1 FINANCE 7311 CORPORATE FINANCIAL PLANNING

2 FINANCIAL PLANNING l Long-Run CORPORATE OBJECTIVES Maximize the Value of the Firm Sub -objectives (INCREASE MARKET SHARE) l STRATEGIES (STEPS) SPECIFIC ACTION PLAN SWOT ANALYSIS; 4 P’S –(PRICE STRATEGY)

3 Financial Planning, cont. l PERFORMANCE MEASUREMENT  OJBECTIVE; SPECIFIC  WERE GOALS ACHIEVED? (% MARKET SHARE) l BUSINESS PLAN => FINANCIAL PLAN  Operating & marketing strategies underlie a financial plan

4 USES OF FINANCIAL PLAN l PROJECTION OF FINANCIAL NEEDS Financial implications of corporate strategies l PERFORMANCE MEASUREMENT  A benchmark which reflects strategies

5 FINANCIAL MODEL  EQUATIONS A = D + E End Balance = Beg. Bal. + Add - Subtract  PARAMETERS Tax rate; NWC requirements  DECISION VARIABLES Investment; Financing

6 COMPONENTS  PRO-FORMA FINANCIAL STMTS  CASH BUDGET  SPECIFIC BUDGETS Production Personnel Marketing; distribution Capital

7 PRO-FORMA B/S & I/S  STEP 1:SALES FORECAST Historical data Growth (size of pie & piece of pie) Capabilities (prod., mgmt, distrib.)  STEP 2: OTHER INFORMATION? YES ==> Use it Capital spending; Debt Schedule; ETC.

8 Pro-Forma’s, cont. NO => Does Account Vary With Sales? NO ==> SAME BALANCE AS LAST YEAR YES ==> PERCENTAGE OF SALES  PERCENTAGE OF SALES APPROACH Increase account by % change in sales Keeps acct/sales ratio constant Ratio analysis from before helpful

9 % OF SALES EXAMPLE S Last Year Sales:10,000 S Last Year Acct. Rec. 1,000 S Forecast Sales Growth: 20% S Forecast Sales: 10,000 X 1.2 = 12,000 S Forecast Acct. Rec.1,000 X 1.2 = 1,200 S OR: 1,000/10,000 X 12,000 = 1,200

10 % of SALES - COMMENTS Þ Method of Last Resort Þ Assets / Sales ratio is optimal Þ Assumes Full Capacity Þ Assumes Assets / Sales relation is linear Economies of Scale Less than full capacity Sales decreases

11 Pro-Forma F/S, cont.  STEP 3: EXTERNAL FINANCING NEED Balance Sheet Does Not Balance Plug is the Financing Need May use Cash or Debt as a Plug  STEP 4: B/S & I/S RELATIONS Net Income and Retained Earnings Depreciation Expense and Accumulated Depreciation Interest Expense and Debt

12 Pro-Forma F/S, cont.  STEP 5: WHAT-IF ANALYSIS Use well-planned spreadsheet Put variables in separate cells PRO-FORMA EXAMPLE: SAMPLE APPAREL COMPANY

13 CASH BUDGET s Projection of future cash flows s Performance benchmark s Useful for seasonal companies s More specific information s Provides same ‘financing’ need as pro- forma financial statements

14 Cash Budget, cont.  STEP 1: Obtain a Sales Forecast Weekly, Monthly, etc.  STEP 2: Project Amount & Timing of Cash Inflows Primarily collection of sales How do we estimate timing? What are other inflows?

15 Cash Budget, cont.  STEP 3: Project amount & timing of cash outflows Purchases Labor Capital Expenditures Dividends & interest Other Expenses

16 Cash Budget, cont.  STEP 4: NET CASH FLOW  STEP 5: FINANCING NEED/SURPLUS NET CASH FLOW + BEGINNING CASH = ‘ENDING’ CASH - DESIRED CASH = FINANCING NEED (= B/S PLUG)

17 GROWTH SOURCE OF SALES GROWTH: QUANTITY PRICE COMBINATION OF BOTH QUANTITY INDUSTRY GROWTH (Pie) MARKET SHARE GROWTH (Piece of Pie)

18 Two Growth Rates INTERNAL GROWTH RATE Rate of growth without resorting to external funds ∆ Assets = ∆ Equity ∆ Equity = Net income x retention ratio IGR = ROA x r The above computes ROA using BEGINNING assets

19 IGR example Wal-Mart 1994:ROA = 13.9% Income = $1.02 : Dividends = $0.13 IGR = 13.9% x.8725 = 12.3% Suppose expected growth is 23% => 10% will have to be financed externally 10% x 16,800MM = $1.68MM financing need

20 Sustainable Growth Rate  No external equity issued  Debt issued such that D/E is constant What happens to D/E with IGR? Want %∆ in equity = %∆ in debt ==> SGR = ROE x r Note: ROE is computed using BEGINNING equity

21 Sustainable Growth, cont. DuPont:  ROE x r = Profitability x turnover x leverage x r Management choices: 3 Squeeze more sales $ out of existing assets 3 Squeeze more income out of existing sales $ 3 Retain more earnings in the firm 3 Be willing to accept more leverage 3 Settle for less growth

22 GROWTH & FIRM VALUE Growth should be Value Enhancing EXAMPLE:  Suppose EPS = $5.00  R = 12.5% (Investors’ required return)  ROE = 15%  r = 0 (No reinvestment)

23 Growth Example, cont. 3 P = D/(R - g) 3 g = ROE x r = 15% x 0 = 0 3 P = 5 / (12.5% - 0) = $ P/E = 8( = 1/R)

24 Growth Example, cont.  Now, suppose r=60% (reinvest 60%) 3 g = ROE x r = 15% x 60% = 9% 3 D = 40% x 5.00 = $ P = 2 / (12.5% - 9%) = $ P/E = Growth has increased Price and P/E!

25 Growth example, cont.  Suppose r = 60% as before  ROE = 10% 3 g = 10% x 60% = 6% 3 P = $2 / (12.5% - 6%) = $ P/E = Growth has decreased both price and P/E! 3 Growth creates Value when: ROE > R