Financial planning my ppt @ bec doms

Financial Planning

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Component Parts of a Business Plan

Typical outline Contents Executive summary Mission and strategy statement

Basic charter and establishes long-term direction Market analysis

Why the business will succeed against its competitors Operations (of the business)

How the firm creates and distributes its product/service

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Component Parts of a Business Plan

Typical outline - continued Management and staffing

Firm’s projected personnel needs Financial projections

Projects the firm’s financial statements into the future

Contingencies What the firm will do if things don’t go as planned

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The Purpose of Planning and Plan Information

Major audience of business plan include Firm’s own management

Planning process helps pull management team together

Provides a road map for running the business Provides a statement of goals Helps predict financing needs

Outside investors Tells equity investors what returns can be expected Tells debt investors how firm will repay loans

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Four Kinds of Business Plan

Kinds of planning1. Strategic Planning2. Operational Planning3. Budgeting4. Forecasting

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Four Kinds of Business Plan

Strategic Planning Addresses broad, long-term issues, contains

summarized, approximate financial projections Five-year horizon is common Concepts expressed mainly in words, not

numbers Firm analyzes itself, the industry and the

competitive situation

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Four Kinds of Business Plan

Operational Planning Translates business ideas (day-to-day

operations) into concrete, short-term projections

Specifies how much the firm will sell, to whom, and at what prices

An equal mix of words and numbers

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Four Kinds of Business Plan

Budgeting Short-term updates of the annual plan

Usually Covers a calendar quarter Used in industries in which business conditions

change rapidly Mostly financial detail with a few words

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Four Kinds of Business Plan

Forecasting Very short-term projections of profit and

cash flow Where will the business’s financial momentum

carry it in the next few weeks Consists almost entirely of numbers Cash forecasts are projections of short-

term cash needs Most large firms do monthly cash forecasts

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Financial Plan as a Component of a Business Plan

Financial plan is the financial portion of the business plan It is a set of pro forma financial statements

projected over the time period covered by the business plan

Financial statements are a piece of the projection, not the center of the projection

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Planning for New and Existing Businesses

Hard to forecast a new operation No history on which to base projections

The Typical Planning Task Most financial planning involves forecasting

changes in ongoing businesses based on planning assumptions

Projected statements reflect assumptions such as: Unit sales will increase by 10% Overall labor costs will rise by 4%, etc.

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The Planning Task What we have and what we need to

project Figure 4.4

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Planning AssumptionsExample 4.1

Q: This year Crumb Baking Corp. sold 1 million coffee cakes per month to grocery distributors at $1 each for a total of $12 million. The firm had year-end receivables equal to two months of sales, or $2 million. Crumb’s operating assumptions with respect to sales and receivables for next year are:

1. Price will be decreased by 10% in order to sell more product.2. As a result of the price decrease, unit sales volume will

increase to 15 million coffee cakes.3. Collection efforts will be increased so that only one month of

sales will be in receivables at year end.

Forecast next year’s revenue and ending receivables balance on the basis of these assumptions. Assume sales are evenly distributed over the year.

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Planning AssumptionsExample 4.1

A: There are three inter-related planning assumptions: (1) a management action regarding pricing; (2) the expected customer response to the price change; and (3) and change in collection efforts.

The first two assumptions establish the revenue forecast. Next year, the firm expects to sell 15 million coffee cakes at $0.90 each,

revenue = 15,000,000 x $.90 = $13,500,000.

The third assumption regarding receivables requires the use of the total revenue forecast. Receivables are expected to decrease from two months of revenue to only one month; thus receivables are expected to be $13,500,000 12 = $1,125,000.

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Plans with Simple Assumptions

The Quick Estimate Based on Sales Growth

The percentage of sales method assumes all financial statement line items vary directly with sales revenue This is an unrealistic assumption Management virtually always has more insight

The modified percentage of sales method assumes most but not all line items vary with sales

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Plans with Simple Assumptions

Forecasting Cash Needs A key reason for financial projections

is to forecast the firm’s external financing needs

When a plan shows increasing debt, additional external financing will be needed Can be obtained by issuing new stock or

borrowing

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The Percentage of Sales Method—A Formula Approach

Assuming net fixed assets as well as other assets and liabilities vary with sales, the percentage of sales method can be condensed into a single formula Purpose – to estimate external financing requirements

approximately and quickly

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The Percentage of Sales Method—A Formula Approach

If the firm’s growth rate in sales is g, it can be shown (see text) that external funds required (EFR) in the planned (next) year will be

EFR = g(assetsthis year) - (g current liabilitiesthis year) - [(1 – d) ROS][(1+g)salesthis year]

Where d=dividend payout ratio

EFR = Growth in assets – growth in current liabilities

– planned year’s retained earnings

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The Percentage of Sales Method—A Formula Approach Example 4.4

Q: Forecast the external financing requirements of the Underhill Manufacturing Company assuming net fixed assets and EAT grow at the same rate as sales. However, also assume the firm plans to pay a dividend equal to 25% of earnings next year.

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The items needed to apply the EFR

equation are highlighted. We

also need the ROS figure of 11% (EAT sales, or $1,488

$13,580) and the expected dividend

payout ratio of 25%. Revenues are

expected to increase by 15%.

Revenue 13,580$ ASSETSCOGS 7,470$ Cash 348$ Gross Margin 6,110$ Accounts receivable 1,698$ Expense 3,395$ Inventory 1,494$ EBIT 2,715$ Current assets 3,540$ Interest 150$ Net fixed assets 2,460$ EBT 2,565$ Total Assets 6,000$ Tax 1,077$ LIABILITIESEAT 1,488$ Accounts payable 125$

Accruals 45$ Current Liabilities 170$ Debt 1,330$ Equity 4,500$ Total L&E 6,000$

Income StatementUnderhill Manufacturing Company This Year ($000)

Balance Sheet

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The Percentage of Sales Method—A Formula Approach Example 4.4

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EFR = g(assetsthis year) - (g current liabilitiesthis year)

- [(1-d)ROS][(1+g)salesthis year]

EFR = .15($6,000) - .15($170) - [(1-.25)(.11)(1.15)($13,580)]

EFR = - $413.9A negative result implies the firm will generate cash

Note that the EFR technique is of limited value because it forces the unrealistic assumption that all

financial statement items vary exactly with sales

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The Sustainable Growth Rate

A theoretical measure of a firm’s strength A firm can grow at its sustainable growth rate without

selling new stock if its financial ratios remain constant

Business operations create new equity equal to the amount of current retained earnings, or (1 – d)EAT

Implies sustainable growth rate in equity, gs gs = EAT(1 – d) / equity

Since ROE = EAT / equity

gs = ROE(1 – d)

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The Sustainable Growth Rate

Assumes the debt/equity ratio is constant Equity growth occurs via retained earnings New debt will need to be raised to keep the

debt/equity ratio constant

Gives an indication of the determinants of a firm’s inherent growth capability

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The Sustainable Growth Rate

Incorporating equations from the DuPont equations into the gs equation we obtain

sEAT sales assetsg 1 dsales assets equity

gs = (1-d)ROS x Total Asset Turnover

x Equity Multiplier Firm’s ability to grow depends on 4 abilities:

Ability to earn profits on sales (ROS) Use of assets to generate sales (T/A Turnover) Use of borrowed money - leverage (equity mult) Percentage of earnings retained (1 – d)

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More Complicated PlansIndirect Planning Assumptions

Financial planning assumptions can be made: directly about the financial items indirectly about a derivative of the item

Indirect planning assumptions are usually based on financial ratios Receivables are usually managed through the Average

Collection Period (ACP)

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Forecasting Accounts Receivable Example 4.6

Q: Mylar’s ACP is 60 days and management wants to forecast an improvement to 40 days. What is the ending A/R balance if revenue is forecast at $7.2 million?

A: A/RACP = x 360

Sales

A/R40 days = x 360

$7,900,000

A/R = $877,777

Exam

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An average balance would generally be used. See footnote in text.

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Management Issues in Financial Planning

The Financial Plan as a Set of Goals The financial plan can be a tool to manage the

company and motivate performance Problems arise when top management puts in stretch

goals A target for which the organization strives, but is unlikely to

fully achieve Want employees to stretch toward max performance But people will give up if the goal seems impossible

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Risk in Financial Planning in General

Stretch planning and aggressive optimism can lead to unrealistic plans with little chance of coming true

Top-down plans forced on the organization by management are often unrealistically optimistic The risk in financial planning is that the plan overstates

achievable performance

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Risk in Financial Planning in General

Underforecasting—The Other Extreme Sets a goal that is easy to meet, ensures success

Doesn’t motivate best possible performance Bottom-up plans are consolidated from lower

management’s inputs and tend to understate what the firm can do

The Ideal Process A combination of the top-down and bottom-up

approaches to planning End result is a realistic, achievable compromise

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Risk in Financial Planning in General

Scenario Analysis—”What If”ing Many companies produce plans

reflecting different scenarios — “what if” Gives planners a feel for the impact of

assumptions not coming true Communication

A business unit is expected to have confidence in its plan

A single plan tends to be published along with its attendant risks