Financial%20Planning%20and%20Control

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Financial Planning and Control

• Chapter 8

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Financial Planning

• The projection of sales, income, and assets based
  on alternative production and marketing
  strategies, as well as the determination of the
  resources needed to achieve these projections

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Financial Control

• The phase in which financial plans are
  implemented
• Control deals with the feedback and adjustment
  process required to ensure adherence to plans
  and modification of plans because of unforeseen
  changes

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Sales Forecasts

• A forecast of a firms unit and dollar sales for
  some future period

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Sales Forecasts

• A forecast of a firms unit and dollar sales for
  some future period
• Generally based on recent sales trends plus
  forecasts of the economic prospects for the
  nation, region, industry, and so forth

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Projected (Pro Forma) Financial Statements

• Project the asset requirements for the coming
  period, then project the liabilities and equity
  that will be generated under normal operations,
  and subtract the projected liabilities and equity
  from the required assets to estimate the
  additional funds needed (AFN) to support the
  level of forecasted operations

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Projected Balance Sheet Method

• A method of forecasting financial requirements
  based on forecasted financial statements
• 1. Forecast the Income Statement
• 2. Forecast the Balance Sheet
• Adjust for spontaneously generated funds obtained
  from routine business transactions

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Projected Balance Sheet Method

• A method of forecasting financial requirements
  based on forecasted financial statements
• 1. Forecast the Income Statement
• 2. Forecast the Balance Sheet
• 3. Determine how to raise the additional funds
  needed

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Projected Balance Sheet Method

• A method of forecasting financial requirements
  based on forecasted financial statements
• 1. Forecast the Income Statement
• 2. Forecast the Balance Sheet
• 3. Determine how to raise the additional funds
  needed
• 4. Financing feedbacks

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Projected Balance Sheet Method

• Financing feedbacks are the effects on the income
  statement and balance sheet of actions taken to
  finance forecasted increases in assets

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Projected (Pro Forma) Financial Statements

• Analysis of the forecast
• determine if the forecast meets the firms
  financial targets
• planned management changes must be incorporated
  into the forecasts
• iterative process

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Other Considerationsin Forecasting

• Excess capacity

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Other Considerationsin Forecasting

• Economies of scale
• variable cost of goods sold ratio changes with
  size of the firm
• this affects the addition to retained earnings,
  and thus the AFN

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Other Considerationsin Forecasting

• Lumpy assets
• assets that cannot be acquired in small
  increments, but must be obtained in large,
  discrete amounts

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Other Considerationsin Forecasting

• Lumpy assets
• assets that cannot be acquired in small
  increments, but must be obtained in large,
  discrete amounts
• small increase in sales can require significant
  increase in plant and equipment

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Financial Control - Budgeting and Leverage

• Relationship between sales volume and
  profitability under different operating
  conditions
• Control phase and process

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OperatingBreakeven Analysis

• An analytical technique for studying the
  relationship among sales revenues, operating
  costs, and profits
• Only deals with the operating section of the
  income statement

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OperatingBreakeven Analysis

• Operating breakeven point
• represents the level of production and sales
  where operating income is zero
• the point where revenues from sales just equal
  total operating costs

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Breakeven Graph
Revenues and Costs( millions)
1,400 1,200 000 00 00 00100
Total Sales Revenues (P x Q)
- - - - - - - - - - - - - -
Total Operating Costs (F Q x V)
Operating Profit (EBIT gt 0)
SBE
Operating Breakeven Point (EBIT 0)
855
Operating Loss (EBIT lt 0)
0 20 40 57 60 80
100 120Units Produced and Sold(millions)
QBE
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Breakeven Computation
(P x Q) TOC (V x Q) F
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Using OperatingBreakeven Analysis

• New product decisions
• required sales to achieve profitability
• Expansion of operations
• increase fixed and variable costs
• increase sales
• Modernization and automation
• increased fixed and reduced variable costs

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Operating Leverage

• The existence of fixed operating costs, such that
  a change in sales will produce a larger change in
  operating income (EBIT)

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Operating Leverage

• Degree of operating leverage (DOL)
• the percentage change in NOI (or EBIT) associated
  with a given percentage change in sales

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Operating Leverage
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Operating Leverage

• Operating leverage and operating breakeven
• higher operating leverage increases operating
  breakeven point

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Financial Leverage

• The existence of fixed financial costs such as
  interest
• When a change in EBIT results in a larger change
  in EPS

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Financial Leverage

• Degree of financial leverage (DFL)
• the percentage change in EPS that results from a
  given percentage change in EBIT

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Financial Leverage
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Combining Operating and Financial Leverage

• The greater degree of operating leverage, or
  fixed operating costs for a particular level of
  operations, the more sensitive EBIT will be to
  changes in sales volume

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Combining Operating and Financial Leverage

• The greater degree of operating leverage, or
  fixed operating costs for a particular level of
  operations, the more sensitive EBIT will be to
  changes in sales volume
• The greater the degree of financial leverage (or
  fixed financial costs for a particular level of
  operations), the more sensitive EPS will be to
  changes in EBIT

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Combining Operating and Financial Leverage

• If a firm has a considerable amount of both
  operating and financial leverage, then a small
  change in sales will lead to wide fluctuations in
  EPS
• Degree of total leverage (DTL)
• the percentage change in EPS resulting from a
  change in sales

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Combining Operating and Financial Leverage
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Using Leverage and Forecasting for Control

• Changes in operations affect income, which
  impacts on the balance sheet and the financing
  needs of the firm
• Forecasted results and their impact can be
  adjusted ahead of time
• Feedback needs evaluated

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Cash Budgeting

• Cash budget
• a schedule showing cash receipts, cash
  disbursements, and cash balances for a firm over
  a specified time period
• Target (minimum) cash budget
• the minimum cash balance a firm desires to
  maintain in order to conduct business

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Cash Budgeting

• Disbursements and receipts method (scheduling)
• the net cash flow is determined by estimating
  the cash disbursements andthe cash receipts
  expected to be generated each period

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End of Chapter 8

• Financial Planningand Control