ChapterOutline26.1WhatisCorporateFinancialPlanning?26.2AFinancialPlanningModel:TheIngredients26.3WhatDeterminesGrowth?26.4SomeCaveatsofFinancialPlanningModels26.5Summary&ConclusionsChapterOutline26.1WhatisCo26.1WhatisCorporateFinancialPlanning?Itformulatesthemethodbywhichfinancialgoalsaretobeachieved.Therearetwodimensions:ATimeFrameShortrunisprobablyanythinglessthanayear.Longrunisanythingoverthat;usuallytakentobeatwo-yeartofive-yearperiod.ALevelofAggregationEachdivisionandoperationalunitshouldhaveaplan.Asthecapital-budgetinganalysesofeachofthefirm’sdivisionsareaddedup,thefirmaggregatesthesesmallprojectsasabigproject.26.1WhatisCorporateFinanci26.1WhatisCorporateFinancialPlanning?ScenarioAnalysisEachdivisionmightbeaskedtopreparethreedifferentplansfortheneartermfuture:AWorstCaseANormalCaseABestCase26.1WhatisCorporateFinanciWhatWillthePlanningProcessAccomplish?InteractionsTheplanmustmakeexplicitthelinkagesbetweeninvestmentproposalsandthefirm’sfinancingchoices.OptionsTheplanprovidesanopportunityforthefirmtoweighitsvariousoptions.FeasibilityAvoidingSurprisesNobodyplanstofail,butmanyfailtoplan.WhatWillthePlanningProcess26.2AFinancialPlanningModel:TheIngredientsSalesforecastProformastatementsAssetrequirementsFinancialrequirementsPlugEconomicassumptions26.2AFinancialPlanningModeSalesForecastAllfinancialplansrequireasalesforecast.Perfectforeknowledgeisimpossiblesincesalesdependontheuncertainfuturestateoftheeconomy.Businessesthatspecializeinmacroeconomicandindustryprojectscanbehelpinestimatingsales.SalesForecastAllfinancialplProFormaStatementsThefinancialplanwillhaveaforecastbalancesheet,aforecastincomestatement,andaforecastsources-and-uses-of-cashstatement.Thesearecalledproformastatementsorproformas.ProFormaStatementsThefinancAssetRequirementsThefinancialplanwilldescribeprojectedcapitalspending.Inadditionitwillthediscusstheproposedusesofnetworkingcapital.AssetRequirementsThefinanciaFinancialRequirementsTheplanwillincludeasectiononfinancingarrangements.Dividendpolicyandcapitalstructurepolicyshouldbeaddressed.Ifnewfundsaretoberaised,theplanshouldconsiderwhatkindsofsecuritiesmustbesoldandwhatmethodsofissuancearemostappropriate.FinancialRequirementsTheplanPlugCompatibilityacrossvariousgrowthtargetswillusuallyrequireadjustmentinathirdvariable.Supposeafinancialplannerassumesthatsales,costs,andnetincomewillriseatg1.Further,supposethattheplannerdesiresassetsandliabilitiestogrowatadifferentrate,g2.Thesetworatesmaybeincompatibleunlessathirdvariableisadjusted.Forexample,compatibilitymayonlybereachedisoutstandingstockgrowsatathirdrate,g3.PlugCompatibilityacrossvarioEconomicAssumptionsTheplanmustexplicitlystatetheeconomicenvironmentinwhichthefirmexpectstoresideoverthelifeoftheplan.Interestrateforecastsarepartoftheplan.EconomicAssumptionsTheplanmABriefExampleTheRosengartenCorporationisthinkofacquiringanewmachine.Themachinewillincreasesalesfrom$20millionto$22million—10%growth.Thefirmbelievesthatitsassetsandliabilitiesgrowdirectlywithitslevelofsales.Itsprofitmarginonsalesis10%,anditsdividend-payoutratiois50%.Willthefirmbeabletofinancegrowthinsaleswithretainedearningsandforecastincreasesindebt?ABriefExampleTheRosengartenABriefExampleCurrentBalanceSheetProformaBalanceSheet

(millions)

ExplanationCurrentassets$6$6.630%ofsalesFixedassets$24$26.4120%ofsalesTotalassets$30$33150%ofsalesShort-termdebt$10$1150%ofsalesLong-termdebt$6$6.630%ofsalesCommonstock$4$4ConstantRetainedEarnings$10$11.1NetIncomeTotalfinancing$30$32.7

$300,000FundsneededABriefExampleCurrentBalanceABriefExample:EFNTheexternalfundsneededABriefExample:EFNTheexternTheStepsinEstimationofProFormaBalanceSheet:Expressbalance-sheetitemsthatvarywithsalesasapercentageofsales.Multiplythepercentagesdetermineinstep1byprojectedsalestoobtaintheamountforthefutureperiod.Whennopercentageapplies,simplyinsertthepreviousbalance-sheetfigureintothefutureperiod.TheStepsinEstimationofProTheStepsinEstimationofProFormaBalanceSheet:(continued)ComputeProjectedretainedearningsasProjectedretainedearnings=Presentretainedearnings+Projectednetincome–CashdividendsAddtheassetaccountstodetermineprojectedassets.Next,addtheliabilitiesandequityaccountstodeterminethetotalfinancing;anydifferenceistheshortfall.Thisequalstheexternalfundsneeded.UsetheplugtofillEFN.TheStepsinEstimationofPro26.3WhatDeterminesGrowth?Firmsfrequentlymakegrowthforecastsonexplicitpartoffinancialplanning.Ontheotherhand,thefocusofthiscoursehasbeenonshareholderwealthmaximization,oftenexpressedthroughtheNPVcriterion.Onewaytoreconcilethetwoistothinkofgrowthasanintermediategoalthatleadstohighervalue.Alternatively,ifthefirmiswillingtoacceptnegativeNPVprojectsjusttogrowinsize,theshareholders(butnotnecessarilythemangers)willbeworseoff.26.3WhatDeterminesGrowth?Fi26.3WhatDeterminesGrowth?Thereisalinkagebetweentheabilityofafirmtogrowanditsfinancialpolicywhenthefirmdoesnotissueequity.TheSustainableGrowthRateinSalesisgivenby:26.3WhatDeterminesGrowth?ThTheSustainableGrowthRateinSalesT=ratiooftotalassetstosalesp=netprofitmarginonsalesd=dividendpayoutratioAgooduseofthesustainablegrowthrateistocompareafirm’ssustainablegrowthratewiththeiractualgrowthratetodetermineifthereisabalancebetweengrowthandprofitability.TheSustainableGrowthRateinUsesoftheSustainableGrowthRateAcommerciallenderwouldwanttocompareapotentialborrower’sactualgrowthratewiththeirsustainablegrowthrate.Iftheactualgrowthrateismuchhigherthanthesustainablegrowthrate,theborrowerrunstheriskof“growingbroke”andanylendingmustbeviewedasadownpaymentonamuchmorecomprehensivelendingarrangementthanjustoneroundoffinancing.UsesoftheSustainableGrowth26.4SomeCaveatsofFinancialPlanningModelsFinancialplanningmodelsdonotindicatewhichfinancialpolicesarethebest.Theyareoftensimplificationsofreality—andtheworldcanchangeinunexpectedways.Withoutsomesortofplan,thefirmmayfinditselfadriftinaseaofchangewithoutarudderforguidance.26.4SomeCaveatsofFinancialSummary&ConclusionsFinancialplanningforcesthefirmtothinkaboutandforecastthefuture.ItinvolvesBuildingacorporatefinancialmodel.Describingdifferentscenariosoffuturedevelopmentfrombesttoworstcase.Usingthemodelstoconstructproformafinancialstatements.Runningthemodelunderdifferentscenarios(sensitivityanalysis).Examiningthefinancialimplicationsofultimatestrategicplans.Summary&ConclusionsFinancialSummary&ConclusionsCorporatefinancialplanningshouldnotbecomeanendinanofitself.Ifitdoes,itwillprobablyfocusonthewrongthings.Thealternativetofinancialplanningisstumblingintothefuture.Summary&ConclusionsCorporateChapterOutline26.1WhatisCorporateFinancialPlanning?26.2AFinancialPlanningModel:TheIngredients26.3WhatDeterminesGrowth?26.4SomeCaveatsofFinancialPlanningModels26.5Summary&ConclusionsChapterOutline26.1WhatisCo26.1WhatisCorporateFinancialPlanning?Itformulatesthemethodbywhichfinancialgoalsaretobeachieved.Therearetwodimensions:ATimeFrameShortrunisprobablyanythinglessthanayear.Longrunisanythingoverthat;usuallytakentobeatwo-yeartofive-yearperiod.ALevelofAggregationEachdivisionandoperationalunitshouldhaveaplan.Asthecapital-budgetinganalysesofeachofthefirm’sdivisionsareaddedup,thefirmaggregatesthesesmallprojectsasabigproject.26.1WhatisCorporateFinanci26.1WhatisCorporateFinancialPlanning?ScenarioAnalysisEachdivisionmightbeaskedtopreparethreedifferentplansfortheneartermfuture:AWorstCaseANormalCaseABestCase26.1WhatisCorporateFinanciWhatWillthePlanningProcessAccomplish?InteractionsTheplanmustmakeexplicitthelinkagesbetweeninvestmentproposalsandthefirm’sfinancingchoices.OptionsTheplanprovidesanopportunityforthefirmtoweighitsvariousoptions.FeasibilityAvoidingSurprisesNobodyplanstofail,butmanyfailtoplan.WhatWillthePlanningProcess26.2AFinancialPlanningModel:TheIngredientsSalesforecastProformastatementsAssetrequirementsFinancialrequirementsPlugEconomicassumptions26.2AFinancialPlanningModeSalesForecastAllfinancialplansrequireasalesforecast.Perfectforeknowledgeisimpossiblesincesalesdependontheuncertainfuturestateoftheeconomy.Businessesthatspecializeinmacroeconomicandindustryprojectscanbehelpinestimatingsales.SalesForecastAllfinancialplProFormaStatementsThefinancialplanwillhaveaforecastbalancesheet,aforecastincomestatement,andaforecastsources-and-uses-of-cashstatement.Thesearecalledproformastatementsorproformas.ProFormaStatementsThefinancAssetRequirementsThefinancialplanwilldescribeprojectedcapitalspending.Inadditionitwillthediscusstheproposedusesofnetworkingcapital.AssetRequirementsThefinanciaFinancialRequirementsTheplanwillincludeasectiononfinancingarrangements.Dividendpolicyandcapitalstructurepolicyshouldbeaddressed.Ifnewfundsaretoberaised,theplanshouldconsiderwhatkindsofsecuritiesmustbesoldandwhatmethodsofissuancearemostappropriate.FinancialRequirementsTheplanPlugCompatibilityacrossvariousgrowthtargetswillusuallyrequireadjustmentinathirdvariable.Supposeafinancialplannerassumesthatsales,costs,andnetincomewillriseatg1.Further,supposethattheplannerdesiresassetsandliabilitiestogrowatadifferentrate,g2.Thesetworatesmaybeincompatibleunlessathirdvariableisadjusted.Forexample,compatibilitymayonlybereachedisoutstandingstockgrowsatathirdrate,g3.PlugCompatibilityacrossvarioEconomicAssumptionsTheplanmustexplicitlystatetheeconomicenvironmentinwhichthefirmexpectstoresideoverthelifeoftheplan.Interestrateforecastsarepartoftheplan.EconomicAssumptionsTheplanmABriefExampleTheRosengartenCorporationisthinkofacquiringanewmachine.Themachinewillincreasesalesfrom$20millionto$22million—10%growth.Thefirmbelievesthatitsassetsandliabilitiesgrowdirectlywithitslevelofsales.Itsprofitmarginonsalesis10%,anditsdividend-payoutratiois50%.Willthefirmbeabletofinancegrowthinsaleswithretainedearningsandforecastincreasesindebt?ABriefExampleTheRosengartenABriefExampleCurrentBalanceSheetProformaBalanceSheet

(millions)

ExplanationCurrentassets$6$6.630%ofsalesFixedassets$24$26.4120%ofsalesTotalassets$30$33150%ofsalesShort-termdebt$10$1150%ofsalesLong-termdebt$6$6.630%ofsalesCommonstock$4$4ConstantRetainedEarnings$10$11.1NetIncomeTotalfinancing$30$32.7

$300,000FundsneededABriefExampleCurrentBalanceABriefExample:EFNTheexternalfundsneededABriefExample:EFNTheexternTheStepsinEstimationofProFormaBalanceSheet:Expressbalance-sheetitemsthatvarywithsalesasapercentageofsales.Multiplythepercentagesdetermineinstep1byprojectedsalestoobtaintheamountforthefutureperiod.Whennopercentageapplies,simplyinsertthepreviousbalance-sheetfigureintothefutureperiod.TheStepsinEstimationofProTheStepsinEstimationofProFormaBalanceSheet:(continued)ComputeProjectedretainedearningsasProjectedretainedearnings=Presentretainedearnings+Projectednetincome–CashdividendsAddtheassetaccountstodetermineprojectedassets.Next,addtheliabilitiesandequityaccountstodeterminethetotalfinancing;anydifferenceistheshortfall.Thisequalstheexternalfundsneeded.UsetheplugtofillEFN.TheStepsinEstimationofPro26.3WhatDeterminesGrowth?Firmsfrequentlymakegrowthforecastsonexplicitpartoffinancialplanning.Ontheotherhand,thefocusofthiscoursehasbeenonshareholderwealthmaximization,oftenexpressedthroughtheNPVcriterion.Onewaytoreconcilethetwoistothinkofgrowthasanintermediategoalthatleadstohighervalue.Alternatively,ifthefirmiswillingtoacceptnegativeNPVprojectsjusttogrowinsize,theshareholders(butnotnecessarilythemangers)willbeworseoff.26.3WhatDeterminesGrowth?Fi26.3WhatDeterminesGrowth?Thereisalinkagebetweentheabilityofafirmtogrowanditsfinancialpolicywhenthefirmdoesnotissueequity.TheSustainableGrowthRateinSalesisgivenby:26.3WhatDeterminesGrowth?ThTheSustainableGrowthRateinSalesT=ratiooftotalassetstosalesp=netprofitmarginonsalesd=dividendpayoutratioAgooduseofthesustainablegrowthrateistocompareafirm’ssustainablegrowthratewiththeiractualgrowthratetodetermineifthereisabalancebetweengrowthandprofit