Slide 1Slide 2Financial PlanningFinancial Planning ProcessFinancial Planning Process Assumptions and ScenariosRole of Financial PlanningRole of Financial PlanningFinancial Planning Model IngredientsFinancial Planning Model IngredientsFinancial Planning Model IngredientsExample I: Constructing a Pro FormaExample I: Constructing a Pro FormaExample I: Constructing a Pro FormaExample I: Constructing a Pro Forma Income StatementExample I: Constructing a Pro Forma Balance SheetExample I: Constructing a Pro Forma Balance SheetPercentage of Sales ApproachPercentage of Sales ApproachExample II: % of Sales Pro FormaPercentage of Sales ApproachPercentage of Sales ApproachExample II: % of Sales Pro Forma Balance SheetSlide 23Example II: External Financing Needed (EFN)Example II: External Financing Needed (EFN)Fixed Assets at Full Capacity?Fixed Assets at Full Capacity?Operating at Less than Full CapacityGrowth and External FinancingGrowth and External FinancingThe Internal Growth RateThe Internal Growth Rate Example from Tasha’s ToysThe Sustainable Growth RateThe Sustainable Growth Rate Example from Tasha’s ToysDeterminants of GrowthWork the WebImportant QuestionsSlide 38Slide 39Slide 40Slide 41Slide 42Slide 43Slide 444-1Long-Term Financial Planning and GrowthChapter 4Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin4-2Chapter Outline•What is Financial Planning?•Financial Planning Models•The Percentage of Sales Approach•External Financing and Growth•Some Caveats Regarding Financial Planning Models4-3Financial Planning•Financial Plan - is a statement of what to be done in the future.•Financial Planning - forces the corporation to think about its goals.•It formulates the way in which financial goals are to be achieved.4-4Financial Planning Process•Planning Horizon - divide decisions into short-run decisions (usually next 12 months) and long-run decisions (usually 2 – 5 years)•Aggregation - combine capital budgeting decisions into one large project4-5Financial Planning ProcessAssumptions and Scenarios•Make realistic assumptions about important variables•Run several scenarios where you vary the assumptions by reasonable amounts•Determine, at a minimum, worst case, normal case, and best case scenarios4-6Role of Financial Planning•Examine interactions – help management see the interactions between decisions•Explore options – give management a systematic framework for exploring its opportunities4-7Role of Financial Planning•Avoid surprises – help management identify possible outcomes and plan accordingly•Ensure feasibility and internal consistency – help management determine if goals can be accomplished and if the various stated (and unstated) goals of the firm are consistent with one another4-8Financial Planning Model Ingredients•Sales Forecast – many cash flows depend directly on the level of sales (often estimated using sales growth rate)•Pro Forma Statements – setting up the plan using projected financial statements allows for consistency and ease of interpretation4-9Financial Planning Model Ingredients•Asset Requirements the additional assets that will be required to meet sales projections•Financial Requirements the amount of financing needed to pay for the required assets4-10Financial Planning Model Ingredients•Plug Variable determined by management deciding what type of financing will be used to make the balance sheet balance•Economic Assumptions explicit assumptions about the coming economic environment4-11Example I:Constructing a Pro FormaGourmet Coffee Inc.Balance SheetDecember 31, 2011Assets 1000 Debt 400Equity 600Total 1000 Total 1000The Current Balance Sheet4-12Example I:Constructing a Pro FormaGourmet Coffee Inc.Income StatementFor Year Ended December 31, 2011Revenues 2000Less: costs (1600)Net Income 400The Current Income Statement4-13Example I:Constructing a Pro FormaInitial Assumptions:•Revenues will grow at 15% (2,000*1.15)•All items are tied directly to sales, and the current relationships are optimal•Consequently, all other items will also grow at 15%4-14Example I: Constructing a Pro Forma Income StatementGourmet Coffee IncorporatedPro Forma Income StatementFor the Year Ended 20122011 Forecasted growth ratePro forma 2012Revenues 2,000 1.15 2,300Less: costs 1600 1.15 (1,840)Net Income 400 1.15 4604-15Example I: Constructing a Pro Forma Balance SheetGourmet Coffee IncorporatedPro Forma Balance SheetDecember 31, 20122011 Forecasted growthPro forma 2012Total Assets 1,000 1.15 1,150Total Debt 400 1.15 460Equity 600 1.15 690Total Liab + OE1,1504-16Example I: Constructing a Pro Forma Balance SheetGourmet Coffee IncorporatedPro Forma Balance SheetDecember 31, 20122011 Forecasted growthPro forma 2012Total Assets 1,000 1.15 1,150Total Debt 400 1.15 90Equity 600 1.15 1,060Total Liab. + OE1,1504-17Percentage of Sales ApproachIncome Statement•Costs may vary directly with sales - if this is the case, then the profit margin is constant•Depreciation and interest expense may not vary directly with sales – if this is the case, then the profit margin is not constant4-18Percentage of Sales ApproachIncome Statement•Dividends are a management decision and generally do not vary directly with sales – this influences additions to retained earnings4-19Example II: % of Sales Pro FormaIncome StatementTasha’s Toy EmporiumIncome Statement, 2011% of SalesSales 5,000Less: costs (3,000) 60%EBT 2,000 40%Less: taxes (40% of EBT)(800) 16%Net Income 1,200 24%Dividends 600Add. To RE 600Tasha’s Toy EmporiumPro Forma Income Statement, 2012Sales 5,500Less: costs (3,300)EBT 2,200Less: taxes (880)Net Income 1,320Dividends 660Add. To RE 6604-20Percentage of Sales ApproachBalance Sheet•Initially assume all assets, including fixed, vary directly with sales•Accounts payable will also normally vary directly with sales4-21Percentage of Sales ApproachBalance Sheet•Notes payable, long-term debt and equity generally do not vary directly with sales because they depend on management decisions about capital structure•The change in the retained earnings portion of equity will come from the dividend decision4-22Example II: % of Sales Pro Forma Balance SheetTasha’s Toy Emporium – Balance SheetCurrent % of SalesPro FormaCurrent % of SalesPro FormaASSETS Liabilities & Owners’ EquityCurrent Assets Current Liabilities Cash $500 10% $550 A/P $900 18% $990 A/R 2,000 40 2,200 N/P 2,500 n/a 2,500