In a context marked by sharp fluctuations in the cost of resources and exchange rates, managers must utilize flexible and efficient planning tools, in particular comprehensive and detailed financial forecasts.
If the trend continues, we predict …
Gilles is the majority shareholder and general manager of a manufacturing company that exports 40% of its production to the U.S. market. The new fiscal year began at the start of May 2004 and a board of directors meeting is scheduled in 5 days in order to review the past year’s financial results and the outlooks for the next 12 months.
The representative of the institutional shareholder that has invested $2 million in the company and that holds 35% of the shares is anxious to receive and analyze the coming year’s financial forecasts. As is the case every year, the budget data that Gilles is using were prepared in March. Outlooks for the coming year appear relatively glum and the company is forecasting minimal profits, which confirms the downbeat trend of the past two years. Gilles is counting on asking his key financial partner to inject an additional $500,000 in order to acquire equipment considered necessary to make the company more competitive. In preparation for the important upcoming meeting, Gilles submits the financial forecasts he has to his external financial consultant in order to obtain his general comments about the budget content and presentation. Following a review, the external financial consultant noted the following:
The forecasted results are invalid due to the recent exchange rate fluctuation and sudden spike of almost 25% in the cost of the key raw material used by the company. The forecasted gross margin does not consider the positive spin-offs from the equipment acquisition. Recent layoffs of indirect employees that have reduced the company’s fixed expenses were not indicated when the forecasts were prepared. The financial forecasts do not include the monthly changes in cash flows such that it is difficult to assess the impact of new forthcoming investments and the company’s financial ability to handle seasonal fluctuations during the coming year. The forecasts do not include the forecasted monthly balance sheet that is used to better judge the accuracy and reasonableness of the forecasted data.
To summarize, based on the available forecasted data, it is highly unlikely that an investment decision, or even a principal agreement on this project, could be obtained from the financial partners.
Moreover, Gilles’ financial consultant informs him of the information that should be included in the financial forecasts:
Concerning forecasted earnings:
The forecasted change in net earnings over the coming months taking into account the most likelyhypothetical assumptions, positive spin-offs from real estate investments and the recent downsizing initiatives;
The information required to determine earnings before interest,
taxes and depreciation and amortization (EBITDA);
Comparative data from the previous fiscal period;
The breakeven point in light of the new operational parameters;
The sensitivity of the expected earnings based on sales and other
significant variables, such as the exchange rate and cost of raw materials;
The effect of a full year following the completion of the investment project
and downsizing initiatives (subsequent typical year).
Concerning forecasted cash flows:
Forecasted changes in cash or the credit margin;
Change in the company’s short-term borrowing capacity;
The effect of future investments and capital expenditures on cash flows.
Concerning the future financial situation:
Monthly changes in the company’s balance sheet;
The creditworthiness and a manageable debt level;
Shareholders’ value.
Gilles therefore decides to make the proposed adjustments and improvements to his financial forecasts, especially considering that more comprehensive and accurate information will also prove useful for the long-term lender, who should also take part in financing the initiative to purchase equipment.
Note: the above-mentioned scenario is purely fictional and merely used to illustrate the usefulness of having an effective budget process in corporate management.
