Financial Planning and Growth

Session 5, 6 and 7
 Financial Planning
 Long term financial planning to refrain from financial distress
and failure
 Long rang and short range financial planning
 normally focuses on big picture means;
 major elements of firms financial and investment policies
 Long range financial planning;
 Percentage of Sales Approach
 Statement in regard to what is to be done in future
 In the uncertain world, decision has to be done in advance
Dimensions of Financial Planning

 1st -Planning horizon;

 Short range financial plan -Generally 12 months
 Long range financial plan -2 to 5 years
 2nd - Level of aggregation
 Alternative business plan
 Normal Case Scenario
 Worse Case Scenario
 Best Case Scenario
WHAT CAN PLANNING ACCOMPLISH?

 Examining Interactions
 Exploring Options
 Avoiding Surprises
 Ensuring Feasibility and Internal Consistency
Financial Planning Model Ingredients

 Sales forecast
 Pro Forma Statement
 Assets Requirement
 Financial Requirement
 The Plug
 Economic Assumption
 Percentage of sales approach
 Forecast your sales using techniques such as time series analysis, regression analysis
and soliciting input from management on what they expect to sell in the next planning
period.
 Once you understand your forecasted sales, estimate your variable expenses.
 Next estimate your level of investment in assets to support your sales. This is usually a
percentage of sales. Adjust this baseline forecast for any new items. For example,
marketing may need more funds for new product development or the Production
Department may request upgrading aging equipment and facilities.
 Prepare a pro-forma or forecasted Balance Sheet and any short fall between your Total
Assets and your Total Liabilities + Equity represent external financing requirements.
Internal and Sustainable Growth

 Internal growth rate: maximum growth rate that can be achieved with no external
financing of any kind

Internal growth rate =(ROA* b) /(1- ROA *b)

 Sustainable growth rate: maximum growth rate that can be achieved with no external
equity financing while maintaining a constant debt–equity ratio

Sustainable growth rate=(ROE* b) /(1- ROE *b)

ROE

 ROE = NI/Sales
 ROE = Profit margin * Assets turnover * equity multiplier
 Equity multiplier = total assets / equity = 1 + debt equity ratio
 Assets turnover = sales / total assets = 1/ capital intensity ratio
 Capital intensity ratio = total assets / sales
EFN

 Required increases to assets given a change in sales. Formula =   (A/S) x (Δ Sales).

 Required increases to liabilities given a change in sales. Note: Long term debt does not
increase with a change in sales and is typically excluded.
 Required increases to retained earnings as a result of income less any distributions
 EFN formula
 EFN = (A/S) x (Δ Sales) - (L/S) x (Δ Sales) - (PM x FS x (1-d))
 A / S: Assets that change given a change in sales, expressed as a percentage of sales.
 Δ = Symbol for Change
 ΔSales: Change in sales between the last reporting period and the forecasted sales.
 L / S: Liabilities that change given a change in sales, expressed as a percentage of sales.
 PM: Profit Margin on Sales; i.e. net income / sales.
 FS: Forecasted Sales
 d: dividend payout percent
 (1 - d): Percent of earnings retained after paying out dividends; d is the dividend payout ratio.
 Example
 Total Assets last year = $ 6.5 Million
 Total Sales last year = $ 21.0 Million
 Total Current Liabilities last year = $ 2.1 Million
 Profit Margin = 4% of sales
 Forecasted Sales = $ 24.5 Million
 Dividend Payout Ratio or d = 60%
 A / S = $ 6.5 / $ 21.0 = 31%
 L / S = $ 2.1 / $ 21.0 = 10%
 Change in Sales or ΔSales = $ 24.5 - $ 21.0 = $ 3.5
 EFN = (.31 x $ 3.5) - (.10 x $ 3.5) - ((.04 x $ 24.5) x (1 - .60))= $ .343
Problem solving