Chapter 16 Financial Planning and Forecasting 525Thus, inventories could be reduced by another $324 million if Allied’s inventory
turnover could be increased to the industry average. That would mean another
$324 million of free cash " ow in 2009, plus further additions going forward.
Again, the CFO could use this example in a discussion with the inventory
manager.
16-6c Other “Special Studies”
Once a! rm has developed a model to forecast its! nancial statements, it can do all
types of special “what if” studies. For example, the model that Allied’s CFO used
to make Table 16-2 (which is part of the chapter Excel model) could be used to! nd
the results shown in the two preceding sections for receivables and inventories.
The model also could be used to estimate the effects of changing the dividend pol-
icy on the statements and on the required AFN. Indeed, the AFN equation could
be modi! ed to obtain a “quick and dirty” estimate of the effects of the dividend
payout on the AFN. As we saw earlier in Section 16-3 in the discussion of the AFN
equation, Allied has a payout ratio of 0.4894; and when that number was used in
the equation, an AFN of $114 million resulted:
AFN! 0.6667("S) # 0.06667("S) # 0.0392(S 1 )(0.5106)
! 0.6667($300) # 0.06667($300) # 0.0392($3,300)(0.5106)! $200 # $20 # $66
! $114 million
Now suppose Allied anticipated problems raising $114 million to carry out its
business plan. The CFO might then suggest to the directors a reduction of the pay-
out ratio to 20%. That would result in an AFN of about $77 million (shown in Part
IV of Table 16-1), which is about $37 million less than the original AFN calculated.
Of course, as we saw in the dividend chapter, lowering the dividend might create
problems of its own; but at times, such an action may be necessary to maximize a
! rm’s intrinsic value and long-run stock price.
This chapter described techniques for forecasting! nancial statements, which is a
crucial part of the! nancial planning process. Both investors and corporations regu-
larly use forecasting techniques to help value a company’s stock; to estimate the
bene! ts of potential projects; and to estimate how changes in capital structure, divi-
dend policy, and working capital policy in# uence shareholder value.
The type of forecasting described in this chapter is important for several reasons.
First, if the projected operating results are unsatisfactory, management can “go back
to the drawing board,” reformulate its plans, and develop more reasonable targets
for the coming year. Second, the funds required to meet the sales forecast may not
be obtainable. If so, it is obviously better to know this in advance and to scale back
projected operations than to suddenly run out of cash and have operations grind to
an abrupt halt. And third,! rms often give guidance to analysts regarding likely fu-
ture earnings; and as GE’s Je" Immelt learned, it is bene! cial to be able to provide
reasonably accurate forecasts.
T Y I N G I T A L L T O G E T H E R