Financial Statements
Forecasting
3 Primary Financial Statements
Income statement
 Balance sheet
 Consolidated statement of cash flows
 Other decision-making measures:

Financial ratios
 Common size statements
 Free cash flow projections & valuation
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Financial Analysis

Assess the strengths and weaknesses of
the firm’s current condition
Ratio analysis
 Break-even analysis
 Operating and financial leverage analysis

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Generate pro forma financial statements
to identify strategies to improve the
condition and assess future risks
Growth and the Need for
Financing

Growth is frequently associated with cash
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Faster growth  more profits  more cash
This is incorrect! Growth and profits do not always
generate sufficient cash flow to cover the assets
needed for growth!
Growth needs to be managed and planned

Firms often fail when the needs of expansion
overwhelm the available resources for expansion
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Flow of a Sales-Driven Model
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Sustainable Growth in the Rapid
Growth Phase
“It takes money to make money" phase
 Increased sales require more assets of all
types
 Internal sources may not generate enough
cash

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Retained earnings
Increase in spontaneous liabilities
May need to raise capital externally

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Debt
Equity
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Calculating the Discretionary
Financing Needed

Compile changes in assets

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Left side of balance sheet
Cash
Current Assets
 Inventories & Account Receivables
Long-term assets
 Net Fixed Assets
 Goodwill
Subtract forecasted Total Liabilities and Equity
from Total Assets to determine Discretionary
Funds Needed (DFN)
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Achieving Equilibrium

When Discretionary Funds Needed is
Positive

Raise external financing
Increase debt
 Issue more stock

Reduce cash &/or marketable security stock
balances
 Decrease dividends

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Achieving Equilibrium

When Discretionary Funds Needed is
Negative

Decrease external capital:
Repurchase shares
 Pay off debt

Hold excess cash &/or marketable security
balances
 Increase dividends

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The “Plug”

The balance-sheet items which will “plug” or balance
the balance sheet model so that Total Assets equals
Total Liabilities & Equity

Models the assumption of how the firm finances itself:

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Cash & marketable securities
Debt
Equity
Dividends
Testing the model for perverse
effects
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Questions:
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Example: Problems associated with using dividends as a
plug
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When assumptions change what happens to the plug values?
Does it make sense?
May not have adequate cash balances to pay the dividends that
are calculated
Negative dividends can be calculated when the firm experiences
a loss
Dividends may not distribute excess cash that the firm wishes to
reduce
Solution involves using =max(Calculated Dividend,0)
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Equilibrium checks

Balance Sheet


Discretionary Funds Needed must equal 0
Statement of Cash Flows
Net increase in cash from Consolidated
Statement of Cash Flows
 less changes in cash & marketable
securities in Balance Sheet
>> must equal 0

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