Financial Planning and Forecasting
Core concepts
Financial planning translates strategy into projected statements. Candidates should understand the percent-of-sales method, pro forma construction, the sustainable growth rate, and the external financing needed (EFN) concept. Know how assumptions about margins, turnover, and payout policy drive forecasted funding requirements, and how scenario and sensitivity analysis support planning under uncertainty.
Traps to watch
- Spontaneous vs. discretionary items: Only certain balance sheet items (receivables, inventory, payables) vary proportionally with sales; fixed assets and long-term debt usually do not.
- Sustainable growth: Sustainable growth rate = ROE × retention ratio (1 − payout). Ignoring payout changes overstates growth capacity.
- Circularity: Interest expense depends on debt, which depends on financing needs-simple models ignore this.
- Plug vs. driver: EFN is a plug; mistaking it for a driver of the model is a common error.
Rule of thumb
Build forecasts from a small set of explicit drivers-sales growth, margin, turnover, and payout-and let financing needs fall out as the plug. Worked example: a firm with 20% ROE and a 40% dividend payout has a sustainable growth rate of 20% × 0.60 = 12%. If management plans 18% growth, the 6-point gap must be funded externally or supported by improved margins or turnover.