Long Term Forecasting Essay

Submitted By desmithey
Words: 1043
Pages: 5

FINANCIAL FORECASTING

Breakeven analysis and cash budgeting are both short-term planning tools. It is equally important that long-term planning be periodically reviewed to ensure that the short-term goals are consistent with the long-term objectives, as well as to provide advance notice of the needs of the corporation so that appropriate decisions can be made and actions taken.

Suppose our Balance Sheet for the past year looked as follows:

2012 Balance Sheet:

Cash

50,000

Accounts Payable
100,000
Accounts Receivable

180,000

Bank Note

90,000
Inventory

200,000

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------------

Total Current Liabs.
190,000
Total Current Assets

430,000

L-T Debt

220,000
Gross Fixed Assets

400,000

(Accum. Depr.)

(130,000)

Common Stock
10,000

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Retained Earnings
280,000
Net Fixed Assets

270,000

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Total Equity
290,000

Total Assets

700,000

Total Liab. & Equity
700,000

The assets should reflect the consequences of the past year’s activities (particularly the receivables and payables) as well as expectations of the coming year’s sales. The primary factor that influences our asset and financing requirements is the level of sales that is anticipated. We must, therefore, get a realistic estimate of what our sales will be in the coming years in order to determine the amount of assets that will be required in order to support the anticipated sales. Once we have an estimate of the amount of assets that will be required, we need to determine what financing will be necessary for the projected asset levels.

Consider the income statement for 2012 as well as the projected income statement for 2013. The assumptions used to construct the projected income statement are listed next to each category:

Income Statements:

2012

2013

Actual

Projected

======

=========

Revenues

1,000,000

1,200,000 20% increase
Cost of Goods Sold

500,000

600,000 50% of Sales

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------------

Gross Profit

500,000

600,000

Gen. & Adm. Expense

Salaries

220,000

226,600 3% inflation Rent

60,000

60,000 Contractual Repairs & Maintenance
14,000

14,420 3% inflation Travel

23,000

23,690 3% inflation Utilities

12,000

12,360 3% inflation Depreciation

40,000

44,000 MACRS determined

------------

------------

EBIT

131,000

218,930

Interest Expense

30,000

30,000

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------------

Taxable Income

101,000

188,930

Taxes (35%)

35,350

66,126

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------------

Net Income

65,650

122,805

Less: Dividends

25,000

25,000

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------------

Addition to Retained Earnings
40,650

97,805

If we intend to be able to meet the growing demand, we need to be sure that we have the necessary assets on hand to support our projected level of sales, as well as the ability to finance these projected asset levels. The easiest means of projecting the balance sheet is to utilize the percent-of-sales method of projection. This technique takes each account on the balance sheet that varies with sales and expresses it as a percentage of sales. This percentage is then applied to the projected sales level to determine what levels can reasonably be expected for these accounts.

If we assume that the balance sheet for 2012 above was about right for the level of sales of $1 million that we experienced in 2012, then we can project the balance sheet for 2013 given our projected sales of $1.2 million for the year:

Note that your bank doesn’t just automatically give you more money, nor are long-term bonds automatically issued. In fact, aside from accounts payable and other accruals (which are referred to as spontaneous sources of financing) which have a zero cost, how assets are financed is a decision…