Outline 2: Financial Planning 2.1 What is Financial Planning? 2.2 Business Planning 2.3 Financial Planning Models 2.3 Pro Forma Financial Statements 2.4 Planning Issues 2.5 External Financing and Growth 2

Financial Planning The Financial Planning Process Analyzing the investment and financing choices open to the firm. Projecting the future consequences of current decisions. Deciding which alternatives to undertake. Measuring subsequent performance against the goals set forth in the financial plan. 3

Financial Planning Planning Horizon - Time horizon for a financial plan. Departments are often asked to submit 3 alternatives Optimistic case = best case Expected case = normal growth Pessimistic case = retrenchment Financial plans help managers ensure that their financial strategies are consistent with their capital budgets. They highlight the financial decisions necessary to support the firm’s production and investment goals. 8

Financial Planning Why Build Financial Plans? Contingency planning Considering options Forcing consistency Raising capital investment funds Remember: Financial plans are a component of a business plan. When developing a financial plan, assumptions for forecasting must be documented and justified. 9

Business Planning What is a Business Plan: Defines the what, how, who, when, where, and why for a business: What business are you in How are you going to reach your mission, goals, and vision (definition of success) Who are the key people resources When how will you get there Why are we in this business – vision and mission 9

Business Planning Components of a Business Plan: Vision Mission Strategic Plan Marketing and Sales Plan Operational Requirements Financial Projections and Projections Business Valuation Assessment 9

Financial Planning Models Inputs Planning Model Planning Model - Equations specifying key relationships. Outputs Outputs - Projected financial statements (pro forma). Financial ratios. Sources and uses of funds. Inputs - Current financial statements. Forecasts of key variables (such as sales or interest rates). 12

Financial Planning Models Pro Formas - Projected or forecasted financial statements. Percentage of Sales Model - Planning model in which sales forecasts are the driving variable and most other variables are proportional to sales. Balancing Item - Variable that adjusts to maintain the consistency of a financial plan. Also called plug. 13

Hypothetical Financials Current Income Statement and Balance Sheet 14

Hypothetical Pro Forma Financials Pro forma Income Statement and Balance Sheet 15

Another Set of Hypothetical Current Financials 2004 Financial Statements

Another Set of Pro Hypothetical Financials 2005 Pro Forma Statements

Actual Pro Forma Model Example Example Prof Forma is an actual pro forma model for a Country Inn. 17

Planning Issues Many models ignore realities such as depreciation, taxes, etc. Risk assessment can be too narrow. Usually linear in nature. Cash flows and cash needs are often ignored. Percent of sales methods are not realistic because fixed costs exist. Not dynamic – no mechanism to adjust following year based on results of previous year in the planning horizon. Goals should not be accounting/financial ratios. 17

External Financing & Growth 20