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average shares outstanding. The plain shares outstanding
refers to the number at the reporting date, but this does
not take into account that there may have been changes in
the shares outstanding over the year. It is also important
to reflect the timing of the changes, which is why the
weighted average number is used. Typically, this infor-
mation is available in the annual reports. If you do not
have this number, a proxy is to take the average of the
shares outstanding at the beginning and the end of the
reporting period.
Compute the historic dividends per share numbers
u

yourself. If they reconcile with the historic figures, then
you have a good basis for using them as the basis for
calculations of future dividends, plus a growth rate that
roughly equals the growth of the economy and/or the
industry. If they do not reconcile, it may be because of
stock splits or rights issues. Companies™ dividends usually
grow at a steady rate, but the growth can stop if earnings
go into a dip.


BALANCE SHEET
Cash
There are two kinds of cash account in the model. One is the cash
that the company needs to have on hand to handle day-to-day
expenses. We can think of this as ˜˜minimum cash.™™ You can
attach an interest rate to this, but more likely than not, this
cash is not kept in the bank and so it is not earning interest.
Because this cash also reflects operational needs, it makes sense
to forecast this as a percentage of sales.
The other is the cash that is automatically produced by the
model when liabilities and equity exceed assets”the Surplus
funds row. You do not forecast this account directly. Rather, it
is a result of the forecast assumptions you make for other parts of




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Forecasting Guidelines 233




the balance sheet and indeed the income statement, too. (It may
be that your assumptions will create a need for additional debt,
in which case you would not see the Surplus funds line.) To the
extent that you will have Surplus funds, make sure that you
enter an interest rate.


Short-Term Investments
If your company has this account, you may want to forecast the
same level going forward, without any growth. By holding it
steady, you will be able to see more clearly the rate of buildup
in Surplus funds or Necessary to finance.


Operating Assets and Liabilities
A large part of the balance sheet is there to support sales. As
sales grow, these operating assets and operating liabilities must
also grow by a more-or-less proportionate rate. As a result, you
can forecast them based on a relationship to revenues in the
income statement.
The operating assets are:
Accounts receivable
u

Inventory
u

Other current assets
u

Net PPE
u

Other assets. You should check if these are related to
u

operations or investments; if the latter, they should be
forecast at some growth rate, not as a percentage of sales.
The operating liabilities are:
Accounts payable
u

Other current liabilities
u


You can project these items on the basis of the last historical
year, but you should take into account any variations from trends
that are booming or reversing. Any unusual or extreme change is
a call for delving further into the information to find out what
the reasons may be.




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234




The net PPE number is a tricky one to forecast, and the
forecast numbers are determined by two main flows: capital
expenditures (which add to the gross PPE number) and deprecia-
tion (which flows into accumulated depreciation and reduces the
gross PPE number). The production base to support sales is a
function of many things, including the product being produced,
the technology in place, and the scale of production. These”and
other factors”represent a ˜˜habit™™ of the production systems in
the company. The net result is a net PPE number that should
have some discernible and steady relationship to sales. Thus,
a good way to forecast net PPE is first to determine the net
PPE to sales ratio and then to use that as the basis of forecasting
net PPE. If we have a depreciation schedule, then, in fact, the
capital expenditures number becomes the ˜˜plug™™ number in the
calculation of net PPE.
Some pointers:
If the latest net PPE to sales ratio is high, this
u

probably reflects recent investments to modernize the
plant. We can let this ratio trend down to the
historical rates, and, as a result, future capex will also
show a downward trend until the ratio meets the
historical levels.
If the ratio is low, this probably means that there will be a
u

need for heavy investments soon.
This measure of net assets to sales should be relatively
u

steady over the forecast period. The logical test is to
extend the projection period into perpetuity. If this ratio is
trending upward, then we will have a company that will
be extremely asset intensive. Likewise, if it is trending
downward, we will have a company that will generate
huge revenues on a sliver of a PPE base.


Other Assets
You should find out if these other assets are operating or
investment assets, and then forecast them accordingly. If they are
operating, you should forecast them in some relationship to sales; if
they are investments, then they should grow at some rate.




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Forecasting Guidelines 235




Other Liabilities
These can be either operating or financing assets. You should
project them accordingly. Sometimes, when you have no infor-
mation, the best recourse would be to hold them steady at the
last reported date levels.


Taxes Payable
You should forecast these as a percentage of current taxes. Taxes
payable reflect the part of taxes not paid until the next year.


Dividends Payable
This should be forecast as a percentage of current dividends.
Like taxes, a part of dividends is not paid out until the following
year.


Debt
You should forecast the debt based on known amortization
schedules. Where debt is being amortized, you may find that
the assets side of the balance sheet is now ˜˜higher™™ than the
liabilities and equity side. In this case, a plug debt line appears
that is the Necessary to finance line in our model.


Common Stock and Other Equity Accounts
Unless you have specific information about these accounts, hold
them at the level of the last historical year.


Retained Earnings
Retained earnings in the equity account should not be directly
projected in the balance sheet. Instead, this should grow in the
model as a result of the flows from net income, which in turn
have been produced by the assumptions in use in the income
statement.




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TLFeBOOK
CHAPTER 14


The Cash Sweep




This chapter expands on what we have done so far. At this
point, you should have a working model that not only allows
you to make forecasts of a company™s performance, but also
presents the results in a format that is GAAP consistent. Now
we will add the cash sweep feature.


THE CASH SWEEP
The cash sweep allows the model to repay debt tranches auto-
matically using the cash being generated by the earnings in your
company. The cash sweep uses the Surplus funds line. It does not
use the cash line in the model. As the debt is repaid, the interest
expenses associated with that debt also are reduced. Having this
feature means that the model will be iterating a few more cycles
before it reaches convergence. However, the additional time
is minimal and, given the high processor speeds available in
computers now, it is not perceptible.
These are the important points to keep in mind:
1. The cash sweep works only where there is a
Surplus funds amount, and the cash sweep is for
projected numbers only. There are no Surplus funds
in a historical year, and we would not want to have
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TLFeBOOK
Chapter 14
238




the model start changing the historical debt outstanding
numbers.
2. The cash sweep is for long-term debt only, and usually only
for bank debt. Short-term debt is any debt that will be
repaid within a year. So, to the extent that we define it year
after year in our forecast, it means that we intend to have
that debt continuously renewed. Thus, we do not need to
have the cash sweep work for the short-term debt.
The cash sweep is also used for bank debt because this
is the kind of debt that can be prepaid (repaid early when
funds are available) without incurring penalties. Bonds, on
the other hand, have specific maturities, and there are
usually penalties if they are repaid early.
3. The cash sweep feature works only if we keep to our
concepts of ˜˜static™™ and ˜˜dynamic™™ numbers (see p. 130).
Thus, the balancing formulas we have to use for the cash
sweep must be the one where we first find the

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