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prepared by: Sujata Madan McGill University Fundamentals of Corporate Finance Third Canadian Edition
Chapter 18   Financial Planning <ul><li>What is Financial Planning </li></ul><ul><li>Financial Planning Models </li></ul><...
What is Financial Planning? <ul><li>The Financial Planning Process </li></ul><ul><ul><li>Analyzing the investment and fina...
What is Financial Planning? <ul><li>The Financial Planning Process </li></ul><ul><ul><li>Planning horizon: Time horizon fo...
What is Financial Planning? <ul><li>The Financial Planning Process </li></ul><ul><ul><li>Financial plans help managers ens...
What is Financial Planning? <ul><li>Why Build Financial Plans? </li></ul><ul><ul><ul><li>Contingency Planning </li></ul></...
Financial Planning Models <ul><li>An Example of a Financial Planning Model </li></ul>Pls insert Fig 18.1 here
Financial Planning Models <ul><li>An Example of a Financial Planning Model </li></ul><ul><ul><li>Pro Formas: Projected or ...
Financial Planning Models <ul><li>Executive Cheese Financial Model </li></ul><ul><ul><li>Executive Cheese’s simplified yea...
Financial Planning Models <ul><li>Executive Cheese Financial Model </li></ul><ul><ul><li>Percentage of sales model used to...
Financial Planning Models <ul><li>Executive Cheese Financial Model </li></ul><ul><ul><li>Executive Cheese’s simplified pro...
Financial Planning Models <ul><li>Executive Cheese Financial Model </li></ul><ul><ul><li>Notice that the dividend payment ...
Financial Planning Models <ul><li>Executive Cheese Financial Model </li></ul><ul><ul><li>Assume, now, that instead of acce...
Financial Planning Models <ul><li>Executive Cheese Financial Model </li></ul><ul><ul><li>Pro forma Balance Sheet with divi...
Financial Planning Models <ul><li>Executive Fruit – 2002 Financial Statements </li></ul>
Financial Planning Models <ul><li>Executive  Fruit – 2003 Pro Forma Financial Statements </li></ul>
Planners Beware <ul><li>Pitfalls in Model Design </li></ul><ul><ul><li>Many models ignore realities such as depreciation, ...
External Financing and Growth <ul><li>Required External Financing </li></ul>=  (Net assets/Sales) x Increase in Sales   - ...
External Financing and Growth <ul><li>Internal and Sustainable Growth </li></ul>= Addition to Retained Earnings / Assets =...
Summary of Chapter 18 <ul><ul><li>The tangible product of the financial planning process is pro forma financial statements...
Summary of  Chapter  18 <ul><ul><li>Focus on aggregate decisions such as whether to commit to capital investment, debt pol...
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Chapter 18.

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Chapter 18.

  1. 1. prepared by: Sujata Madan McGill University Fundamentals of Corporate Finance Third Canadian Edition
  2. 2. Chapter 18 Financial Planning <ul><li>What is Financial Planning </li></ul><ul><li>Financial Planning Models </li></ul><ul><li>Planners Beware </li></ul><ul><li>External Financing and Growth </li></ul>
  3. 3. What is Financial Planning? <ul><li>The Financial Planning Process </li></ul><ul><ul><li>Analyzing the investment and financing choices open to a firm. </li></ul></ul><ul><ul><li>Projecting the future consequences of current decisions. </li></ul></ul><ul><ul><li>Deciding which alternatives to undertake. </li></ul></ul><ul><ul><li>Measuring subsequent performance against the goals set forth in the financial plan. </li></ul></ul>
  4. 4. What is Financial Planning? <ul><li>The Financial Planning Process </li></ul><ul><ul><li>Planning horizon: Time horizon for a financial plan. </li></ul></ul><ul><ul><li>Departments are often asked to submit 3 alternatives </li></ul></ul><ul><ul><ul><li>Optimistic case = best case </li></ul></ul></ul><ul><ul><ul><li>Expected case = normal growth </li></ul></ul></ul><ul><ul><ul><li>Pessimistic case = retrenchment </li></ul></ul></ul>
  5. 5. What is Financial Planning? <ul><li>The Financial Planning Process </li></ul><ul><ul><li>Financial plans help managers ensure that their financing strategies are consistent with their capital budgets. </li></ul></ul><ul><ul><li>They highlight the financing decisions necessary to support the firm’s production and investment goals. </li></ul></ul>
  6. 6. What is Financial Planning? <ul><li>Why Build Financial Plans? </li></ul><ul><ul><ul><li>Contingency Planning </li></ul></ul></ul><ul><ul><ul><li>Considering Options </li></ul></ul></ul><ul><ul><ul><li>Forcing Consistency </li></ul></ul></ul>
  7. 7. Financial Planning Models <ul><li>An Example of a Financial Planning Model </li></ul>Pls insert Fig 18.1 here
  8. 8. Financial Planning Models <ul><li>An Example of a Financial Planning Model </li></ul><ul><ul><li>Pro Formas: Projected or forecasted financial statements. </li></ul></ul><ul><ul><li>Percentage of Sales Models: Planning models in which sales forecasts are the driving variable and most other variables are proportional to sales. </li></ul></ul><ul><ul><li>A balancing item (or plug): Variable which adjusts to maintain the consistency of a financial plan. </li></ul></ul>
  9. 9. Financial Planning Models <ul><li>Executive Cheese Financial Model </li></ul><ul><ul><li>Executive Cheese’s simplified year end financial statements are below: </li></ul></ul>Income Statement Sales $1,200 Less: Costs 1,000 Net Income $200 Balance Sheet Assets $2,000 Debt $800 Equity 1,200 Total $2,000 Total $2,000
  10. 10. Financial Planning Models <ul><li>Executive Cheese Financial Model </li></ul><ul><ul><li>Percentage of sales model used to build pro forma financial statements for next year. </li></ul></ul><ul><ul><li>Assumptions: </li></ul></ul><ul><ul><ul><li>Sales will increase by 10% next year. </li></ul></ul></ul><ul><ul><ul><li>Costs will be a fixed proportion of sales, so they too will increase by 10%. </li></ul></ul></ul><ul><ul><ul><li>The firm has no spare capacity and must increase assets by 10%. </li></ul></ul></ul><ul><ul><ul><li>The firm will keep its current debt-equity ratio. </li></ul></ul></ul>
  11. 11. Financial Planning Models <ul><li>Executive Cheese Financial Model </li></ul><ul><ul><li>Executive Cheese’s simplified pro formas are below: </li></ul></ul>$880 1,320 Income Statement Sales $1,320 Less: Costs 1,200 Net Income $220 Balance Sheet Assets $2,200 Debt ? Equity ? Total $2,200 Total ? $2,200
  12. 12. Financial Planning Models <ul><li>Executive Cheese Financial Model </li></ul><ul><ul><li>Notice that the dividend payment is not chosen by management. </li></ul></ul><ul><ul><ul><li>Instead, it is a consequence of the other decisions. </li></ul></ul></ul><ul><ul><li>Most firms would not want dividends to be a consequence of other decisions. </li></ul></ul><ul><ul><ul><li>The managers prefer to show a steady progression of dividends. </li></ul></ul></ul>
  13. 13. Financial Planning Models <ul><li>Executive Cheese Financial Model </li></ul><ul><ul><li>Assume, now, that instead of accepting a dividend which falls out of the planning process, that management commits to a $180 dividend. </li></ul></ul>
  14. 14. Financial Planning Models <ul><li>Executive Cheese Financial Model </li></ul><ul><ul><li>Pro forma Balance Sheet with dividends fixed at $180 and debt used as the balance item. </li></ul></ul>$960 1,240 Income Statement Sales $1,320 Less: Costs 1,200 Net Income $220 Balance Sheet Assets $2,200 Debt ? Equity ? Total $2,200 Total ? $2,200
  15. 15. Financial Planning Models <ul><li>Executive Fruit – 2002 Financial Statements </li></ul>
  16. 16. Financial Planning Models <ul><li>Executive Fruit – 2003 Pro Forma Financial Statements </li></ul>
  17. 17. Planners Beware <ul><li>Pitfalls in Model Design </li></ul><ul><ul><li>Many models ignore realities such as depreciation, taxes, etc. </li></ul></ul><ul><ul><li>Percent of sales methods are not realistic because fixed costs exist. </li></ul></ul><ul><ul><li>Most models generate accounting numbers not financial cash flows </li></ul></ul><ul><ul><li>Adjustments must be made to consider these and other factors. </li></ul></ul>
  18. 18. External Financing and Growth <ul><li>Required External Financing </li></ul>= (Net assets/Sales) x Increase in Sales - Addition to Retained Earnings = (Growth Rate x Initial Assets) - Addition to Retained Earnings
  19. 19. External Financing and Growth <ul><li>Internal and Sustainable Growth </li></ul>= Addition to Retained Earnings / Assets = Plowback Ratio x ROE x (Equity / Assets) Internal Growth Rate Sustainable Growth Rate = Plowback Ratio x ROE
  20. 20. Summary of Chapter 18 <ul><ul><li>The tangible product of the financial planning process is pro forma financial statements, the establishment of financial goals and the creation of a benchmark for evaluating subsequent performance. </li></ul></ul><ul><ul><li>A good financial planning process forces the financial managers to think about the future and to devise strategies for the events which might occur. </li></ul></ul>
  21. 21. Summary of Chapter 18 <ul><ul><li>Focus on aggregate decisions such as whether to commit to capital investment, debt policy and the target dividend payout ratio. </li></ul></ul><ul><ul><li>One output of a financial model is an understanding of effects of growth on the need for external financing. </li></ul></ul><ul><ul><ul><li>The internal growth rate is the maximum rate that the firm can grow at if it relies entirely on invested profits to finance its growth. </li></ul></ul></ul><ul><ul><ul><li>The sustainable growth rate is the rate at which the firm can grow without changing its leverage ratio. </li></ul></ul></ul>

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