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Chapter 18 long term financial planning

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Chapter 18 long term financial planning

  1. 1. FINANCIAL PLANNING CHAPTER OUTLINE
  2. 2.  WHAT IS FINANCIAL PLANNING? Financial Planning Focuses on the Big Picture Why Build Financial Plans?  FINANCIAL PLANNING MODELS Components of a Financial Planning Model An Example of a Planning Model An Improved Model  PLANNERS BEWARE Pitfalls in Model Design The Assumptions in Percentage-of-Sales Models The Role of Financial Planning Models  EXTERNAL FINANCING AND GROWTH
  3. 3. WHAT IS FINANCIAL PLANNING? Financial planning is a process of analyzing the investment and financing choices available to the business. • Financial Planning Focuses on the Big Picture Financial plans include the strategic plan of the business or a “big picture” perspective, rather than the implications of individual investments and other decisions. Alternative business plans might consider three scenarios relating to Best case, Normal growth, or Worst case or Retrenchment. • Why Build Financial Plans? Planning allows managers to consider a variety of alternative opportunities or future options. Thinking about possible outcomes allows the company to make contingency plans. Financial planning provides an opportunity to identify and evaluate considering options available, such as expansion, plant closure, etc. Building a financial plan forces managers to make connections between plans for growth and financing requirements. This helps to ensure that firm's goals are mutually consistent
  4. 4. FINANCIAL PLANNING MODELS Financial planning models are most useful if they can be used to explore what might happen. Financial plans include three components: inputs, the planning model, and outputs.
  5. 5. Percentage of sales model: The percentage of sales model is a financial planning model in which the future level of asset investment, and subsequent financing needs, is a function of forecasted sales. The assumption is that sales drives asset requirements and asset requirements drive the financing needed. “WHY THEY ARE USEFUL?????” Because of balancing item, it adjusts the consistency of financial plan. For example, an existing balance sheet might show an inventory of $600 at the fiscal year's end, while the income statement reports sales of $1,200. In this case, the percentage of sales method assumes that inventory in future years is likely to be reported at 50 percent of the projected sales
  6. 6. Improved Model: Sales are estimated for the coming periods. Sales, the independent variable, drive the level of assets needed and the estimated required external financing need.
  7. 7. PLANNERS BEWARE • Pitfalls in Model Design The value of the financial plan is to prepare for a variety of outcomes, not build the ultimate, realistic financial planning model. • The Assumptions in Percentage-of-Sales Models Do not naively assume that the percentage-of-sales forecast factors must be based on the previous year's financial statements. Think of the previous year as a starting point for determining appropriate forecast factors. Though a good “rough” first estimate for financial planning, the percentage-of-sales model is limited in that many estimated variables, such as assets, are not or are not always proportional to sales. • The Role of Financial Planning Models Financial planning models estimate accounting statements, and do not focus on financial decision tools such as incremental cash flows, time value, market risk etc. Which increase market value, though the debt/equity standards of the firm and the dividend policy of the business are built into financial planning
  8. 8. EXTERNAL FINANCING AND GROWTH Financial planning produces consistency between growth, investment, and financing goals of the business, for all are included in the plan. This section studies the relationships between growth objectives and requirements for external financing.
  9. 9. Internal growth rate: The internal growth rate of the firm is the maximum rate of growth without external financing.
  10. 10. Sustainable growth rate: The sustainable growth rate is the maximum growth rate (sales or assets) the firm can maintain without changing the debt/equity ratio and without any external equity financing (sale of stock). While the internal growth rate is the maximum growth rate without any external financing (debt or equity), the sustainable growth rate is the maximum growth rate sustainable without any external equity financing.
  11. 11. Example of Sustainable growth:

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