2. Copyright © 2011 Nelson Education Limited Finance for Non-Financial Managers, 6 th edition PowerPoint Slides to accompany Prepared by Pierre Bergeron, University of Ottawa

3. Copyright © 2011 Nelson Education Limited Finance for Non-Financial Managers, 6 th edition CHAPTER 7 PLANNING, BUDGETING, AND CONTROLLING

4. Copyright © 2011 Nelson Education Limited 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 7: Planning, Budgeting and Controlling

5. Copyright © 2011 Nelson Education Limited 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.

6. Copyright © 2011 Nelson Education Limited 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?

7. Copyright © 2011 Nelson Education Limited 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.

8. Copyright © 2011 Nelson Education Limited Hierarchy of Plans 1.Strategic plans 2.Tactical plans 3.Operational plans

9. Copyright © 2011 Nelson Education Limited 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)

10. Copyright © 2011 Nelson Education Limited 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

11. Copyright © 2011 Nelson Education Limited Budgeting by Results 1. ___________________________________ 2. ___________________________________ 3. ___________________________________ 4. ___________________________________ 5. ___________________________________ 6. ___________________________________ 7. ___________________________________ 8. ___________________________________ 9. ___________________________________ 10. ___________________________________ 11. ___________________________________ 12. ___________________________________ Demassing Planned downsizing Reengineering (activity based budgeting) Reward simplification Productivity indicators Cut useless activities Reward quality Employee empowerment Balanced scorecard Reward good behaviour Cut salaries and benefits Arbitrary cuts

12. Copyright © 2011 Nelson Education Limited SWOT analysis Planning assumptions Goals and Plans Operating budgets and consolidated budgets Projected statement of income and statement of financial position 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, equity and liability accounts? 2. SWOT Analysis and Planning Assumptions

13. Copyright © 2011 Nelson Education Limited 3. 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)

14. Copyright © 2011 Nelson Education Limited Budgeting and Financial Projections Staff budget Manufacturing budget Sales budget Operating budgets Financial projections Projected statements Cash budget Investment plan Financing plan

15. Copyright © 2011 Nelson Education Limited 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 Projected financial statements New plants Expansion/modernization Operating budgets

16. Copyright © 2011 Nelson Education Limited 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

17. Copyright © 2011 Nelson Education Limited 4. 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.

18. Copyright © 2011 Nelson Education Limited 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.

19. Copyright © 2011 Nelson Education Limited 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

20. Copyright © 2011 Nelson Education Limited 5. Projected Statement of Income ____% 3.24.6 Revenue Cost of sales Gross profit Other income and expenses Profit before taxes Income tax expense Profit for the year $ 2,500,000 (1,400,000) 1,100,000 (940,000) 160,000 (80,000) $ 80,000 Modern Industries Ltd. Projected Statement of Income For the Period ended December 31 2010 $ 2,875,000 (1,553,000) 1,322,000 (1,059,000) 263,000 (131,500) $ 131,5 00 15% increase 54% of revenue from 56% 20.2% increase 36.8% of revenue from 37.6% 64.4% increase 2011

21. Copyright © 2011 Nelson Education Limited Projected Statement of Financial Position Non-current assets Property, plant and equipment Accumulated depreciation Total non-current assets Current assets Inventories Trade receivables Marketable securities Cash Total current assets Total assets Equity Share capital Retained earnings Total equity Non-current liabilities Mortgage Long-term borrowings Total non-current liabilities Current liabilities Trade and other payables Notes payable Accruals Total current liabilities Total equity & liabilities $ 900,000 (100,000) 800,000 150,000 190,000 10,000 50,000 400,000 $ 1,200,000 $ 100,000 300,000 400,000 500,000 100,000 600,000 100,000 80,000 20,000 200,000 $ 1,200,000 Modern Industries Ltd. Projected Statement of Financial Position as at December 31 2010 $ 1,200,000 (160,000) 1,040,000 160,000 194,500 10,000 57,000 421,500 $ 1,461,500 $ 100,000 381,500 481,500 650,000 130,000 780,000 101,000 79,000 20,000 200,000 $ 1,461,500 2011 Refer to the capital budget for details Adjusted for increase in non-current assets 1.0 time improvement 3-day collection improvement No change 2% of revenue No change See the statement of income and the statement of changes in equity for details Increase to purchase non-current assets From 7.1% of cost of sales to 6.5% Working capital loan No change

22. Copyright © 2011 Nelson Education Limited Projected Inflows and Outflows of Cash Non-current assets Property, plant and equipment Accumulated depreciation Total non-current assets Current assets Inventories Trade receivables Marketable securities Cash Total current assets Total assets Equity Share capital Retained earnings Total equity Non-current liabilities Mortgage Long-term borrowings Total non-current liabilities Current liabilities Trade and other payables Notes payable Accruals Total current liabilities Total equity & liabilities $ 900,000 (100,000) 800,000 150,000 190,000 10,000 50,000 400,000 $ 1,200,000 $ 100,000 300,000 400,000 500,000 100,000 600,000 100,000 80,000 20,000 200,000 $ 1,200,000 (160,000) 1,040,000 160,000 194,500 10,000 57,000 421,500 $ 1,461,500 $ 100,000 381,500 481,500 650,000 130,000 780,000 101,000 79,000 20,000 200,000 $ 1,461,500 Modern Industries Ltd. Projected Inflows and Outflows of Cash as at December 31 --- 60,000 ----- ----- 81,500 150,000 30,000 1,000 ----- $ 322,500 $ 300,000 ----- 10,000 4,500 ----- 7,000 ----- ----- ----- 1,000 ----- $ 322,500 InflowsOutflows 20102011

23. Copyright © 2011 Nelson Education Limited Projected Statement of Cash Flows Modern Industries Ltd. Projected Statement of Cash Flows Inflows Outflows Adjustments in working capital Increase in cash --- 7,000 Increase in trade receivables --- 4,500 Increase in inventories ---10,000 Increase in trade and other payables 1,000 --- Increase in notes payable --- 1,000 Total 1,00022,500 Net change in working capital ---21,500 Funds from operations Profit for the year 131,500 --- Depreciation 60,000 --- Net funds from operations 191,500 --- Changes in financing Proceeds from long-term note 30,000 --- Proceeds from mortgage150,000 --- Payment of dividends --- 50,000 Total180,00050,000 Net change in operating activities170,000 Net change in financing activities130,000 Net change in investing activities ---300,000 Total300,000300,000 1. 2. 3.

24. Copyright © 2011 Nelson Education Limited 6. The Sustainable Growth Rate Administrative expenses SALES Finance costs Cost of goods sales Inventories Trade and other payables Non-current assets Trade receivable Depreciation Distribution costs Growth Funds Increase profit on sales New debt New equity Pay less dividends Invest in less assets

25. Copyright © 2011 Nelson Education Limited Modern’s sales growth should not exceed 11.1% or $2,775,000. M = Profit for the year earned on each dollar of revenue R = Percentage of profit for the year reinvested in the business (subtract the dividend paid from profit and divide the result by the profit) D/E = Divide total liabilities by total net worth A = Assets needed to support each revenue dollar Modern Industries Ltd.’s Growth Potential 1.Ratio of profit for the year to revenueM =.032 2.Ratio of reinvested profit to profit before dividendsR =.50 3.Ratio of total liabilities to net worthD/E = 2.00 4.Ratio of total assets to revenueA =.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) (1 + 2.00) (.48) – (.032) (.50) (1+ 2.00).048.432 With 4.6% ROR the new sustainable growth would be 20.4%

26. Copyright © 2011 Nelson Education Limited Green zone3.0 and over Yellow zone1.8 to 3.0 Red zone0 to 1.8 Z = 1.2 ( a ) + 1.4 ( b ) + 3.3 ( c ) + 0.6 ( d ) + 1.0 ( 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 Revenue Total assets

27. Copyright © 2011 Nelson Education Limited Modern Industries Ltd.’s 2010 Z-Score Z = 1.2 ( a ) + 1.4 ( b ) + 3.3 ( c ) + 0.6 ( d ) + 1.0 ( e ) Z = 1.2 (.17 ) + 1.4 (.25 ) + 3.3 (.196 ) + 0.6 (.50 ) + 1.0 ( 2.08 ) = 3.581 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 Revemie 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

28. Copyright © 2011 Nelson Education Limited 6. 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 2. 3. 1. yes 4. 5. 6. no

29. Copyright © 2011 Nelson Education Limited Types of Controls Plans Feedback controls Screening controls Results Preventive controls FinishActionStart