Financial Planning
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Transcript of Financial Planning
FINANCIAL PLANNING
• What is financial Planning?
It provides a roadmap for guiding, coordinating, and controlling firms actions to achieve goals.
Two Key aspects of financial planning:-
1) Cash Planning
2) Profit Planning
Financial Planning Process
• Long Term or Strategic financial Plan
Lays out a company’s action plan ranging over a period of 2 to 10 years.
• Short Term or Operating financial Plan
Specify plan that covers financial actions to be taken over a 1to 2 years time period.
Long term or Strategic Plan
•Proposed outlays for purchase of Fixed Asset
•Research & Development Activities
•Making a Product development action
•Major sources of financing
•Termination of existing projects products or
line of business
•Repayment or retirement of debts
•Any planned acquisition
Operating PlanSales
Forecast
Pro Forma income
statement
Production Plan
Long termfinancial plan
Cash BudgetFixed asset outlay plan
Current period Balance sheet
Pro FormaBalanceSheet
Proforma or Projected Financial Statements
1.For assessing whether the firm’s anticipated performance is in line with the firm’s own target or investor expectations.
2.To estimate the effect of proposed operating changes. Doing “what if” analysis.
3.To anticipate the firm’s future financing needs
4.To estimate future free cash flows
Sales Forecasts
•Monthly cash flows resulting from projected sales receipts
•Outlays related to production , inventory and sales
It can be derived from external forecast
or Internal Forecast or both.
Financial Statement Forecasting
• The Percent of Sales Method
Many items on the income statement and balance sheets are assumed to increase proportionally with sales.
Constant Ratio Method
2004 Forecasted Income Statement
2003 Factor2004
1st PassSales $2,000 g=1.25 $2,500.0
Less: COGS Pct=60% 1,500.0 SGA Pct=35% 875.0 EBIT $125.0Interest 0.1(Debt03) 20.0 EBT $105.0Taxes (40%) 42.0Net. income $63.0
Div. (40%) $25.2Add. to RE $37.8
2004 Balance Sheet (Assets)Forecasted assets are a percent of forecasted sales.
Factor 2004
Cash Pct= 1% $25.0Accts. rec. Pct=12% 300.0
Pct=12% 300.0
Total CA $625.0Net FA Pct=25% 625.0Total assets $1,250.0
2004 Sales = $2,500
Inventories
2004 Preliminary Balance Sheet (Claims)
*From forecasted income statement.
2003 Factor Without AFN
AP/accruals Pct=5% $125.0Notes payable 100 100.0
Total CL $225.0L-T debt 100 100.0Common stk. 500 500.0Ret. earnings 200 +37.8* 237.8Total claims $1,062.8
20042004 Sales = $2,500
• Required assets = $1,250.0• Specified sources of fin. = $1,062.8• Forecast AFN = $ 187.2
What are the additional funds needed (AFN)?
Implications of AFN
• If AFN is positive, then you must secure additional financing.
• If AFN is negative, then you have more financing than is needed.– Pay off debt.– Buy back stock.– Buy short-term investments.
Assumptions about How AFN Will Be Raised
• No new common stock will be issued.
• Any external funds needed will be raised as debt, 50% notes payable, and 50% L-T debt.
How will the AFN be financed?
Additional notes payable = 0.5 ($187.2) = $93.6.
Additional L-T debt = 0.5 ($187.2)= $93.6.
2004 Balance Sheet (Claims)
w/o AFN AFN With AFNAP/accruals $ 125.0 $ 125.0 Notes payable 100.0 +93.6 193.6 Total CL $ 225.0 $ 318.6 L-T debt 100.0 +93.6 193.6 Common stk. 500.0 500.0Ret. earnings 237.8 237.8 Total claims $1,071.0 $1,250.0
1st Pass Feedback 2nd PassSales $2,500 $2,500 Less: COGS 1,500 1,500
SGA 875 875 EBIT $ 125 $ 125 Interest 20 +18.72 38.72 EBT $ 105 $ 86.28 Taxes (40%) 42 34.5 Net income $ 63 $ 54.78 Div. (40%) $ 21.91 Add. to RE $ 32.87
2002 2nd Pass Income Statement
2002 2nd Pass Balance Sheet (Assets)
1st Pass AFN 2nd Pass
Cash $25 $25
Accts. rec. 300 300
Inventories 300 300
Total CA $625 $625
Net FA 625 625
Total assets $1,250 $1,250
No change in asset requirements.
2002 2nd Pass Balance Sheet (Claims)
1st Pass Feedback 2nd PassAP/accruals $ 125 $ 125 Notes payable 193.6 193.6 Total CL $ 318.6 $ 318.6 L-T debt 193.6 193.6Common stk. 500 500 Ret. earnings 237.8 232.82 Total claims $1,250 $ 1,245
Forecasted assets = $1,250 (no change) Forecasted claims = $1,245 (higher) 2nd pass AFN = $ 5 (short)
The $5 shortfall came from the $5 reduction in retained earnings. Additional passes could be made until assets exactly equal claims.
$5(0.10) = $0.50 interest on 3rd pass.
Results After the Second Pass
AFN Equation
Additional= Required - Spontaneous - IncFunds Inc in assets Liabilities in RENeeded
AFN = (A*/S0)S - (L*/S0)S - M(S1)(RR)
Definitions of Variables in AFN
• A*/S0: assets required to support sales;
called capital intensity ratio.
S: increase in sales.
• L*/S0: spontaneous liabilities ratio
• M: profit margin (Net income/sales)
• RR: retention ratio; percent of net income not paid as dividend.
Assets must increase by $250 million. What is the AFN, based on
the AFN equation?
AFN = (A*/S0)S - (L*/S0)S - M(S1)(RR)
= ($1,000/$2,000)($500)
- ($100/$2,000)($500)
- 0.0270($2,500)(1 - 0.4)
= $184.5 million.
Equation method assumes a constant profit margin.
Pro forma method is more flexible. More important, it allows different items to grow at different rates.
Equation AFN = $184.5 vs.
Pro Forma AFN = $187.2Why are they different?
Factors that affect External Financial Requirements
• Sales Growth ( increase in sales)
• Capital intensity ( A*/ S0)
• Spontaneous liabilities to sales ratio (L*/S0)
• Profit Margin (M)
• Retention Ratio (RR)
How would increases in these items affect the AFN?
Higher sales:
Increases asset requirements, increases AFN. Higher capital intensity ratio, A*/S0?
Increases AFN: Need more assets for given sales increase.
• Higher dividend payout ratio?
Increase AFN: Less retained earnings.
• Higher profit margin?
Decrease AFN: Higher profits, more retained earnings.
Pay suppliers in 60 days rather than 30 days?
Decrease AFN: Trade creditors supply more capital, i.e., L*/S0 increases.
Higher profit margin:
Increases funds available internally, decreases AFN
Higher Retention Ratio:
Decreases AFN: Due to increase in
retained earnings.
Relationship between Sales Growth and Financial Requirements
1. Financial Feasibility
2. Effect of Dividend Policy on financing needs
3. Capital Intensity
4. Profit Margin
When Balance Sheet Ratios are subject to change
Three such conditions are:-
1.Economies of Scale
2.Lumpy Assets
3.Excess assets due to forecasting errors