The Basic Model for F552 A set of questions to be answered involving expectations and plans for the future operations of the business, their financial implications, and the use of external financing sources.

Strategic Issues 1. What is management’s strategy or plan for the firm? 2. What are the financial implications of that strategy? In particular, does implementation of the strategy require external financing or create problems given existing financial obligations?

External Financing Issues 1. What are the available sources of external financing? 2. What terms or conditions will be imposed on the firm by each source? 3. Will the firm be able to service its current and future debt? With what degree of confidence? 4. Is ownership (stockholder) composition a problem? 5. What are the relative costs? 6. Any other concerns or problems associated with a given source?

Conclusions 1. Do the terms, conditions, requirements, or costs of the best available financing source pose significant risks or problems in the future? 2. If the answer to the above is “yes”, should management’s strategy be re-evaluated?

Comments The answers to the questions posed are not always clear and there can be legitimate differences of opinion about them. We shall also see that the basic model does not always apply—that firms sometimes raise money for reasons other than implementing a business or corporate strategy.

Financial Forecasting and Planning A Three Step Process: 1. Decide on the macro model— What do you need to know? 2. Specify the micro structure— What methods will you use? 3. Specify the assumptions—Where will you get the data?

Choosing a Macro Model 1. What forecast intervals are needed? Daily, Monthly, Quarterly, Annual 2. What should be the model structure? Cash flow statements Income statements and balance sheets Free cash flow Other?

Choices for Micro Structures-- Relationships 1. Subjective (Guesstimates) Should be based on facts. You should be able to explain your reasoning to other people. 2. Use Historical Relationships or Trends Various methods can be used. 3. Use Management Plans and Expectations Same methods are available as in #2.

Financial Forecasting Methods 1. No change from current value. 2. Maintain current trends. Absolute ($), Relative (%), Other? Absolute ($), Relative (%), Other? 3. Statistical modeling—linear or other. 4. Relationship modeling 1. Relative to another variable; e.g. % of sales. 2. Accounting relationship—T-accounts.