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1. CHAPTER 5
Funds Flow Analysis
And
Financial Forecasting

2. Introduction
• This chapter demonstrates a number of
techniques for forecasting the company’s
financial requirements. As the last of te
three consecutive “tools” chapters, the
discussions here will find later
applications, particularly on the issues
involving determination of asset levels and
financing sources and in the assessment
of the degree of risk in investment and
financial decisions.

3. Funds Flow Analysis
• The previous chapter examined some
methods of evaluating the company’s
financial condition and performance using
financial relationships or ratios.

4. Uses and Types of Funds Flow
Analysis
• The funds flow statement addresses this deficiency of
the financial ratio technique.
• It also uses two sets of financial statements, along with
an accounting classification technique. Essentially, a
funds flow statement uses two sets of financial
statements, along with an accounting classification
technique, in order to asses how the company has
moved from a previous financial status to the present.
• Since the fund flow statement is lifted directly from the
basic financial statements, it has become a standard
supplementary statement are offered to the public for
sale.

5. There are two conceptually separate types
of funds being utilized and sourced by a
company.
• The first involves the long-term funds
cycle which includes fixed assets, other
long term assets, and permanent fund
sources like long-term debt and equity.
• The second involves the short term, or
operating funds cycle which consists of
movements in current assets and current
liabilities.

6. Long Term Funds Cycle
The long term funds cycle describes the
company’s pattern of productive capacity
or investment expansion (or
divestment/liquidation) and the balance of
sources of permanent capital (long-term
debt or equity).

7. Operating Funds Cycle
• Indicates the flow of funds and its
composition in relation to the current or
day to day conduct of the business .
• The operating cycle is actually the “funds”
description of the company’s basic
revenue and expense transactions and it’s
access to trade and bank creditors.

8. The Funds Flow Statement
• Requires as basis, the balance sheets at two
points in time and an income statement
covering the two balance sheet dates. The
preparation of the funds flow statement
proceeds by:
2. Comparing balance sheet accounts and
determining whether there have been
increases o decreases over time. Other off-
balance sheet information like dividends and
sale of fixed asset are also gathered.
3. Classifying the changes as either sources or
uses of working capital o cash;

9. 3. Classifying, from the income statement, the
factors which increase or decrease working
capital or cash.
Sources of funds which increase working
capital are:
3. A decrease in fixed assets (e.g.; asset sale o
disposition);
4. An increase in long-term debt (new
borrowing);
5. Proceeds from sale of common or preferred
stock; and
6. Funds provided by operations (cash income)

10. Uses of funds which decrease
working capital are:
• An increase in fixed assets (e.g.,
acquisition);
• Repayment of long term debt;
• Purchase of own stock (treasury stock);
• Cash dividends; and
• Funds used in operations (excess of net
loss over depreciation and other non-cash
charges).

11. The change in net working capital
can be verified as follows:
Sources of Funds-Uses of Funds=Changes in Net
Working Capital
Change in Net Working Capital= Current Assets
(1983)- Current
Liabilities (1983)
LESS
Current Assets (1982)-
Current Liabilities ( 1982)

12. Sources of funds which increase
cash are:
• Changes which were previously classified
as sources of funds which increase
working capital (all items in Table 5.1);
• A net increase in any current liability (new
borrowings);
• A net decrease in any current asset other
than cash (liquidation of assets)

13. Uses of funds which decease cash
are:
• Changes which were previously classified
as funds which decrease working capital
(all items in Table 5.1);
• A net increase in any current asset
(working capital build-up );
• A net decrease in any current liability
(repayment of debt).

14. Limitations and Implications of
Funds Flow Statements
In describing the scope of analysis possible
using the funds flow statement, we should
first note that the funds statement depicts
net rather than gross changes of financial
statement accounts over two points in
time. We could determine the net asset
increases or decreases from one year-end
to another but we could not describe how
assets changed during the year.

15. • A second major limitation of the funds flow
statement is its inability to trace very
specific financing sources to particular
fund uses.

16. Some limited interpretations based on the
Bacnotan Consolidated figures in the
tables are advanced by way of example:
3. Internal cash generation
The first item in the sources of funds is the
internal cash generation of the company,
consisting of net income and
depreciation.

17. 2. Balance in asset growth
Assets are usually expected to change in
relation to certain external or discretionary
factors.
3. Determination of financing
requirements
A funds statement can reveal the nature and
amount of future funding needs.

18. 4. Balance in financing sources
Even after the nature of financing needs has
been determined, the analyst might want
to review whether the company has
achieved a balance among its financing
sources.

19. COMMON SIZE STATEMENT
ANALYSIS
When analyzing the flow of funds for a company,
we deal with monetary values and can
sometimes miss out the significance of funds
changes relative to the company’s picture.
The common size financial statement is an
expression of the balance sheet and the income
statement in percentages, with total assets and
net sales as reference points, respectively.

20. The importance of common size analysis
lies in its insights regarding the company’s
changing patterns, over time, in asset
expansion, financing sources and
operating perfomance.

21. FINANCIAL FORECASTING
The preceding discussions about funds flow and common
size statement analysis and the financial ratio technique
of the previous chapter share a common limitation up to
this time: all are based on past or historical financial
statements.
In this section, we cover financial forecasting tools as they
apply to the prediction of future company financial
performance and condition.
It will be noted that past financial reports remain important
component of forecasting, but we will demonstrate that
certain techniques involved in incorporating past data
into forecasts can be useful to the analyst and that other
bases for prediction (other than historical data) are
available as well.

22. Types and Uses of Financial
Forecast
The three major categories of financial
forecast are:
2. The Cash Forecast
3. The Balance Sheet Forecast
4. The Income Statement Forecast

23. Forecasting Techniques
While it may be difficult to disagree with the
claim of forecasts are useful, it is often
equally difficult to make managers and
other decision-makers rely on forecasts.
The reason lies in (a.) the inherent
uncertainty of future events and (b.) the
subjective nature of the assumptions used
in forecasts.

24. The subjective nature of the assumptions
used in forecasts has also led some to
doubt the inherent validity of the
exercise. In particular, the core of the
forecast lies on the choice of set of
assumptions used by the analyst. We
should emphasize that process of
forecasting consists of two steps,
namely:
2. The application of “objective” forecasting
techniques to analyze data; and

25. 2. The use of “subjective” judgment to
choose the specific forecast technique
and to interpret the results.

26. The “objective” forecasting techniques can
be either of two types: one based on
analysis of trends over time, o one based
on derived relationships among
variables. We now describe these
approaches in some detail.
• Trend Analysis
simplest relationship is that between a
financial variable and time periods.

27. The most common technique is to
extrapolate future values using “past
experience”. There are several
interpretations which might be used in
incorporating the past into predictions
about the future, in particular,
(a.) the use of immediately preceding value,
adjusted for subjective factors,
(b.) the use of average growth rates, and
(c.) the use of entire set of historical data to
derive a prediction model relative to time.

28. Forecasts Based on Relationships
Among Variables
Many financial variables appear to behave
in the same direction as certain
determining factors other than the lapse of
time.
There are two alternative methods of
forecasting using relationships among
financial variables, namely, (a.) the ratio
technique and (b.) regression analysis.

29. Financial Statement Forecasts
While the different financial variables can be
forecasted using any of the techniques
discussed in the preceding section, we
should recognize that these forecasts
should tie into a “total financial picture”-
the cash budget, the forecasted income
statement and the balance sheet. These
comprehensive financial forecasts have
one common starting point: the forecast of
sales or activity level of the company.

30. The financial statement forecast simply ties
in all the individual financial variable
forecasts into the indicated form.
2. Forecasted Income Statement
2. Forecasted Balance Sheet
3. Cash Flow Forecast

31. A monthly cash forecast would need the
following estimates:
b) Monthly accounts receivable collection
c) Payments of accounts payable
d) Cash purchases of inventory
e) Loan amortization and other payables
(e.g., income taxes)
f) Anticipated drawings on existing credit
lines
g) Capital expenditures and other payables
(e.g)., income taxes)

32. g) Proceeds from new equity issues
h) Dividend payments
i) Proceeds from sale of fixed assets or
investments.

33. Improving the Accuracy of
Forecasts: Sensitivity Analysis
1. Use of several variables to “explain”
movements in the financial variable
being forecasted.
2. Use of two-stage analysis in forecasting:
quantitative techniques followed by
qualitative analysis
3. Use of consensus approaches

34. THANK YOU!!!

35. :A REPORT IN FM1 BY
Christian B. Dilao
Yvette Llamasares
Maricris Patimo