Financial Planning Tools and Concepts

Management Planning
It is about setting the goals of the organizations and identifying ways on how to achieve them.
Long-term financial plans
• These are a set of goals that lay out the overall directions of the company
• It is an integrated strategy that considers various departments such as sales, production, marketing
and operations for the purpose of guiding these department towards strategic goals.
• Those long-term plans consider proposed outlays for fixed assets, research and development
activities, marketing and product development actions, capital structure, and major sources of
financing.
• Also included would be termination of existing projects, product lines, or lines of business;
repayment or retirement of outstanding debts; and any planned acquisitions.
Short-term Financial Plans
• Specified short-term actions and the anticipated impact of those actions.
• Include setting the sales forecast and other forms of operating and financial data. This would then
translate into operating budgets: the cash budget and pro forma financial statements.

Long Term Planning Short Term Planning

Persons Involved More Participation from top Top management is still
management involved but there is more
participation from lower level
managers (production,
marketing, personnel, finance,
and plant facilities) because
their inputs are crucial at this
stage since they are the ones
who implement these plans.
Time Period 2 to 10 years 1 year or less
Level of Detail Less More
Focus Direction of the company Everyday functioning of the
company

Long Term Goals - It sets the direction of the company.

Short Term Goals - These are specific steps or actions that will ultimately reach the company’s long-
term goals.
The steps in planning are:
1. Set goals or objectives.
2. Identify resources.
3. Identify goal-related tasks.
4. Establish the evaluation system for monitoring and controlling.
5. Determine contingency plans.
Characteristics of an effective planning:
In planning, the goal of maximizing shareholder’s wealth must always be put in mind.
Criteria:
1. Specific – target a specific area for improvement
2. Measurable – quantify or at least suggest an indicator of progress
3. Assignable – specify who will do it
4. Realistic – state what results can realistically be achieved, given available resources
5. Time – related – specify when the result/s can be achieved.
Planning and Controlling
What is a budget?
What is the importance of a budget?
What will happen if the budget is not met?
A plan is useless if it is not quantified. A quantified plan is represented through budgets and projected
or pro-forma financial statements.
These budgets and pro-forma financial statements are useful for controlling. They serve as the bases
for monitoring actual performance.
Meeting the plans is good. However, failing to meet the plans is not equivalent to failure if the reasons
for not meeting such plans can be justified especially when the reasons are fortuitous in nature and
are beyond the control of management.
Sales Budget
Most important account in the financial statement in making a forecast is sales since most of the
expenses are correlated with sales.
Given the importance of the sales forecast, the financial manager must be able to support sales
figures with reasonable assumptions. The following external and internal factors should be
considered in forecasting sales:
External
• Gross Domestic Product (GDP) growth rate
• Inflation
• Interest Rate
• Foreign Exchange Rate
• Income Tax Rates
• Developments in the Industry
• Competition
• Economic Crisis
• Regulatory Environment
• Political Crisis
Internal
• Production capacity
• Manpower requirements
• Management style of managers
• Reputation and network of the controlling stockholders
• Financial resources of the company
Macroeconomic Variables
GDP rate, inflation rate and interest rates
They play an important role in forecasting sales because it tells us how much the consumers are
willing to spend. A low GDP rate coupled by a high inflation rate means that consumers are spending
less on their purchases of goods and services. This means that we should not forecast high sales of
the periods of low GDP.
Developments in the Industry (Internal)
Products and services which have more developments in its industry would likely have a higher sales
forecast than a product or service in slow moving industry. Consumer trends are always changing;
thus, the industry should be competitive to be able to appeal to more customers and stay in the
market.
Competition (External)
Suppose you are selling bread and you know that each person in your community eats an average of
one loaf of bread a day. The population of your community is 500 people. If you are the only person
selling bread in your town, then your sales forecast is 500 units of bread.
However, you also must take account your competition. What if there are 4 other sellers of bread?
You will need to have to divide the sales between the 5 of you. Does this mean your new forecast
should be 100 units of bread? Not necessary. You should also know the preference of our
consumers. If more of them would prefer to buy more bread from you, then you should increase your
sales forecast.
Product Capacity and Manpower (Internal)
Suppose that you have already evaluated the macroeconomic factors and identified that there is a
very strong market for your product and consumers are very likely to buy from you. You forecasted
that you will be able to sell 1,000 units of your product. However, you only have 20 employees who
can produce 20 units each. Your capacity cannot cover your expected demand; hence, you are
limited by it. To be able to increase capacity, you should be able to expand your operations.
What if sales budget is not correct? If understated, there can be lost opportunities in the form of
foregone sales. If it is too optimistic, the management may decide to unnecessarily increase capacity
or hire more employees and end up with more inventories.
Production Budget
It provides information regarding the number of units that should be produced over a given
accounting period based on expected sales and targeted level of ending inventories.
It is computed as follows:
Required production in units = Expected Sales + Target Ending Inventories – Beginning
Inventories
Note: Ending inventory of current period is beginning inventory of next period.
Example: Company A forecasts sales in units for January to May as follows:

Moreover, Company A would like to maintain 100 units in its ending inventory at the end of each
month. Beginning inventory at the start of January amounts to 50 units. How many units should
Company A produce in order to fulfil the expected sales of the company?

Operations Budget
It refers to the variable and fixed costs needed to run the operations of the company but are not
directly attributable to the generation of sales.
Examples:
• Rent payments
• Wages and Salaries of selling and administrative personnel
• Administrative costs
• Travel and representation expenses
• Professional fees
• Interest payments
• Tax payments
Cash Budget or Cash Forecast
A cash budget itemizes the projected sources and uses of cash in a future period. This budget is
used to ascertain whether company operations and other activities will provide enough cash to meet
projected cash requirements.
It is for cash planning and control that presents expected cash inflow and outflow for a designated
time period. The cash budget helps management keep cash balances in reasonable relationship to its
needs. It aids in avoiding idle cash and possible cash shortages.
Example:
Likewise, the cash budget allows management to forecast large amounts of cash. Having large
amounts of cash sitting idle in bank accounts is not ideal for companies. At the very least, this money
should be invested to earn a reasonable amount of interest. In most cases, excess cash is better
used to expand and develop new operations than sit idle in company accounts. The cash budget
allows management to predict cash levels and adjust them as needed.
Here are the steps to prepare your own cash flow budget:
1. Find the right tool
2. Set a time frame
3. Prepare a sales forecast.
4. Project cash inflows
5. Project cash outflows
6. Calculate the ending cash balance
7. Set a minimum cash flow balance
The cash budget typically consists of four major sections:
(1) Receipts section, which is the beginning cash balance, cash collections from customers, and other
receipts;
(2) Disbursement section comprised of all cash payments made by purpose;
(3) Cash surplus or deficit section showing the difference between cash receipts and cash payments;
and
(4) Financing section providing a detailed account of the borrowings and repayments expected during
the period.
Who prepares the cash budget?
Because money and personnel are the two primary resources allocated, typically, the financial
department controls and manages the overall budgeting process. However, if the company is big
enough, each department head often has oversight over the sub-budget for their departments.
Advantages of a Cash Budget
1. You can avoid debt.
2. You are forced to budget better.
3. You become more resourceful.
4. You stay in-touch with reality.
5. You can quickly identify potential deficits.
6. You can communicate your financial position.
List of the Disadvantages of a Cash Budget
1. It creates a danger of theft.
2. It limits your spending power.
3. It limits where you spend your money.
4. It can be easy to lose.
5. It limits your ability to build a credit profile.
6. It eliminates rewards.
7. It is not always a reflection of profit.
8. It relies on estimates to meet future needs.
9. It forces cost to be the primary factor in making decisions
Projected Financial Statements
It is a tool of the company to set an overall goal of what the company’s performance and position will
be for and as of the end of the year. It sets targets to control and monitor the activities of the
company. The following reports may be forecasted:
1. Projected Income Statement
2. Projected Statement of Financial Position
3. Projected Statement of Cash Flows

PROJECTED FINANCIAL STATEMENTS

Steps on Financial Statement Projection:
1. Forecast sales.
Exercise: Sales are expected to increase by 10% in 2015 from the 2014 sales level. This growth
assumption is based on the assessment of the external and internal factors related to the company
and the historical growth of the company. The company’s sales grew by 10.3% annually from 2010 to
2014.
- compute for projected sales.
Projected sales in 2015
= (5,250,000 x 10%) + 5,250,000 = 5,775,000
2. Forecast cost of sales and operating expenses.
- In determining the cost of sales and operating expenses, variable and fixed costs should be
identified.
-Cost of sales are direct costs associated in the generation of sales. One way of projecting cost of
sales is using the cost of sales ratio. Companies would generally have a consistent historical cost of
sales ratio. The company may use this as a starting point.
- Suppose that the company has an average of 60% cost of sales ratio. In doing projections, the
financial manager may use the same average ratio or, if the company is pushing for efficiency, the
financial manager may reduce this ratio to say 57% depending on his judgement.
- Operation costs are a mix of variable and fixed costs. Variable costs usually vary with sales. To
project these costs, the percentage of sales method may be used. On the other hand, fixed costs
remain the same no matter how the volume of sales has change.
Exercise: The company wants to maintain the same gross profit per year as 2014. Variable operating
expense is 5% of sales. Depreciation expense is 5% of the gross beginning balance of property, plant
and equipment. As of December 31, 2014, the gross balance of PPE is Php5,200,000. For January
2015, Php1,000,000 new PPE will be acquired. It is the policy of the company that PPE acquired in
the first half of the year will be depreciated for one full year.
Compute for Cost of Sales, Variable Operating Expense and Depreciation Expense:

3. Forecast Net Income and Retained Earnings.

- To forecast net income, interest expense and income tax expense should also be considered using
the relevant interest and tax rates. Retained earnings is arrived at by adding projected net income to
beginning retained earnings then deducting dividends to be declared during the year.
- Just note this information. Return to this when all income statement items are complete.
Exercise: Income tax rate is 30% of the income before taxes. 75% of the income tax expense will be
paid in 2015 while the balance will be paid in 2016.
4. Determine balance sheet items that will vary with sales or whose balances will be highly correlated
to sales.
- Balance sheet items that may vary with sales or will be highly correlated with sales are cash,
accounts receivable, inventories, accounts payable, and accrued expense payable.
5. Determine payment schedule for loans.
6. Check other information like retained earnings.
7. Determine external funds needed (EFN).
8. Determine how external funds needed (EFN) may be financed.

To summarize the steps on Financial Statement Projection:

1. Forecast sales
2. Forecast cost of sales and operating expenses.
3. Forecast net income and retained earnings.
4. Determine balance sheet items that will vary with sales or whose balances will be highly correlated
to sales.
5. Determine payment schedule for loans.
6. Check other information like retained earnings.
7. Determine external funds needed (EFN).
8. Determine how external funds needed (EFN) may be financed

To summarize the financial planning tools:

1. Sales budget
2. Production Budget
3. Operations Budget
4. Cash Budget or Cash Forecast
5. Projected Financial Statements
Now:
What should the management do if the actual performance of the company fell short of the plans as
early as in the first quarter?
Suggested answer:
Try to identify the sources of the differences, whether these are beyond or within the control of the
management. Whatever the causes are, remedial actions should have to be taken. Or depending on
the circumstance, the plans may have to be adjusted.
Managing Personal Finance
Personal Finance
It includes all financial decisions and activities of an individual including budgeting, insurance,
mortgage planning, savings, and retirement planning.
It also involves analysing current financial positions, projecting short-term and long-term funding
needs, and executing a plan to fulfil those needs considering individual financial constrains.
It is primarily dependent on one’s earnings, cost of living, and personal goals and wants.
1. Setting Financial Goals
*Quantify monetary objectives with definite time frames
*Prioritize objectives
*Examine these objectives with an individual’s resources and limitations
2. Gathering Relevant Information
*Use surveys, questionnaires, and interviews to gather quantitative and qualitative information from
the individual
*Quantitative – for assessing financial status (investments, cash flow, liabilities, etc.)
*Qualitative – to identify individual’s goals and objectives, lifestyle, risk-tolerance, etc
3. Analysis of Data
*Analyze the individual’s position and cash flows
*Review legal papers (insurance policies, trust agreements, wills, etc.)
*Evaluate objectives in relation to the individual’s resources and economic conditions
4. Recommendation of Financial Plan
*Propose financial products
*At this point, the individual can comment on the proposed solutions
5. Implementation of Financial Plans
*Assist the individual in the execution of the recommended financial plan
*Implementation may involve other entities so assist the individual in dealing with the parties in the
execution of the financial plan.
6. Monitoring of Financial Plan
*Review the financial plan periodically to evaluate changing market conditions (economic conditions,
taxes, interest rates, etc.)
*Evaluate the financial plan regularly to see if it effectively meets the individual’s goals and objectives
6 Key Areas of Personal Financial Planning
1. Financial Position
- Understanding of personal resources by checking an individual’s net worth and cash flow.
- Net worth = assets less liabilities at a point in time
- Cash flow = expected sources of income less expected expenses within a period (ex. Year).
- Financial Position helps in determining the time frame to which personal goals can realistically be
met
- It may need to answer the following questions:
A. Do they have a clear understanding of their goals?
B. How do they track their income, expenses, and net worth?
C. What financial benefits do they get from their employer?
2. Adequate Protection
- It is the analysis of protection needed for unforeseen risks.
- It includes plans and enjoy some tax benefits.
- It may need to answer the following questions:
A. What things can they not afford to lose?
B. How will they take care of their dependents?
C. How have they planned for financial risks such as disability, illness, long-term care and death?
3. Tax Planning
- It is the management of when and how much taxes will be paid.
- It is understanding possible tax incentives, deductions, rebates, etc. can have a significant impact
on managing personal finances given the magnitude of taxes paid by an individual.
- It may need to answer the following questions:
A. How do they manage their taxes?
B. How do they plan the timing of income and deductions for tax purposes?
C. Are they comfortable with the tax environment applicable to them?
4. Investment and Accumulation Goals
- It is planning on wealth accumulation for large purchases such as house, educational expenses,
investments for retirement, etc.
- It may need to answer the following questions:
A. What are their goals for wealth accumulation? (ex. Education, home business, retirement comfort,
etc.)
B. How are their current investments performing to meet their goals?
C. How much will they need? When will they need it?
5. Retirement Planning
- Understanding the cost of retirement.
- Analysis of cash flows to produce investment plans that will meet the costs of retirement in the
future.
- It may need to answer the following questions:
A. How are they preparing for their retirement?
B. How are their liabilities affecting their retirement objectives?
C. Do they think they can maintain their standard of living during their retirement?

6. Estate Planning
- Planning for disposition of one’s assets after death.
- Estate taxes paid to the government are huge, so avoiding these taxes can significantly impact
one’s personal finances.
- It may need to answer the following questions:
A. How should their assets be distributed upon death?
B. How will their intentions be carried out? (i.e. will, trust, power of attorney, etc.)
Four Simple Habits for Personal Finance Success:
1. Save money – spend less than what you earn.
2. Avoid debt – manage your credit and debt wisely.
3. Invest – invest what you save.
4. Don’t lose it. – protect your downside by diversification of or insurance