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Financial Planning
BUSINESS PLAN
Strategic Planning
Operational Planning
Budgeting
Forecasting
...differ according to three attributes:
(1) Length of the planning horizon
(2) Kinds of issues addressed
(3) Level of detail projected
Budgets:
Operating Budgeta collection of individual budgets combined to form a part of an
integrated business plan, usually for next year
Used to Coordinate activity
Control-serving as performance measurement
Capital Budget-listing of capital projects it plans to place in service during some future
period,usually next year
Cash Budget- projection of a companys cash receipts and disbursements over some
future time period
The Business Planning Spectrum
Annual
Operating
Plan
Strategic
Plan
Quarterly
Budgets
Long Term
General,
Conceptual
Short-Term
Forecasts
Short Term
Detailed,
Numerical
PLANNING ASSUMPTIONS
3. Ending Equity: Calculate ending equity as beginning equity plus EAT (less
dividends plus new stock to be sold if either exist).
4. Ending Debt: Calculate ending debt as total L&E (=Total Assets) less current
liabilities less ending equity.
5. Interest: Average beginning and ending debt. Calculate interest by multiplying
average debt by the interest rate.
6. Test Results: Compare the calculated interest from step 5 to the original guess in
step 1.
a. If the two are significantly different, return to step 1 replacing the
guess at interest with the value just calculated and repeat steps 2 through 6.
b. If the calculated value is close to the guess, stop.
Determine the level of assets that will need to vary proportionately with
sales.
How to determine this?
look at ratios
what has happened over last few years within the company
forecast for future economic state
(2)
(3)
A
CL
S
S
S
S
A
CL
S
S ) ( NI D )
S
S
A
CL
S
S ) (CF D )
S
S
S = 15m
Sales will increase 25%
S 3.75m
CA=6.5M
FA 1M
CL= 2M
Notes Payable = .5 M
E (Expense)
E (NI)
Dividends
17.75m
1m
.25 M
=.25(7.5M)-.25(2M-.5M)=1.5 M
Additional Financing Needed
=(7.5M(.25)-(2M-.5M).25)-(1M-.25M)=.75 M
Example:
Expected Sales
Expected NI
Expected D
$ 6,000,000
400,000
50,000
Adjustments to Process
If can use some economics of scale then the relationships may not be strictly proportions.
Ex.:
5,000
20,000
40,000
65,000
50,000
115,000
A.P.
N.P.
Total C.L.
LT Debt 30,000
S. Equity
15,000
10,000
25,000
60,000
115,000
Sales $150,000. Expect 25% increase in sales to generate after-tax cash flow $16,000 dividend
of $5,000 F.A. at 90% capacity.
(1)
(2)
(3)
(4)
(5)
(6)
g(Assetsthis yr)
- g(Current Liabilitiesthis yr)
- [(1-d)ROS][(1+g)Salesthis yr]
The rate at which the firm can grow without newly sold equity
if none of its financial ratios change
Equivalent to forecasting growth using the Unmodified
Percentage of Sales Method
Simply the Growth in Equity Created by Retained earnings
where d is the dividend payout ratio
(1-d)
.75
.40
T/A
Equity
ROS x Turnover x Multip
6%
1.2
2.5
8%
1.0
1.5
Example 15-6
Next year's revenue is forecast at $7,900,000. What receivables figure should be
included in a financial plan to reflect a 40 day ACP assumption.
Solution:
ACP =(AR/Sales) * 360
40=(AR/7,900,000)*360
A/R = $877,777
$ 1,420
$ 568
$ 852
$ 341
$
511
10.0
4.0
6.0
2.4
3.6
$16,653
$ 4,000
$ 6,000
$ 5,707
$16,653
FACTS
1. Virtually all payables are due to inventory purchases, and the COGS is
approximately 60% purchased material.
2. Assets currently on the firm's books will generate depreciation of $510,000 next
year.
3. The only balance sheet accrual represents unpaid wages. Preliminary estimates
indicate that next year's payroll will be about $6.1M. Next year's closing balance
sheet date will be nine working days after a payday.
4. The combined state and federal income tax rate is 40%.
5. Interest on current and future borrowing will be at a rate of 10%.
PLANNING ASSUMPTIONS
Income, Cost, and Expense
1. During the coming year, the firm will mount a major program to expand sales.
The expected result is a 20% growth in revenue. Pricing and product mix will
remain unchanged.
2. The revenue growth will be accomplished by increasing efforts in the
marketing/sales department. The increased expenses generated will be
accommodated by planning Marketing Department expenses at 19% of the
expanded revenue rather than the current 18%.
3. A major cost reduction effort is underway in the Manufacturing Department
which is expected to reduce the Cost Ratio (COGS/Revenue) to 53% from its
current level of 55%.
4. The Engineering Department will be unaffected by the expansion in sales. Its
dollar expenses will increase by normal inflation at a 4% rate over last year.
5. Finance and administration expenses will need to expand to support the higher
volume, but due to scale economies the expansion will be at a
lower
rate than the growth in sales. A target growth of 10% is planned for those
expenses.
Assets and Liabilities
6. A lock box system will reduce cash balances 20%.
7. The current 90 day collection period (ACP) is considered unacceptable. Increased
attention to credit and collections in both finance and sales is expected to bring
the ACP down to 65 days.
8. Top management feels that the firm is operating with more inventory that it
needs. Manufacturing management has been challenged to increase the
Inventory Turnover Ratio based on COGS to 5 from its present level of 3 .
9. The Capital Plan has been put together in preliminary form, and indicates capital
spending of $5M. The average depreciation life of the assets to be acquired is 10
years. Straight line depreciation will be used, and a convention of taking one half
year's depreciation in the first year will be followed.
10. Vendors are complaining because the firm pays its bills in 55 days even though
most terms call for payment within 30 days. Fearing that inventory
and supplies will be cut off, management has decided to shorten the payment
cycle to 45 days.
11. No dividends will be paid next year, and no new stock will be sold.
Accounts Receivable:
65=(AR/17040)x 360
A/R = $3,077
Inventory:
5.0=(9031/Inventory) =$1806
Fixed Assets:
Gross Fixed Asset Additions = $5,000
Depreciation
New Equipment = [$5,000/10] 1/2 = $250
Old Equipment
= $510
$760
MACADAM COMPANY
PROJECTED CHANGES IN WORKING CAPITAL
NEXT YEAR (000)
Accts Rec
Inventory
Accts Pay
Accruals
Decr/(Incr)
in W/C
Beginning
$3,550
$2,603
$ 716
$ 230
Ending
$3,077
$1,806
$ 677
$ 211
Change
$ 473
$ 797
($ 39)
($ 19)
$5,207
$3,995
$1,212
MACADAM COMPANY
PROJECTED STATEMENT OF CASH FLOWS - NEXT YEAR (000)
OPERATING ACTIVITIES
EAT
$1,016
Depreciation
$ 760
Decrease in W/C
$1,212
Cash From Operating Activities
$2,988
INVESTING ACTIVITIES
Increase in Gross
Fixed Assets
($5,000)
Cash From Investing Activities
($5,000)
FINANCING ACTIVITIES
Increase in Debt
$1,700
Cash From Investing Activities.
$1,700
NET CASH FLOW
($ 312)
RECONCILIATION
Beginning Cash
$1,560
Net cash flow
($ 312)
Ending Cash
$1,248
Performance Measures
Bonuses
Stretch goals
RISK IN FINANCIAL PLANNING IN GENERAL