LDP 6.2 Preparing and Interpreting Annual Financial Projections

Question 1

Three benefits of using annual projections:

Answer 1

• You can quantify and assess the potential impact of unfavorable changes in a company’s internal or external business variables.
• You can fine-tune your understanding of a company’s borrowing causes and repayment sources.
• You can model the impact on repayment ability of proposed loan amounts, terms and repayment schedules.

Question 2

What’s the most important assumption for projections?

Answer 2

SALES - Sales are the engine of profitability and a major factor in asset requirements.

Question 3

To develop or test assumptions on the four key areas (sales, expenses, assets, debt):

Answer 3

1. Review historical performance and trends.
   - Best indicator of the future
2. Identify management’s expectations and plans.
   - Mgmt may change conditions or circumstances that historical trends will not apply
3. Evaluate industry and economic factors.
   - External events can change conditions or circumstances that historical trends will not apply
4. Form or accept assumptions.

Question 4

You need valid and realistic assumptions in these four key areas:

Answer 4

1) Net sales
- Most important
- The level and growth of sales have the greatest
- Influence on the company’s future financial condition and performance.
- Sales are the engine of profitability and a major factor in asset requirements.

2) Expenses
3) Asset Changes - understand that growth in assets will enable more sales and require more retained earnings and debt to finance them
4) Debt relationships - remember that projected debt requirements begin with the debt currently on the company’s balance sheet. When you consider plans and requests for additional debt, make logical assumptions about the term and amortization of new debt. Short-term debt assumptions begin by understanding existing debt availability and any plans to alter trade credit use and working capital financing.

Question 5

Out-of-balance - If assets are SMALLER than liabilities plus NW:

Answer 5

Reduce short-term notes payable up to the amount needed to shrink liabilities enough to balance the balance sheet. If notes payable do not provide enough reduction opportunity, reduce them to zero and then add the needed balancing amount to cash.

Question 6

Out-of-balance - If assets are LARGER than liabilities plus NW:

Answer 6

Reduce cash to remove any excess, but leave an adequate amount for operating needs. If cash cannot be reduced enough, reduce it to a logical amount and then add the needed balancing amount to notes payable.