these projections is the
percentofsales method, in which the various expenses, assets, and liabilities for a future period are
estimated as a percentage of sales. These percentages, together with the projected sales, are then used
to construct pro forma (planned or projected) balance sheets.
The calculations for a pro forma balance sheet are as follows:
1. Express balance sheet items that vary directly with sales as a percentage of sales. Any item that
does not vary directly with sales (such as longterm debt) is designated not applicable (n.a.).
2. Multiply the percentages determined in step 1by the sales projected to obtain the amounts for
the future period.
3. Where no percentage applies (such as for longterm debt, common stock, and capital surplus),
simply insert the figures from the present balance sheet in the column for the future period.
4. Compute the projected retained earnings as follows:
Projected retained earnings = present retained earnings
+ projected net income  cash dividends paid
(Youâ€™ll need to know the percentage of sales that constitutes net income and the dividend
payout ratio.)
5. Sum the asset accounts to obtain a total projected assets figure. ?hen add the projected liabilities
and equity accounts to determine the total financing provided. Since liability plus equity must
balance the assets when totaled, any difference is a shortfall, which is the amount of external
financing needed.
68
69
CHAP. 31 FINANCIAL FORECASTING, PLANNING, AND BUDGETING
EXAMPLE 3.1 For the following pro forma balance sheet, net income is assumed to be 5 percent of sales and the
dividend payout ratio is 4 percent.
Pro Fonna Balance Sheet
(In Millions of Dollars)
of Sales Projected
Present O/O
(19x2Sales = $ 4
2)
(19x1) (19x1 Sales = $20)
ASSETS
$24 X 10% = $2.4
$2.0 10%
Current assets
4.8
 
20Yo
4.0
Fixed assets
$7.2
$6.0
 
Total assets
LIABILITIES AND
STOCKHOLDERS' EQUITY
Current liabilities $2.4
10%
$2.0

Longterm debt n.a.' 2.5
2.5
Total liabilities $4.9
$4.5
 
n.a."
Common stock $0.1
$0.1
n.a."
Capital surplus 0.2
0.2

Retained earnings  1.92'
1.2

Total equity $2.22
$1.5
Total liabilities and Total financing
 provided
stockholders' equity $7.12
$6.0

External financing
$.8
0 0 ' needed

$7.2 Total
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