BUAD 306 Business Finance Chapter 4 Long term nancial planning and growth No company can afford not to move forward It may be at the top of the heap today but at the bottom of the heap tomorrow if it doesn t Growth is never by mere chance it is the result of forces working together James Cash Penney founder JCP Julia Plotts Associate Professor of Clinical Finance and Business Economics plotts marshall usc edu T A O ce Hours Tutoring Schedule T A Russell Yue HOH 221 Wednesdays 9 11am O ce hours by appointment T A Maariyah Patel Mondays 12 1pm T A Michael Aronson Mondays 8 9am and after 2pm Wednesdays 8 9am 12 2pm Fridays anytime 2 Reminders for Next Week 1 24 Chapter 5 Time Value of Money present value future value In class calculator review 1 26 Chapter 6 Discounted Cash Flow Valuation net present value annuities perpetuities Homework 1 due 3 Pro table growth needs to be managed Managing cash ow and external nancing is an important aspect of nance for any rm or organization Is the cash ow pattern feasible If we have a cash shor all how will we get the needed money If we have excess cash ow what should we do with the money Many pro table rms go out of business because they run out of cash Growth can be very cash intensive 4 Pro Forma Points of Emphasis Bottom up detailed plans vs top down bird s eye view plans Pro forma nancial statements are forecasted nancial statements Can stem from broad outlines or detailed subplans Future need for external funding external nancing required EFR 5 External Financing Required External Financing Required Total Assets Liabilities Owners Equity PLUG Sales Forecast many cash ows depend directly on the level of sales often estimated using sales growth rate Pro Forma Statements setting up the plan using projected nancial statements allows for consistency and ease of interpretation Asset Requirements the additional assets that will be required to meet sales projections Financial Requirements the amount of nancing needed for required assets Plug Variable determined by management deciding what type of nancing will be used to make the balance sheet balance Economic Assumptions explicit assumptions about the coming economic environment 6 Steps 1 Examine historical data to ascertain the extent to which percent of sales ratios stay constant over time 2 Forecast sales 3 Do sensitivity analysis to see how nancial statements respond to di erent percent ofsales parameters 7 Planning in Large Companies Three stages to planning 1 Hammer out corporate strategy with broad brush nancial planning 2 Translate qualitative goals into internal division activities with rough nancial forecasts 3 Quantitative plans and budgets both operating budgets and capital budgets Integration of 3 leads to the rm s nancial plan 8 Elements of Financial Planning Investment in new assets determined by capital budgeting decisions Degree of nancial leverage determined by capital structure decisions Cash paid to shareholders determined by dividend policy decisions Liquidity requirements determined by net working capital decisions 9 Role of Financial Planning Examine interactions help management see the interactions between decisions Explore options give management a systematic framework for exploring its opportunities 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 rm are consistent with one another 10 Financial Planning Model Ingredients Sales Forecast many cash ows depend directly on the level of sales often estimated using sales growth rate Pro Forma Statements setting up the plan using projected nancial statements allows for consistency and ease of interpretation Asset Requirements the additional assets that will be required to meet sales projections Financial Requirements the amount of nancing needed to pay for the required assets Plug Variable determined by management deciding what type of nancing will be used to make the balance sheet balance Economic Assumptions explicit assumptions about the coming economic environment 11 Example Historical Financial Statements Gourmet Coffee Inc Gourmet Coffee Inc Income Statement Balance Sheet December 31 2015 Assets 1000 Debt For Year Ended December 31 2015 400 Revenues Equity Tota l 1000 Total 2000 600 Less costs 1600 Net Income 400 1000 12 Example Pro Forma Income Statement Initial 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 Gourmet Coffee Inc Pro Forma Income Statement For Year Ended 2016 Revenues 2 300 Less costs 1 840 Net Income 460 13 Example Pro Forma Balance Sheet Gourmet Coffee Inc Case I Dividends are the plug variable so equity increases at 15 Dividends 460 NI 370 increase in equity 90 dividends paid Case II Debt is the plug variable and no dividends are paid Debt 1 150 600 460 90 Repay 400 90 310 in debt Pro Forma Balance Sheet Case 1 Assets 1 150 Debt 460 690 1 150 Equity Total 1 150 Total Gourmet Coffee Inc Pro Forma Balance Sheet Case 2 Assets 1 150 Debt Equity Tota l 1 150 Total 90 1 060 1 150 14 Percentage of Sales Approach Some items vary directly with sales while others do not Income Statement Costs may vary directly with sales if this is the case then the pro t margin is constant Depreciation and interest expense may not vary directly with sales if this is the case then the pro t margin is not constant Dividends are a management decision and generally do not vary directly with sales this in uences additions to retained earnings Balance Sheet Initially assume all assets including xed vary directly with sales Accounts payable will also normally vary directly with sales 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 decision 15 Example Income Statement Tasha s Toy Emporium Tasha s Toy Emporium Pro Forma Income Statement 2016 Income Statement 2015 Sales 5 000 Less costs 3 000 EBT 2 000 of Sales 60 40 Sales 5 500 Less costs 3 300 EBT 2 200 Less taxes Less taxes 40 of EBT Net Income Dividends Add To RE 800 1 200 16 24 600 600 Net Income Dividends 880 1 320 660 Add To RE Assume Sales grow at 10 660 Dividend Payout Rate 50 16 Example Balance