Practical financial managment 7e LASHER chapter 4

Chapter 4 Financial Planning


Business Plan

A business plan is a model of what management expects a
business to become in the future
Financial statements are pro forma
Good business plans are comprehensive

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Component Parts of a Business Plan
Typical outline

– Contents
– Executive summary
– Mission and strategy statement
– Market analysis
– Operations (of the business)
– Management and staffing
– Financial projections
– Contingencies

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The Purpose of Planning and
Plan Information
Major audiences of business plan

– Firm’s own management

Planning process helps pull management team together
Provides a road map for running the business
Provides a statement of goals
Helps predict financing needs

– Outside investors
Tells equity investors what returns can be expected
Tells debt investors how firm will repay loans

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The Purpose of Planning and
Plan Information

Planning process
Roadmap for running the business
Statement of goals
Predicting financing needs
Investor communication


Figure 4-1 Using a Plan to Guide Business Performance

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Credibility and Supporting Detail

Shows enough supporting detail to indicate it is the
product of careful thinking
Displays summarized financial projections

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Four Kinds of Business Plan

Kinds of planning

– Strategic Planning
– Operational Planning
– Budgeting
– Forecasting

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Four Kinds of Business Plan

Strategic Planning

– Addresses broad, long-term issues,

contains summarized,

approximate financial projections

Five-year horizon is common
Concepts expressed mainly in words, not numbers
Firm analyzes itself, the industry and the competitive situation

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Four Kinds of Business Plan

Operational Planning

– Translates business ideas (day-to-day operations) into concrete, shortterm projections

– Usually one year or less
– Specifies how much the firm will sell, to whom, and at what prices

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Four Kinds of Business Plan

Budgeting

– Short-term updates of the annual plan
Usually Covers a three month quarter
Attempts a precise estimate of company expenses
Mostly financial detail with a few words

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Four Kinds of Business Plan
Forecasting

– Very short-term projections of profit and cash flow
Where will the business’s financial momentum carry it in the next few weeks
– Consists almost entirely of numbers
– Cash forecasts are projections of short-term cash needs
Most large firms do monthly cash forecasts

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Four Kinds of Business Plan
The Business Planning Spectrum

–

Broad, long-term planning on one end and numerical short-term forecasting
on other

Relating Planning Processes of Small and Large Businesses

–

Small businesses tend to develop a single business plan containing both
strategic and operating elements

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Figure 4-2
The Business Planning Spectrum

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Figure 4-3 Relating Business Planning in Large and Small Firms

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Financial Plan as a Component of a Business Plan

Financial plan is the financial portion of the business plan

– A set of pro forma financial statements projected over a time period
– Financials are only pieces of the projection

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Planning for New and
Existing Businesses

Hard to forecast a new operation

– No history on which to base projections
The typical planning task

– In ongoing businesses, based on planning assumptions such as
Unit sales will increase by 10%
Overall labor costs will rise by 4%, etc.

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Figure 4-4 The Planning Task

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Planning Assumptions

Planning Assumptions: expected physical or economic condition
that dictates the size of one or more financial statement items

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Concept Connection Example 4-1 Planning Assumptions

This year Crumb Baking Corp. sold 1 million coffee cakes per
month at $1 each for a total of $12 million. Year-end
receivables equal to two months of sales or $2 million.

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Concept Connection Example 4-1 Planning Assumptions

Crumb’s operating assumptions for sales and receivables are:
1. Price will be decreased by 10%.
2. As a result unit sales volume will increase to 15 million coffee cakes.
3. Collection efforts increased - only one month of sales in receivables at year
end.

Forecast next year’s revenue and ending receivables balance.


Concept Connection Example 4-1 Planning Assumptions

Three interrelated planning assumptions

– a management action with respect to pricing,
– the expected customer response to that action
– 15 million coffee cakes will be sold at $.90
– Rev = 15,000,000 x $.90 = $13,500,000

Collection activities will be more effective

– one months of revenue in accounts receivable at year end.

A/R = $13,500,000/12 = $1,125,000


The General Approach, Assumptions, and the Debt/Interest
Problem
The Procedural Approach

– Financial plans are built line-by-line beginning with revenues

Debt/Interest Planning Problem

– The next items needed are interest expense and debt
– Planned debt is required to forecast interest, but interest is
required to forecast debt

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An Iterative Numerical Approach

Solves the debt/interest problem

– Interest: Guess a value of interest expense
– Net Income: Complete the income statement
– Ending equity: Calculate as beginning equity plus net income
– Ending debt: Calculate as total L&E (= total assets) less current
liabilities less ending equity

– Interest:

Average beginning and ending debt then calculate interest
expense on that value

– Test the results:

Compare calculated interest to the original guess

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Figure 4-5 The Debt/Interest
Planning Problem

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