418 CHAPTER 11 Financial Planning and Forecasting Financial Statements
but it does plan to increase the dividend by 8 percent, resulting in a forecasted divi-
dend of 1.08($1.15) $1.242, rounded up to $1.25 per share. With 50 million shares,
the total forecasted dividend is 50($1.25) $62.5 million. The forecasted addition to
retained earnings is equal to the net income available to common stockholders minus
the total dividends: $127.8 $62.5 $65.3 million, as shown on Row 15.Step 3. Forecast the Balance Sheet
Before going into the details of forecasting balance sheets ,let’s take a look at the big
picture. First ,a company must have assets to support the sales as forecasted on the
income statement ,and if sales are growing ,then assets typically must also grow.
Second ,if assets are to grow ,then the company must obtain funds to purchase the
new assets. Third ,the needed funds can come from internal sources ,mainly as rein-
vested earnings ,or externally ,from the sale of short-term investments ,from new
loans (either notes payable or long-term bonds) ,from new stock issues ,or by in-
creasing operating current liabilities ,mainly accounts payable or accruals. Here are
the steps: (1) Determine the amount of new assets needed to support the forecasted
sales ,(2) determine the amount of internal funds that will be available ,and (3) plan
to raise any required additional financing. This sounds simple ,but the devil is in the
details.
Let’s start with the assets required to support sales. Notice that these consist of op-
erating current assets plus operating long-term assets. The percent of sales approach
assumes initially that each class of assets is proportional to sales, so we can forecast all
of the assets on MicroDrive’s balance sheet except for short-term investments, which
is a nonoperating asset. Many firms use short-term investments as a temporary repos-
itory for any extra cash, or as a “slush fund” for use in times when operating cash flows
are lower than expected. We’ll show how to forecast the final level of short-term in-
vestments shortly, but for now we assume that MicroDrive plans to maintain its cur-
rent level of short-term investments.
The liability side of the balance sheet is a little trickier because it involves both op-
erating effects driven by the sales and costs forecasts and financial effects that result
from management’s financial policy decisions. The percent of sales method is based on
the assumption that accounts payable and accruals are both proportional to sales, so
given the sales forecast we can forecast operating current liabilities. Forecasting the
other liability and equity items is more complicated, because these are affected by the
firm’s financial policies, which can vary widely. We explain one fairly typical set of fi-
nancial policies below, and we go through the calculations in detail in the chapter
spreadsheet model, Chapter 11 Tool Kit.xls. However, there are many other possible
policies. The Web Extension to this chapter describes a procedure that can be used to
develop a model to fit any set of financial policies.
First ,as we explain in Chapter 13 ,most mature companies rarely issue new common
stock ,so the forecast for common stock is usually the previous year’s common stock.
Second, most firms grow their dividends at a fairly steady rate, which allows us to
forecast dividend payments; see Chapter 14 for a discussion of dividend policy. Sub-
tracting forecasted dividends from forecasted net income gives the addition to retained
earnings, which allows us to specify the forecasted amount of total common equity.
Third, most firms do not use preferred stock, and those that do issue it infre-
quently. Therefore, we assume that the forecasted preferred stock is equal to last year’s
preferred stock.
Fourth, issuing more long-term bonds is a major event for most firms, and it often
requires approval from the board of directors. Chapter 13 discusses long-term debt fi-
nancing in detail, but for now we simply assume that MicroDrive will not issue any
new long-term debt, at least in the initial forecast.