Financial Planning - Textbook MediaFinancial Planning Introductory concepts – the role of planning Specific-item forecasting Forecasts that relate to sales The percentage-of-sales

Chapter 5

Financial Planning

5-2 © 2002, 2012 Frank M. Werner and James A.F. Stoner

Financial Planning

Introductory concepts – the role of

planning

Specific-item forecasting

Forecasts that relate to sales

The percentage-of-sales method

illustrated

Interpreting the pro-forma statements


Financial Planning


planning




illustrated



The Role of Planning

Planning

– Step 1 – MISSION STATEMENT: a broad

statement of purpose

– Step 2 – UNDERSTAND CUSTOMERS: what

does it take to exceed their expectations?

– Step 3 – STRATEGY: aligning the firm with its

internal culture and strengths and its external

environment

– Step 4 – OPERATING PLANS: making them

consistent with strategy



Budgeting – the translation of the

organization’s plan into dollar impacts

– Divides the plan into time units

– Guides resource use and tests results

– Can have unintended side effects

• Damaging the firm to meet budget

• Leading to internally competitive rather than

cooperative behaviors

• Tampering – overreacting to environmental changes



Financial planning

– Six tasks

• Make assumptions explicit and shared

• Identify healthy actions

• Identify financial resources

• Guide financing choices

• Benchmark results

• Communicate with stakeholders



Financial planning (continued)

– Three parts

• The long-run financial plan

• The capital budget

• The operating or cash budget

– Pro-forma financial statements

• Projected future statements

• Used to examine the financial implications of

alternative decisions


Financial Planning


planning




illustrated



Specific-Item Forecasting

Defined – projecting each financial

statement account independent of the

other accounts

Advantage – flexibility

Disadvantage – ignores relationships

among variables that might improve

forecasting accuracy


Financial Planning


planning




illustrated



Forecasts That Relate to Sales

Why? – many accounts depend on sales

Three requirements for success

– Start with a good sales forecast

– Correctly identify the accounts that relate to

sales – ask three questions:

• Why is the firm spending this money?

• What is the time horizon of the account?

• How will management respond?

– Accurately establish the relationship of those

accounts to sales


Forecasts That Relate to Sales

Income statement accounts

– Variable costs – change with sales

– Fixed costs – do not change with sales

Balance sheet accounts

– Spontaneous accounts – change with sales

without the need for specific management action

– Discretionary accounts – do not change with

sales but rather are set by management decisions


Financial Planning


planning




illustrated



The Percentage-of-Sales

Method

Seven steps

– Forecast sales

– Classify accounts

– Determine relationships

– Project new values

– Fill in the pro-forma income statement and

balance sheet

– Force the pro-forma balance sheet to balance

– Produce the pro-forma cash flow statement



Method



Method

Sales 2,500 $

– Cost of Goods Sold 1,738

Gross profit 762

– Operating expenses 550 $

– Depreciation 40

590

EBIT 172

– Interest expense 18

EBT 154

– Tax expense 54

EAT 100 $

– Dividends 33

Addition to retained earnings 67 $

THE JEFFERSON COMPANY Income Statement

For the year ended December 31, 2011



Method

Cash 100 $ Accounts payable 150 $

Marketable securities 50 Accrued payables 200

Accounts receivable 150 Bonds payable 200

Inventories 200 Common stock 150

Plant, net 500 Retained earnings 300

Total assets 1,000 $ Total liability and equity 1,000 $

THE JEFFERSON COMPANY Balance Sheet

December 31, 2011



Method

Data obtained from:

Sales 3,000 $ Step 1 - forecast

-Cost of goods sold 2,086 Step 4a - projection

Gross profit 914

-Operating expenses 625 $ Step 4a - projection

-Depreciation 40 Step 2a - fixed cost

665

EBIT 249

-Interest expense 18 Step 4c - projection

EBT 231

-Tax expense (35%) 81 Step 2f - calculation

EAT 150 $

-Dividends 50 Step 2g - calculation

Addition to retained earnings 100 $

THE JEFFERSON COMPANY Pro-Forma Income Statement




Method

Data obtained from:

Cash 120 $ Step 4b - projection

Marketable securities 50 Step 2d - discretionary

Accounts receivable 180 Step 4b - projection

Inventories 240 Step 4b - projection

Plant, net 600 Step 4b - projection

Total Assets 1,190 $

Accounts Payable 180 $ Step 4b - projection

Accrued Payable 240 Step 4b - projection

Bonds payable 150 Step 4c - projection

Common stock 150 Step 2d - discretionary

Retained earnings 400 Step 5 - pro-forma income statement

1,120 $

External Financing Needed 70 Step 6 - force a balance

Total liability and equity 1,190 $

THE JEFFERSON COMPANY Pro-Forma Balance Sheet

December 31, 2012



Method

Data obtained from:

CASH FLOW FROM OPERATIONS

Received from customers 2,970 $ Pro-forma statements

Paid to suppliers and employees (2,681) Pro-forma statements

Interest Paid (18) New income statement

Income taxes paid (81) New income statement

Net cash provided by operating activities 190

CASH FLOW FROM INVESTMENTS

Payment for purchase of

property plant and equipment (140) Both balance sheets

CASH FLOW FROM FINANCING

External financing 70 New balance sheet

Repayment of long-term debt (50) Both balance sheets

Dividents paid (50) New income statement

Net cash used by financing activities (30)

THE JEFFERSON COMPANY Pro-Forma Statement of Cash Flows




Method

NET INCREASE (DECREASE) IN CASH 20

Cash and equivalents, beginning of year 150

Cash and equivalents, end of year 170 $

RECONCILIATION OF NET INCOME TO CASH PROVIDED

BY OPERATIONS

Net income 150 $ New income statement

Add back: Depreciation 40 New income statement

Subtract increase in:

Accounts receivable (30) Both balance sheets

Inventories (40) Both balance sheets

Add increase in:

Accounts payable 30 Both balance sheets

Accrued payables 40 Both balance sheets

Net cash provided by operations 190 $


Financial Planning


planning




illustrated



Interpreting the Pro-Forma

Statements

There are two reasons why firms need

external funds

– Growth – long-term trend

– Seasonality – temporary fluctuations

The cash flow statement gives additional

clues to funding – it identifies why funds

are needed and whether the money will

return to the firm in the short or long term


Interpreting the Pro-Forma

Statements

Financial (ratio) analysis can be used to examine the results – Test for trends in the ratios not directly related to

sales

– Test the choice of EFN source using the ratios sensitive to financing choice – calculate the ratios for each financing alternative

Relationships are changing – the percentage relationships of most accounts to sales is changing as companies improve their business processes

Documents

Financial Planning - Textbook MediaFinancial Planning Introductory concepts – the role of planning Specific-item forecasting Forecasts that relate to sales The percentage-of-sales