© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.1 Finance for Non-Financial Managers Fifth Edition Slides prepared by Pierre G. Bergeron University of Ottawa

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.2 Chapter Objectives 1.Describe the meaning of planning, its process and how to measure organizational performance. 2.Explain why the SWOT analysis and planning assumptions are important for formulating goals, preparing plans, budgets and projected financial statements. 3.Show how budgeting fits within the overall planning process, the different types of budgets, and how to make budgeting a meaningful exercise. 4.Explain the nature of a business plan, its benefits and contents. 5.Describe projected financial statements and how to measure financial performance. 6.Comment on the importance of controlling, the control system, and the different types of controls. Planning, Budgeting, and Controlling Chapter Reference Chapter 5: Planning, Budgeting, and Controlling

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.3 Planning, Budgeting, Financial Projections, and Controlling SWOT analysis PlanningBudgetingBusiness Plans & Financial Projections Controlling A. Planning assumptions Mission Value goals Corporate priorities Strategic goals and plans Operational priorities Tactical and operational goals Tactical and operational plans SWOT analysis Operating budgets sales manufacturing staff Consolidated budget Capital budget Cash budget Consolidated business plan Financial projections Divisional business plans Financial projections Results and monitoring corporate performance Results and monitoring operational performance Corporate level Divisional level B. C. D. E. H. G. F. I.K. J.

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.4 SWOT Goals Planning Implementation Controlling 1. The Planning Process Activities Decisions What have we achieved so far and what are our strengths, weaknesses, opportunities, and threats? What do we want to accomplish and what impact will these goals have on the profile of our financial statements? How and when are we going to implement our plans? Who is going to implement them? How much will these plans cost and what are the financial benefits? What should we do to ensure that we will be on course and that the goals and plans will materialize as planned? Did we reach our goals and implement our plans? Are the financial results in line with our financial projections?

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.5 Why Planning is Important 1.Creative, innovative, resourceful. 2.Goal congruence. 3.Sense of purpose and direction. 4.Cope with change. 5.Simplifies managerial control.

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.6 Hierarchy of Plans 1.Strategic plans 2.Tactical plans 3.Operational plans

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.7 Performance Indicators High Low Pursuing the wrong goals but not wasting resources Pursuing the wrong goals and wasting resources Pursuing the right goals and not wasting resources Pursuing the right goals but wasting resources Low High Effectiveness (goal achievement and doing the right things) Efficiency (good use of resources and doing things right)

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.8 the right things Budgeting by Results The aim How Mechanism This means being … To reach the highest level of performance with the least expenditure of resources. Planning priority setting objective setting By doing ________________ things right Budgeting Proper use of resources ________________ effectiveeconomical efficient

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.9 Budgeting by Results Demassing Planned downsizing Reengineering (activity based budgeting) Reward simplification Productivity indicators Cut useless activities Reward quality Employee empowerment Identify levels of services Reward good behaviour 1. ___________________________________ 2. ___________________________________ 3. ___________________________________ 4. ___________________________________ 5. ___________________________________ 6. ___________________________________ 7. ___________________________________ 8. ___________________________________ 9. ___________________________________ 10. ___________________________________ 11. ___________________________________ 12. ___________________________________ Cut salaries and benefits Arbitrary cuts

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.10 SWOT analysis Planning assumptions Goals and Plans Operating budgets and consolidated budgets Projected income statement and balance sheet What are our strengths, weaknesses, opportunities and threats? What are the boundaries within which we should set our priorities, goals and plans? What should we try to accomplish (goals) and how should we implement them (plans)? How much does it cost to realize our goals and implement our plans? How will the planning assumptions impact on our revenue, expense, asset, liability, and equity accounts? 2. SWOT Analysis and Planning Assumptions

© 2008 by Nelson, a division of Thomson Canada Limited Transparency Budgeting Within the Planning Process Phase 1Corporate planning Phase 2Management by objectives Phase 3Budgeting by results Phase 4Operational planning Phase 5Controlling Mission statement Key success factors Value goals Corporate priorities Strategic goals and plans Roll-down process Objectives (on-going activities) Objectives (projects)

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.12 Budgeting and Financial Projections Overhead budgets Manufacturing budgets Sales budgets Operating budgets Financial projections Projected statements Cash budget Investment plan Financing plan

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.13 Types of Budgets Complementary budgets Capital budgets Comprehensive budgets Product budgets Program budgets Item-of-expenditure budgets Cash budgets Sales budgets Flexible budgets Overhead unit budgets Pro-forma financial statements New plants Expansion/modernization Operating budgets

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.14 Rules for Sound Budgeting 1. Pinpoints authority 2. Integrates all planning activities 3. Insists on sufficient and accurate information 4. Encourages participation 5. Links budgeting to monitoring 6. Tailors budgeting to the organization's needs 7. Communicates budget guidelines and planning assumptions 8. Relates costs to benefits 9. Establishes standards for all units 10. Be flexible

© 2008 by Nelson, a division of Thomson Canada Limited Transparency The Business Plan What it is A business plan is a document that gives a complete picture about an organization’s goals, plans, operating activities, financial needs and financing requirements. Benefits - for the company Shows how management intends to implement plans. Forces managers to be realistic. Helps managers to monitor plans. Helps to pinpoint how resources should be deployed.

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.16 The Business Plan Benefits - for the investors Provides base for judging the company. Assures that managers are aware of the opportunities and threats (external environment). Shows the ability of the business to repay its debt. Helps to analyze all components related to the company (internal and external). Identifies the timing and nature of future cash requirements. Helps to assess management’s ability. Indicates funding requirements and sources.

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.17 Contents of The Business Plan Cover sheet Executive summary Company and ownership External environment Mission, statement of purpose and strategy statements Products and services Management team Operations Financial projections Appendixes

© 2008 by Nelson, a division of Thomson Canada Limited Transparency Projected Income Statement Modern Industries Ltd. Projected Income Statement For the Period Ended December Sales revenue$2,875,000$2,500,00015% increase Cost of sales 1,553,000 1,400,00054% of sales from 56% Gross profit 1,322,000 1,100, % increase Other expenses 1,064, ,00037% of sales from 37.8% Operating income 258, , % increase Interest income 5,000 5,000no change Income before taxes 263, , % increase Income taxes 131,500 80, % increase Net income$ 131,500* $ 80, % increase *Payment of $50,000 in dividends ____%

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.19 Projected Balance Sheet Modern Industries Ltd. Projected Balance Sheet As at December Current assets Cash $ 57,000 $ 50,0002% of sales Accounts receivable 194, ,000A 3-day collection improvement Marketable securities 10,000 10,000No change Inventory 160, ,000a 1.0 time turnover improvement Total current assets 421, ,000 Capital assets Capital assets (at cost)1,200, ,000Refer to capital budget for details Less: accumulated amortization 160, ,000Adjusted for increase in capital assets Capital assets (net)1,040, ,000 Total assets $ 1,461,500 $ 1,200,000 Current liabilities Accounts payable $ 101,000 $ 100,000From 7.1% of cost of goods sold to 6.5% Notes payable 79,000 80,000Working capital loan Accruals 20,000 20,000No change Total current liabilities 200, ,000 Long-term debts Mortgage 650, ,000Increase to purchase capital assets Long-term note 130, ,000Increase to purchase capital assets Total long-term debts 780, ,000 Equity Capital shares 100, ,000No change Retained earnings 381, ,000See income statement and statement of Total equity 481, ,000retained earnings for details Total liabilities & equity $ 1,461,500 $ 1,200,000

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.20 Projected Inflow and Outflow of Cash Modern Industries Ltd. Projected Inflow and Outflow of Cash Inflow Outflow Current assets Cash$ 57,000 $ 50, ,000 Accounts receivable 194, , ,500 Marketable securities 10,000 10, Inventory 160, , ,000 Total current assets 421, ,000 Capital assets Capital assets (at cost)1,200, , ,000 Less: accumulated amortization 160, ,000 60, Capital assets (net)1,040, ,000 Total assets $ 1,461,500 $ 1,200,000 Current liabilities Accounts payable $ 101, ,000 1, Notes payable 79,000 80, ,000 Accruals 20,000 20, Total current liabilities 200, ,000 Long-term debts Mortgage 650, , , Long-term note 130, ,000 30, Total long-term debts 780, ,000 Equity Capital shares 100, , Retained earnings 381, ,000 81, Total equity 481, ,000 Total liabilities & equity $ 1,461,500 $ 1,200, , ,500

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.21 Projected Funds Flow Statement Modern Industries Ltd. Projected Cash Flow Statement Inflow Outflow Changes in working capital Increase in cash --- 7,000 Increase in accounts receivable --- 4,500 Increase in inventory ---10,000 Increase in accounts payable 1, Increase in notes payable --- 1,000 Total 1,00022,500 Net change in working capital ---21,500 Funds from operations Net income 131, Amortization 60, Net funds from operations 191, Changes in financing Proceeds from long-term note 30, Proceeds from mortgage150, Payment of dividends ,000 Total180,00050,000 Net change in operating activities170,000 Net change in financing activities130,000 Net change in investing activities ,000 Total300,000300,

© 2008 by Nelson, a division of Thomson Canada Limited Transparency The Sustainable Growth Rate Administrative expenses SALES Interest charges Cost of goods sold Inventory Accounts payable Capital assets Accounts receivable Amortization Selling expenses Growth Funds Increase profit on sales New debt New equity Pay less dividends Invest in less assets

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.23 Modern’s sales growth should not exceed 11.1% or $2,775,000. M = Income after taxes earned on each dollar of sales R = Percentage of net income reinvested in the business (subtract the dividend paid from net income and divide the result by net income) D/E = Divide total liabilities by total net worth A = Assets needed to support each sales dollar Modern Industries Ltd.’s Growth Potential 1.Ratio of income after taxes to salesM = Ratio of reinvested income to income before dividendsR =.50 3.Ratio of total liabilities to net worthD/E = Ratio of total assets to salesA =.48 The formula Growth = Growth = = =.111 Transparencies 4.4 and 4.5 (M)(R) (1 + D/E) (A) – (M) (R) (1+ D/E) (.032) (.50) ( ) (.48) – (.032) (.50) ( ) With 4.6% ROS the new sustainable growth would be 20.4%

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.24 Green zone3.0 and over Yellow zone1.8 to 3.0 Red zone0 to 1.8 Z = 1.2 ( a ) ( b ) ( c ) ( d ) ( e ) a = b = c = d = e = Altman’s Financial Z-Score This is a linear analysis where five measures are objectively weighted to give an overall score that becomes the basis for classification of firms into one of three groupings: Working capital Total assets Retained earnings Total assets Earnings before interest and taxes Total assets Equity Total liabilities Sales Total assets

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.25 Modern Industries Ltd.’s 2003 Z-Score Z = 1.2 ( a ) ( b ) ( c ) ( d ) ( e ) Z = 1.2 (.17 ) (.25 ) (.196 ) (.50 ) ( 2.08 ) = a ===.17 b ===.25 c ===.196 d ===.50 e === 2.08 Working capital Total assets Retained earnings Total assets Earnings before interest and taxes Total assets Equity Total liabilities Sales Total assets $200,000 $1,200,000 $300,000 $1,200,000 $235,000 $1,200,000 $400,000 $800,000 $2,500,000 $1,200,000

© 2008 by Nelson, a division of Thomson Canada Limited Transparency The Control Process Planning Objectives Plans Design the subsystem Performance indicators Analyze variations There is no need to do anything Measure performance Performance standards Corrective action yes no

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.27 Types of Controls Plans Feedback controls Screening controls Results Preventive controls FinishActionStart