BUSINESS AND FAITH INTEGRATION

Long-Term Financial Planning

Financial plans establish a firm’s financial goals and provide a benchmark for evaluating performance.

This chapter analyzes long-term financial plans and provides a discussion of growth

Chapter 18 Outline

· Financial Planning

· Long-term vs. Short-term Planning

· Why Plan?

· 3 Reasons for Financial Planning

· Financial Planning Models

· Percentage of Sales Models

· Planning Model Limits

· Common Pitfalls

· External Financing and Growth

· Internal Growth Rate

· Sustainable Growth Rate

Financial Planning

Firms plan for both the short term and the long term.

Planning Horizon – Time horizon for financial plan (typically 5 years for long-term planning)

· Short-term planning: Plans for the next 12 months.

· Long-term planning: Plans that exceed the next 12 months.

Long-Term Planning

· Long-term planning focuses on:

· Long-term financial goals

· Investments required to meet these goals

· Financing that must be obtained

· Dividend policies

· Appropriate debt ratios

Focus on the Big Picture

Financial plans combine the planning of managers at every level, but they also reflect senior management’s strategic plans.

· Firms don’t plan on a project-by-project basis.

· Small projects are aggregated and treated as one large project.

3 Plans in One:

Why Build Financial Plans?

· Contingency Planning:

· Financial plans allow managers to formulate quick responses to inevitable surprises.

· Considering Options:

· Financial plans often include plans to enter new markets for mere “strategic” reasons, not due to an immediate positive NPV

· Forcing Consistency:

· Financial plans force managers at all levels to adhere to the same standards of measure and success metrics.

Note: While financial models ensure consistency between growth assumptions and financing plans, they do not identify the best financing plan.

Financial Planning models

Financial planning models help planners explore the consequences of alternative strategies.

The effects of a change in sales on working capital will be seen in which section of a financial plan?

Pro Formas – Projected or forecast financial statements.

Percentage of Sales Models

· Percentage of Sales Model – Planning model in which sales forecasts are the driving variables and most other variables are proportional to sales.

· Balancing Item – Variable that adjusts to maintain the consistency of a financial plan. Also called a plug item.

· Example: Suppose a firm commits to a dividend of $100 and raises any extra money it needs by an issue of debt.

· In this case, debt is the balancing item.

Percentage of Sales Models: Example

A forecast using a percentage of sales model expects sales to increase by 12% annually over the next five years. If costs are proportional to sales at 80%, and last year's sales were $1,000, what is the projected net income in year 5?

· Projected sales in year 5:

· Projected COGS in year 5:

Planning Model: Example

Assume this year’s financial statements are as follows:

Calculate pro forma statements for 2012, assuming:

1. Sales and operating costs are expected to grow 10%.

2. Interest rates will remain constant.

3. The firm will continue to pay 2/3 earnings in dividends.

4. The firm will need 10% more fixed assets and net working capital next year to support the higher sales volume.

Planning Model: Example

2,200 10% higher