Chapter 9
PROJECTING FINANCIAL STATEMENTS
FOCUS
In this chapter, we focus on projecting financial statements for several years into the future.
Inadequate financial resources often constrains the venture’s ability to grow, is a primary cause
LEARNING OBJECTIVES
LO 9.1: Discuss the role of long-term financial planning over the venture’s life cycle.
LO 9.2: Explain differences in forecasting sales for seasoned firms versus early stage ventures.
CHAPTER OUTLINE
9.1 LONG-TERM FINANCIAL PLANNING THROUGHOUT THE VENTURE’S LIFE
CYCLE
9.2 BEYOND SURVIVAL: SYSTEMATIC FORECASTING
9.3 ESTIMATING SUSTAINABLE SALES GROWTH RATES
9.4 ESTIMATING ADDITIONAL FINANCING NEEDED TO SUPPORT GROWTH
9.5 PERCENT-OF-SALES PROJECTED FINANCIAL STATEMENTS
A. Forecasting Sales
SUMMARY
DISCUSSION QUESTIONS AND ANSWERS
1. Why is it usually easier to forecast sales from seasoned firms in contrast with early-stage
ventures?
It is usually easier to forecast a seasoned firm’s sales compared to early-stage ventures because a
seasoned firm generally has an operating history. The forecast of the firm’s financials therefore could
2. Explain how projected economic scenarios can be used to help forecast a firm’s sales growth
rate.
Since future state of the economy cannot be known, sales forecasts should be based on
3. Identify and describe the four-step process typically used to forecast sales for seasoned firms.
Forecasting sales or revenues for a firm that has been in operation for a number of years
usually begins with a review of the firm’s sales for the past several years. Typically, a five–
4. What are the three steps typically used to forecast sales for early-stage ventures?
A new venture usually begins its forecast with a “top–down” market-driven approach. First,
5. Describe the general relationship between the life cycle stage and the ability to accurately
forecast sales for a firm.
Venture capitalists and other seasoned investors know that forecasting sales usually gets
stage.
6. How do venture investors adjust for the belief that entrepreneurs tend to be overly optimistic
in their sales forecasts?
Entrepreneurs tend to be exceedingly optimistic in their sales and cash flow forecasts.
Venture capitalists and other seasoned outside investors know that the ability to forecast
7. What is meant by a sustainable sales growth rate?
The sustainable sales growth rate is the rate at which a venture can grow based on its
8. Identify and describe the two equations that can be used to estimate a firm’s sustainable
growth rate.
A firm’s sustainable growth rate ‘g’ can be calculated by:
9. Describe the basic additional funds needed (AFN) equation.
The “additional funds needed” is the financial funds still needed to finance asset growth after
spontaneously generated funds and the increase in retained earnings have been used. It is
10. List the major sources of funds typically available to ventures that have successfully entered
into their rapid-growth life cycle stage.
Refer to Figure 9.6. The types of financing available during the rapid-growth life cycle stage
11. Explain how the AFN equation can be used to forecast the amount of funds that will be
needed over a several year period.
To use the AFN equation to forecast the amount of the funds needed over a several year
period, one must estimate the venture’s asset intensity. This provides an estimate of the
12. What is the percent of sales forecasting method?
The percent of sales forecasting method makes the projections based on the assumption that
13. After forecasting sales, describe how the income statement is projected.
Once one has projected sales, one can project the income statement by modeling the costs as
14. Describe how balance sheets are projected once a sales forecast has been made.
The balance sheet projection typically separates into Asset Projections and Liabilities and
Equity Projections. The Asset forecast is usually consistent with estimating the necessary
15. What role does the statement of cash flows play in long-term financial planning?
Most long-term financial planning efforts set cash as a percentage of sales or as a fixed dollar
amount for planning purposes. Thus, the statement of cash flows is primarily used as a
16. From the Headlines – Automox: Describe how cash budgets and projected financial
statements could be used in estimating how far $9 million could take Automox after its Series
A round.
Answers will vary: While $9 million seems like a lot of money for a venture, in reality, one
INTERNET ACTIVITIES
1. Using a Web search, what is an expected long-term growth rate for the U.S. economy? What
are the current and longer-term expectations of inflation?
2. Using a Web search, find an industry report for an industry of your choosing. What are that
industry’s expected near-term and longer-term growth rates?
EXERCISES/PROBLEMS AND ANSWERS
1. [Sales Growth Rates, Sales, and Profits] Petal Providers Corporation opens and operates
“mega” floral stores in the U.S. The idea behind the super store concept is to model the U.S.
floral industry after its European counterparts whose flower markets generally have larger
selections at lower prices. Revenues were $1 million with net profit of $50,000 last year
when the first “mega” Petal Providers floral outlet was opened. If the economy grows
A. Estimate the average sales growth rate for Petal Providers for next year.
Average sales growth rate = Rapid growth rate x Rapid probability
B. Estimate the dollar amount of sales expected next year under each scenario, as well as
the expected value sales amount.
C. Estimate the dollar amount of net profit expected next year under each scenario, as well
as the expected value net profit amount.
2. [Sustainable Sales Growth Rates] Petal Providers Corporation, described in Problem 1, is
interested in estimating its sustainable sales growth rate. Last year revenues were $1
million, the net profit was $50,000, the investment in assets was $750,000, payables and
A. Estimate the sustainable sales growth rate for Petal Providers based on the information
provided in this problem.
B. How would your answer in Part A change if economic growth is average and Petal
Providers’ net profit margin is 7 percent?
Note (Historical View): The 12.5% sustainable growth rate in Part A is based on last
year’s operating performance and financial policy relationships holding for this year. If
we just revise last year’s operating and financial relationships to reflect a net profit
margin increase from 5% to 7%, we would have:
Looking forward and assuming the 30% sales growth rate can be funded this year and the
asset turnover ratio will remain the same, the sustainable sales growth rate for next year
can be estimated as follows:
Expected sales = 1,000.000 x 1.30 = 1,300,000
Expected net income = 1,300,000 x 7% = 91,000
3. [Additional Funds Needed] Petal Providers Corporation, described in Problem 1, is
interested in estimating its additional financing needs to support a rapid increase in sales
next year. Last year revenues were $1 million, the net profit was $50,000, the investment in
assets was $750,000, payables and accruals were $100,000, and equity at the end of the year
was $450,000. The venture did not pay out any dividends and does not expect to pay
dividends for the foreseeable future.
A. What would be your estimate of the additional funds needed next year to support a 30
percent increase in sales?
B. How would your answer in Part A change if the expected sales growth were only 15
percent?
Forecasted Sales = 1,000,000 x 1.15 = 1,150,000
4. [Sustainable Sales Growth Rates and Additional Funds Needed] The Minoso Corporation
anticipates a 20 percent increase in sales for 2020 over its 2019 level. Minoso is currently
operating at full capacity and thus expects to increase its investment in both current and fixed
assets in order to support the increase in forecasted sales.
Minoso Corporation
A. Estimate Minoso’s sustainable sales growth rate based on the financial data
relationships for 2019. In making your estimate, calculate each component of the firm’s
operating performance and financial policies.
g = operating performance x financial policies = (net profit margin x asset turnover (or
B. Estimate the additional funds needed (AFN) for 2020 using the formula or equation
method that is based on constant “percent of sales” relationships.
2020 sales = 15000 x 1.20 = 18000; change in sales = 3000 (i.e., 18000 – 15000)
C. Briefly describe differences in calculation assumptions between Part A and Part B.
The sustainable sales growth rate calculation assume a constant financial leverage policy
5. [Sustainable Sales Growth Rates and Additional Funds Needed] Following are two years of
income statements and balance sheets for the Munich Exports Corporation.
Munich Exports Corporation
2018
2019
Cash
$ 50,000
$ 50,000
Accounts receivable
200,000
300,000
Inventories
450,000
570,000
Total current assets
700,000
920,000
Fixed assets, net
300,000
380,000
Total assets
$1,000,000
$1,300,000
Accounts payable
130,000
$ 180,000
Accruals
50,000
70,000
Bank loan
90,000
90,000
Total current liabilities
270,000
340,000
Long-term debt
400,000
550,000
Common stock ($.05 par)
50,000
50,000
Additional paid-in-capital
200,000
200,000
Retained earnings
80,000
160,000
Total liabilities and equity
$1,000,000
$1,300,000
2018
2019
Net sales
$1,300,000
$1,600,000
Cost of goods sold
780,000
960,000
Gross profit
520,000
640,000
Marketing
130,000
160,000
General and administrative
150,000
150,000
Depreciation
40,000
55,000
EBIT
200,000
275,000
Income taxes (40% rate)
62,000
88,000
Net income
Cash dividends
$ 93,000
$37,000
$ 132,000
$52,000
A. Munich has a target dividend payout of 40 percent of net income. Based on the 2019
financial statements relationships, estimate the sustainable sales growth rate for the
Munich Corporation for 2020.
2018 total common (stockholders’) equity = 50,000 + 200,000 + 80,000 = 330,000
Actual 2019 total common equity = 50,000 + 200,000 + 160,000 = 410,000
B. Show how your answer in Part A would change if Munich decided not to pay any
dividends in 2020.
Retention rate = 1.00 or 100%
Retention amount = 132,000 x 1.00 = 132,000
C. Assume the Munich Corporation wants to grow its sales by 40 percent in 2020 over its
2019 level. Estimate the additional funds needed that will be necessary to support this
rapid increase in sales.
Forecasted Sales = 1,600,000 x 1.40 = 2,240,000
D. Sales are forecasted to increase an additional 20 percent in 2021 over 2020. Estimate
the two-year AFN that the Munich Corporation will need to finance its 2020 and 2021
sales growth plans.
Estimated 2021 sales = 1,600,000 x 1.40 x 1.20 = 2,688,000
Or,
Estimated 2020 sales = 1,600,000 x 1.40 = 2,240,000
AFN = (1,300,000/1,600,000 x 1,088,000) – ((180,000 + 70,000)/1,600,000 x 1,088,000)
– (4,928,000 x 132,000/1,600,000) x (1 – .40)
= (.8125 x 1,088,000) – (.15625 x 1,088,000) – (4,928,000 x .0825) x .60
= 884,000 – 170,000 – (221,760 x .60) = 884,000 – 170,000 – 243,936 =
= 470,064
SPREADSHEET EXERCISES/PROBLEMS
[Note: The following activities are for students with spreadsheet software skills.]