Fundamentals of

Chapter 18 Corporate Finance

Fourth Edition

Financial Planning

Slides by
Matthew Will

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Topics Covered
What is Financial Planning?
Financial Planning Models
Example: Executive Cheese
Planners Beware
External Financing and Growth

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Financial Planning

The Financial Planning Process

 Analyzing the investment and financing choices
open to the firm.
 Projecting the future consequences of current
decisions.
 Deciding which alternatives to undertake.
 Measuring subsequent performance against the
goals set forth in the financial plan.

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Financial Planning
Planning Horizon - Time horizon for a financial plan.
Departments are often asked to submit 3 alternatives
 Optimistic case = best case
 Expected case = normal growth
 Pessimistic case = retrenchment

 Financial plans help managers ensure that their

financial strategies are consistent with their capital
budgets. They highlight the financial decisions
necessary to support the firm’s production and
investment goals.

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Financial Planning

Why Build Financial Plans?

Contingency planning
Considering options
Forcing consistency

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Financial Planning Models

Inputs Planning Model Outputs

Inputs - Current financial statements. Forecasts of key

variables (such as sales or interest rates).

Planning Model - Equations specifying key

relationships.

Outputs - Projected financial statements (pro forma).

Financial ratios. Sources and uses of funds.

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Financial Planning Models

Pro Formas - Projected or forecasted financial
statements.
Percentage of Sales Model - Planning model in
which sales forecasts are the driving variable and
most other variables are proportional to sales.
Balancing Item - Variable that adjusts to maintain
the consistency of a financial plan. Also called
plug.

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Executive Cheese
Current Income Statement and Balance Sheet
Income Statement
Sales $1,200
Costs 1,000
Net Income 200

Balance Sheet (YTD)

Assets $2,000 Debt $ 800
Equity 1,200
Total $2,000 Total $2,000

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Executive Cheese
Pro forma Income Statement and Balance Sheet
Income Statement
Sales $1,320
Costs 1,100
Net Income 220

Balance Sheet
Assets $2,200 Debt $ 800
Equity 1,320
Total $2,200 Total $2,200

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Executive Cheese
 Pro forma Balance Sheet with dividends fixed at
$180 and debt used as the balance item.

Panel A Panel B
Balance Sheet Balance Sheet
Assets $2,200 Debt $ 960 Assets $2,200 Debt $ 900
Equity 1,240 Equity 1,300
Total $2,200 Total $2,200 Total $2,200 Total $2,200

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Executive Fruit
2002 Financial Statements
Income Statement
Revenue $ 2,000
COGS 1,800 90% of sales
EBIT 200 Difference = 10% of sales
Interest 40 10% of debt at start of year
Earnings before taxes 160 EBIT-interest
State and federal tax 64 40% of (EBIT-interest)
Net income 96 EBIT-interest-taxes
Dividends 64 Payout ratio=2/3
Retained earnings 32 Net income - dividends

Balance Sheet
Assets
Net working capital 200 10% of sales
Fixed assets 800 40% of sales
Total assets 1,000 50% of sales
Liabilities and shareholders' equity
Long term debt 400
Shareholders' equity 600
Total Liab + Equity 1,000 Equals total assets
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Executive Fruit
2003 Pro Forma Statements
Income Statement
Revenue $ 2,200 10% higher
COGS 1,980 10% higher
EBIT 220 10% higher
Interest 40 unchanged
Earnings before taxes 180 EBIT-interest
State and federal tax 72 40% of (EBIT-interest)
Net income 108 EBIT-interest-taxes
Dividends 72 Payout ratio=2/3
Earnings retained 36 Net income - dividends

Balance Sheet
Assets
Net working capital 220 10% higher
Fixed assets 880 10% higher
Total assets 1,100 10% higher
Liabilities and shareholders' equity
Long term debt 400 Temp held fixed
Shareholders' equity 632 Increased by RE
Total Liab + Equity 1,032 Sum of debt plus equity
Required external financing 68
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Planners Beware
Many models ignore realities such as
depreciation, taxes, etc.
Percent of sales methods are not realistic
because fixed costs exist.
Most models generate accounting numbers
not financial cash flows
Adjustments must be made to consider
these and other factors.

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External Financing & Growth

Required external financing = (sales/net assets) Increase in cales - retained earnings
= (.50 200,000) - 32,000
$68,000

retained earnings
Internal growth rate =
assets
retained earnings net income equity
= x x
net income equity assets

Sustainable growth rate = plowback ratio x retrun on equity

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Web Resources
Click to access web sites
Internet connection required

www.jaxworks.com/zscore2.htm

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