Chapter 4: Financial forecasting

Question 1

to do a reasonable job of forecast we must first complete what

Answer 1

a comprehensive financial analysis in order to develop a good understanding of the relationships in the firm’s f.s.

Question 2

financial forecasting is critical job for

Answer 2

the firm, its financial advisors and its external analysts

Question 3

a firm cannot decide how to finance itself unit it

Answer 3

first assesses the nature of the financing need to determine whether funds are required in the short or long-run, whether financing needs will grow over time, whether financing needs arise from a problem that is self-correcting

Question 4

Equity investors need the forecast for

Answer 4

must also consider the firm’s financing needs when buying the co.s shares

Question 5

fianancial advisors nees the forecast for

Answer 5

must also consider the firm’s needs when recommending a financial strategy

Question 6

what do we use to forecast the f.s

Answer 6

percentage of sales method

Question 7

what are the steps in the percentage of sales method

Answer 7

1. determine which financial policy variables you are interested in
2. set all the non-financial policy variables as a % of sales
3. extrapolate the balance sheet based on % of sales
4. estimate future retained earnings
5. modify the iterate until the forecast makes sense

Question 8

what are the financial variables

Answer 8

the variables the treasurer is concerned with
ex. common equity (wether the firm needs to issue equity or not), Long-term funds (equity +long term funds) , Firm’s total external financing requirements

Question 9

what is total external financing requirements (EFR)

Answer 9

the money a firm has to raise by using equity or debt or both

bank loans (or short term loans)
+ long term debt
+ Common equity
= invested capital

because common shareholders and bank and long term debt investors have made a decision to invest in the firm

Question 10

what are spontaneous liabilities

Answer 10

accruals and payables that arise during the normal course of business
- will automatically increase with sales

• only the financial policy variables will initially be kept constant

Question 11

step 2: convert non-policy variables to % of sales, explain

Answer 11

the result from sales levels are reasonable for future?
- look at ratios over time (past 5 years) factor in current business conditions for the firm (ie new orders) and assess what values would be reasonable going forward

Question 12

step 3: extrapolate the b.s based on sales forecast by using % of sales

Answer 12

the result will be a naïve initial forecast

• it ignores any new equity that the firm will generate simply by retaining some of its future earnings
• it assumes that the existing debt wills till be there in 3 years

Question 13

how do you calculate the firm’s retained earnings as a % of sales

Answer 13

c