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forecasted growth is rapid, or if earnings the demand for each is probably
retained are limited, even the most profitable interdependent.
agribusiness firm will have to seek external
capital; i.e., increases in debt or equity. At this 2. The next critical step in sales forecasting
point, it becomes very important to prepare or includes assessing market share. You must
calculate reasonably accurate estimates of appraise your firm's current and future
forecasted capital requirements. Under normal share of current or potential markets. You
conditions, an agribusiness firm only need to consider factors such as current
infrequently would look for substantive productive capacity, competitor's capacity
increases in its long-term debt and/or equity. and new products you or your competitors
The timing of debt acquisitions or the issuance are considering. Your firm's pricing
of long-term securities is particularly important strategies relative to that of competitors
under conditions of economic volatility. also becomes an important element in
Consider the plight of those agribusiness firms market share analysis. Advertising
now struggling under fixed rate long-term loans campaigns, promotional discounts, credit
initiated in the early 1980s when interest rates terms and product differentiation may also
had peaked at record levels. Because investors alter your projected market share.
are interested in “future” cash flows, firms Regardless, every manager must recognize
lacking financial forecasts are ill-prepared to that the act of forecasting future sales does
attract equity capital. directly reference market share, whether
considered explicitly or not.
THE SALES FORECAST; THE FIRST
STEP 3. Too often, agribusiness firms developing
sales forecasts often focus on the expected
Preparing a sales forecast is the critical first step. future demand for products or services.
In many regards, the sales forecast comprises the Equal focus must rest on the supply side;
driving force of all planning activity and AFN i.e., your firm's future ability to acquire
calculations. Because each agribusiness firm supplies or raw products in a timely
confronts a uniquely different set of market and manner and at a competitive price. Order
supply/demand conditions, it's difficult to backlogs and/or intermittent supplies can
generalize regarding the ways such a forecast is rapidly destroy the credibility of well-
prepared. I will later inject data from a prepared sales forecasts.
hypothetical agribusiness firm to provide some
reader guidance. First, I will point out that 4. Finally, remember that a sales forecast is
almost all viable sales forecasts address the actually an “expected value of a
following basic issues: probability distribution” of possible levels
of sales. Because any sales forecast is
1. Since most agribusiness firms are multi- subject to a greater or lesser degree of
product or multi-service entities, each uncertainty, for sound financial planning
division within the firm must first be we often are just as interested in this
viewed separately, and their individual degree of uncertainty (sales variance) as
sales potentials assimilated into a total we are in a single expected value of sales.
demand forecast. As historical and future
sales for each division are plotted and ILLUSTRATIVE AGRIBUSINESS FIRM
projected, management must pay close
attention to preexisting product-service To illustrate the procedure, I have calculated the
interdependencies. For example, AFN for Agrigrow, a hypothetical agribusiness
forecasting substantive increases in future firm. (See page 3.)
liquid fertilizer sales cannot be completed
separately from the firm's willingness to Agrigrow generated a 4%, profit on sales during
expand its inventory of applicators because 1991 and distributed 40% of 1991 net income to
its stockholders as dividends. Let's further
assume that during 1991 Agrigrow operated its
WASHINGTON STATE UNIVERSITY & U.S. DEPARTMENT OF AGRICULTURE COOPERATING
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fixed assets at full capacity and retained no
underutilized stocks of current assets. If The first step in the percentage of sales forecast
Agrigrow is going to attain its 1992 sales is to identify and separate those balance sheet
forecast of $750,000, what will its 1992 pro items expected to vary directly with sales. For
forma balance sheet look like and how much example, since Agrigrow was operating in 1991
additional funding will be required during 1992? at full physical capacity, one would expect that
AFN must, be calculated for the forecasted sales selected asset items would have to increase to
period. attain the 1992 sales forecast. Any increase in
assets employed by Agrigrow will have to be
AFN COMPUTATIONAL STEPS accompanied by an increase in liabilities and/or
equity; i.e., those increases in assets must be
While several methods for developing pro forma financed by some source. In this regard, we
financial statements, I will use the “percentage would expect some financing will be “generated
of sales” method. This method provides a simple spontaneously;” i.e., some sources of funds such
and quite practical means for forecasting as accounts payable and accruals will rise
financial variables. The method rests on two spontaneously with sales. While retained
basic assumptions. First, it assumes that most earnings will also increase, they will not respond
agribusiness balance sheets are linked directly to in direct proportion to sales. And finally, there is
sales (i.e., over time, sales impact balance sheet no reason to expect notes payable, mortgage
components). Second, it assumes that the current debt, or common stock to rise spontaneously
complement of assets effectively serves the with sales because higher sales do not
current level of sales (i.e., there are no “automatically” trigger increases in these items.
underutilized assets remaining in the firm's
inventory).
Assets Liabilities
Cash $10,000 Accounts Payable $40,000
Receivables 85,000 Notes Payable 10,000
Inventories 100,000 Accrued Wages/Taxes/Interest 25,000
Total Current Assets $195,000 Total Current Liabilities $75,000
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Next, one must express those 1991 Balance
Sheet items which vary directly wit h sales as a Having calculated AFN, we must now determine
percentage of 1991 sales. Items such as notes whether these additional funds are to be raised
payable which do not automatically vary with by additional bank borrowings and/or by issuing
sales are designated “not applicable,” in Column securities. (Note that for simplicity we have
1 of the following table. You then multiply these assumed that cash flows generated by
percentages by the projected 1992 $750,000 depreciation are used to replace worn-out fixed
sales to obtain the projected amounts as of assets.)
12/31/92, in Column 2. Retained earnings for
12/31/92 is obtained by adding to retained SOURCES OF AFN
earnings for 1991 those generated in 1992, (see
footnote b). Summing the 1992 asset accounts Up to this point, we have assumed that notes
shows total projected assets of $518,000 while payable, mortgage debt and common stock have
summing the projected liabilities and equity remained unchanged from 1991 levels (see
items shows $396,000 in available funds. This footnote a). If we are to generate $122,000 in
funds shortfall of $122,000 is designated as AFN, we must use one, or a combination of
AFN. these funds sources, to make up the shortfall.
(1) (2)
Pro Forma Balance Sheet
12/31/91 12/31/92
Balance Sheet Items Expressed as Based on 1992 Projected Sales
Item % of 1991 Sales of $500,000 ($750,000 x Column 1)
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Ordinarily, agribusiness firms would choose financial constraints imposed on the firm by its
among funds sources on the basis of relative lenders, new additions to debt are limited to
costs, subject to certain constraints. For $79,000 and only $9,000 of that can be short-
example, let's assume that Agrigrow has a loan term debt. It must now raise $43,000 from the
covenant in its mortgage agreement restricting sale of additional common stock if 1992 AFN
the firm from increasing its total debt beyond requirements are to be met.
50% of total assets. Yet, another covenant
requires that Agrigtow maintain a current ratio PROJECTED FINANCIAL STATEMENT
of 2.5 or greater. Given these restrictions,
Agrigrow would evaluate alternative sources of Based largely on the pro forma computations,
AFN in the following manner. AFN calculations and the financial restrictions
noted, Agrigrow can now prepare projected
As calculated earlier, Agrigrow requires financial statements for 1992. They would
$122,000 in AFN for 1992. Because of simple appear as shown on page 7:
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AFN CALCULATION SHORTCUT Arrived at quickly in this manner it can be
shown that for Agrigrow to increase its 1992
The most common method to calculate AFN sales by $250,000, this agribusiness firm must
involves constructing pro forma financial increase its assets by $172,500. This $172,500 in
statements as described above. Under certain new assets must be financed in some manner. Of
conditions, however, you can use a shortcut the total amount, $32,500 will come from a
method to calculate AFN. While pro forma spontaneous increase in liabilities and an
financial statements are not generated, the additional $18,000 will result from retained
following formula -generated AFN highlights the earnings from 1992 operations. The remaining
relationship between sales growth and financial $122,000 must be generated from external
requirements. sources. Based on Agrigrow's financial
constraints described earlier, $9,000 of AFN will
Additional Required Increase come from additions to short-term debt (notes
= − payable), $70,000 will result from an increase in
Funds Needed in Sales mortgage debt and the remaining $43,000 will
be generated from the sale of common stock.
Spontaneous Increase − Increase in
in Liabilities Retained Earnings SUMMARY
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PROJECTED FINANCIAL STATEMENTS
AGRIGROW, 1992
Ken D. Duft
Extension Economist