2. Copyright © 2014 Nelson Education Ltd. 7–1 PowerPoint Presentations for Finance for Non-Financial Managers: Seventh Edition Prepared by Pierre Bergeron University of Ottawa

3. Copyright © 2014 Nelson Education Ltd. 7–2 CHAPTER 7 Planning, Budgeting, and Controlling

4. Copyright © 2014 Nelson Education Ltd. 7–3 1.Comment on the activities that link planning, budgeting, and controlling. 2.Describe the meaning of planning, its process, and how to measure organizational performance. 3.Explain why SWOT analysis and planning assumptions are important for setting goals and preparing plans, budgets, and projected financial statements. 4.Show how budgeting fits within the overall planning process, the different types of budgets, and how to make budgeting a meaningful exercise. 5.Explain the nature of a business plan and its benefits and contents. 6.Describe projected financial statements and how to measure growth and financial health. 7.Discuss the importance of controlling, the control system, and the different types of controls. Learning Objectives

5. Copyright © 2014 Nelson Education Ltd. 7–4 Planning, Budgeting, Financial Projections and Controlling LO 1

6. Copyright © 2014 Nelson Education Ltd. 7–5 The Planning Process LO 2

7. Copyright © 2014 Nelson Education Ltd. 7–6 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 LO 2

8. Copyright © 2014 Nelson Education Ltd. 7–7 Hierarchy of Plans LO 2

9. Copyright © 2014 Nelson Education Ltd. 7–8 Performance Indicators LO 2

10. Copyright © 2014 Nelson Education Ltd. 7–9 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 LO 2

11. Copyright © 2014 Nelson Education Ltd. 7–10 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 LO 2

12. Copyright © 2014 Nelson Education Ltd. 7–11 SWOT Analysis and Planning Assumptions LO 3

13. Copyright © 2014 Nelson Education Ltd. 7–12 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 (ongoing activities) Objectives (projects) LO 3

14. Copyright © 2014 Nelson Education Ltd. 7–13 Budgeting and Financial Projections LO 3

15. Copyright © 2014 Nelson Education Ltd. 7–14 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 LO 4

16. Copyright © 2014 Nelson Education Ltd. 7–15 Rules for Sound Budgeting 1. Pinpoint authority 2. Integrate all planning activities 3. Insist on sufficient and accurate information 4. Encourage participation 5. Link budgeting to monitoring 6. Tailor budgeting to the organization's needs 7. Communicate budget guidelines and planning assumptions 8. Relate costs to benefits 9. Establish standards for all units 10. Be flexible LO 4

17. Copyright © 2014 Nelson Education Ltd. 7–16 The Business Plan What is it? a document that gives a complete picture about an organization’s goals, plans, operating activities, financial needs, and financing requirements. Benefits: For 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 used LO 5

18. Copyright © 2014 Nelson Education Ltd. 7–17 The Business Plan Benefits: For investors Provides base for judging the company Assures managers are aware of the opportunities and threats (external environment) Shows the ability of business to repay its debt Helps to analyze all components related to the company (internal and external) Identifies timing and nature of future cash requirements Helps to assess management’s ability to plan and organize Indicates funding requirements and sources LO 5

19. Copyright © 2014 Nelson Education Ltd. 7–18 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 Appendices LO 5

20. Copyright © 2014 Nelson Education Ltd. 7–19 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 2013 $ 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 2014 LO 6

21. Copyright © 2014 Nelson Education Ltd. 7–20 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 2013 $ 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 2014 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 LO 6

22. Copyright © 2014 Nelson Education Ltd. 7–21 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 20132014 LO 6

23. Copyright © 2014 Nelson Education Ltd. 7–22 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. LO 6

24. Copyright © 2014 Nelson Education Ltd. 7–23 The Sustainable Growth Rate Administrative expenses SALES Finance costs Cost of goods sales Inventories Trade and other payables Non-current assets Trade receivables Depreciation Distribution costs Growth Funds Increase profit on sales New debt New equity Pay less dividends Invest in less assets LO 6

25. Copyright © 2014 Nelson Education Ltd. 7–24 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 Growth = Growth = = =.111 Refer to Slides 4-8 and 4-10 (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% LO 6

26. Copyright © 2014 Nelson Education Ltd. 7–25 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 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 LO 6

27. Copyright © 2014 Nelson Education Ltd. 7–26 Modern Industries Ltd.’s 2013 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 Revenue 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 LO 6

28. Copyright © 2014 Nelson Education Ltd. 7–27 The Control Process LO 7

29. Copyright © 2014 Nelson Education Ltd. 7–28 Types of Controls LO 7