Practical financial manaegment lasher 7th ed chapter 04

Chapter Financial Planning Business Plan A business plan is a model of what management expects a business to become in the future Financial statements are pro forma Good business plans are comprehensive Component Parts of a Business Plan Typical outline – Contents – Executive summary – Mission and strategy statement – Market analysis – Operations (of the business) – Management and staffing – Financial projections – Contingencies The Purpose of Planning and Plan Information Major audiences of business plan – 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 The Purpose of Planning and Plan Information Planning process Roadmap for running the business Statement of goals Predicting financing needs Investor communication Figure 4-1 Using a Plan to Guide Business Performance Credibility and Supporting Detail Shows enough supporting detail to indicate it is the product of careful thinking Displays summarized financial projections Four Kinds of Business Plan Kinds of planning – Strategic Planning – Operational Planning – Budgeting – Forecasting 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 Four Kinds of Business Plan Operational Planning – Translates business ideas (day-to-day operations) into concrete, shortterm projections – Usually one year or less – Specifies how much the firm will sell, to whom, and at what prices 10 Concept Connection Example 4-8 Complex Plans 46 Concept Connection Example 4-8 Complex Plans 47 Figure 4-6 Supporting Detail for Annual Planning at the Department Level 48 The Cash Budget The cash budget is a detailed projection of receipts and disbursements of cash – A fundamentally different approach than projecting financial statements In large part based on time lags between events and receipt or disbursement of related cash 49 Receivables and Payables—Forecasting with Time Lags Forecasting receivables collection is difficult because a company never knows when customers will pay their bills 50 Debt and Interest Forecasting short-term debt and interest is difficult if current cash needs are funded directly by borrowing – The current month’s interest payment is based on the preceding month’s loan balance Other Items – Forecasting most other items is relatively straightforward 51 Concept Connection Example 4-9 Cash Budgeting 52 Concept Connection Example 4-9 Cash Budgeting 53 Concept Connection Example 4-9 Cash Budgeting 54 Concept Connection Example 4-9 Cash Budgeting 55 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 56 Inherent Conflicts Stretch planning and aggressive lead to unrealistic optimism can plans with little chance of coming true Top-down plans forced on the organization by management are often unrealistically optimistic 57 Risk in Financial Planning in General Top-down plans forced on the organization by management are often unrealistically optimistic Under forecasting Bottom-up Planning 58 Risk in Financial Planning in General Scenario Analysis—“What If”ing – Different scenarios — “what if” – Gives planners a feel for the impact of assumptions not coming true Communication – A single plan tends to be published along with its attendant risks 59 Financial Planning and Computers Computers make planning quicker but don’t improve the judgments that are the heart of good planning Repetitive Calculations Changing Assumptions 60 [...]... $1,125,000 The General Approach, Assumptions, and the Debt/Interest Problem The Procedural Approach – Financial plans are built line-by-line beginning with revenues Debt/Interest Planning Problem – The next items needed are interest expense and debt – Planned debt is required to forecast interest, but interest is required to forecast debt 23 An Iterative Numerical Approach Solves the debt/interest problem... Figure 4-2 The Business Planning Spectrum 14 Figure 4-3 Relating Business Planning in Large and Small Firms 15 Financial Plan as a Component of a Business Plan Financial plan is the financial portion of the business plan – A set of pro forma financial statements projected over a time period – Financials are only pieces of the projection 16 Planning for New and Existing Businesses Hard to forecast a new... over this year’s The firm has some excess factory capacity, so no new fixed assets beyond normal replacements will be needed to support the growth This year’s income statement and ending balance sheet are estimated as follows: 27 Example 4.3 Plans with Simple Assumptions Assume the firm pays state and federal income taxes at a combined flat rate of 42%, borrows at 12% interest, and expects to pay no dividends... by using the modified percentage of sales method A: We’ll increase everything except net fixed assets by 15% All highlighted items were increased by 15% At this point we are at the debt/interest impasse We’ll guess at interest (using last year’s interest of $150,000 as a starting point) and work through the procedure 28 Example 4.3 Plans with Simple Assumptions Net Income was computed using an Interest... Income was added to Equity and the Debt figure was a plug, calculated by subtracting Equity and Current Liabilities from Total L&E Taking the average debt at 12% yields a calculated interest of $86,000 which is considerably less than the $150,000 assumed Two additional iterations yield the following result 29 Example 4.3 Plans with Simple Assumptions Forecasting Cash Needs Forecasting Cash Needs – A key... 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 31 The Percentage of Sales Method A Formula Approach Purpose – to estimate external financing requirements approximately and quickly growth in assets -growth in current liabilities -earnings retained ... will be decreased by 10% 2 As a result unit sales volume will increase to 15 million coffee cakes 3 Collection efforts increased - only one month of sales in receivables at year end Forecast next year’s revenue and ending receivables balance Concept Connection Example 4-1 Planning Assumptions Three interrelated planning assumptions – a management action with respect to pricing, – the expected customer... results: Compare calculated interest to the original guess 24 Figure 4-5 The Debt/Interest Planning Problem 25 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... 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 33 Concept Connection Example 4-4 Concept Connection Example 4-4... Attempts a precise estimate of company expenses Mostly financial detail with a few words 11 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 12 Four