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Financial plans help managers ensure that their financial strategies are consistent with
capital budgets. Highlight the financial decisions necessary to support the firms
production and investment goals or objectives for growth.
Financial planning process
Contingency planning
o How to deal with unexpected events i.e. sensitivity analysis whilst
changing variables / what if scenarios
o Formulate responses to situations
o Typically form best case / aggressive growth plan, normal growth plan,
retrenchment plan if firms market contracts
Considering options (can we allowing for growth options in our plans)
o New markets? Valuable follow-on investments - options
Forcing consistency (mutually consistent)
o Are all departments etc working towards the same plans / goals
o i.e. sales / profit growth goal of X% - what decisions / changes need to be
made to get there?
o Ensure goals arent distracting rest of business i.e. shifting priorities or
too much emphasis
Inputs
o Current financials statements and forecasts of key variables such as sales
and interest rates (also likely to include macroeconomic events)
o Typically principal forecast is growth in sales as other variable such as
labour and inventory levels are tied to sale
Planning Model
o Equations specifying key relationships and relating variables
implications of forecasts
Outputs
o Projected (pro forma) financial statements, ratios. Sources and uses of
cash. Forecasts based on inputs and assumptions
Planning model in which sales forecast are the driving variable, most other
variables are proportionate to sales
Balancing (plug) variable
o Variable that adjusts to maintain the consistency of a financial plan
o Common plug variables include cash, dividends, debt and equity
Ensure consistency between growth assumptions and financing plans but they
do not identify the best financing plan
Limitations
Steps
1) forecast sources of cash
a. cash sales
b. collection of credit sales / AR
i. keep track of average time taken to pay bills what proportion of
sales paid that quarter and what proportion carried into next
quarter as AR
c. asset disposals
d. other e.g. tax refund, insurance claim
2) forecast uses of cash
a. payments of accounts payable assumption these are payed on time
i. stretching your payables (expensive form of short term
financing, lose discounts)
ii. Could result in ill will increasing credit risk
b. labour, admin, other expenses (regular business expenses)
c. capex
d. tax, interest and dividend payments
3) calculate if firm is facing shortage or surplus
a. Financial plan sets out strategy for investing cash surpluses or financing
deficits
Stretching payables
Bank financing
Short term financing is liability originally scheduled for repayment within 1 year
Spontaneous
o Accruals expenses incurred but not paid (accrued wages / taxes)
Represent free financing
Difficult to manipulate
o Accounts payable (trade credit)
Deferred payment of purchases
Credit terms stated on invoice
Credit reputation suffers if payment delayed beyond due date
(could change payment policy so to punish debtor if repeat
behaviour)
Prompt payment discount usually offered
Negotiated financing
o Bank loans, bank bills, promissory notes, secured financing
o NB value more liquid stocks higher, if illiquid rates of return would
increase
o Bank overdraft
Firm can overdraw check account up to a certain level
Interest rate set at margin above base rate
Interest calculated daily on overdrawn balance
Usually secured by charge over assets
Penalty interest is charged if limit exceeded
Banks charge upfront / annual fees
o Self liquidating loans sale of goods provides cash to repay the loan
o Secured loans need for collateral. If short term only then collateral
restricted to liquid assets such as receivables, inventories or securities.
Terms of sale
Credit, discount and payment terms offered on a sale
Firm that buys on credit is effectively borrowing from its supplier. Save cash today but
have to pay later implicit loan
2/10 net 30 EOM
EOM indicates when the credit period starts usually the end of the purchase
month (therefore have more time if buy earlier in the month). If dropped the
credit period starts from the date of invoice
Net 30 means the credit period lasts 30 days
2/10 means firm gets 2% discount if payment is made within first 10 days of
credit period
In calculations per period will be low, annualised will be high
Going beyond net date cheaper loan by expending period but damages
creditworthiness
o Often high those who pay late often strapped for cash so it makes sense
to charge high rate
Minimum operating cash balance absorbs unexpected cash inflows and outflows
Short term deficits are not necessarily a bad thing could be seasonal or investing in
assets