Upload
christian-greer
View
213
Download
0
Embed Size (px)
DESCRIPTION
4.2 Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved. Chapter Outline What is Financial Planning? Financial Planning Models: A First Look The Percentage of Sales Approach External Financing and Growth Some Caveats On Financial Planning Models
Citation preview
© 2003 The McGraw-Hill Companies, Inc. All rights reserved.
Long-Term Financial Planning and
Corporate Growth
Chapter Four
Prepared by Anne Inglis, Ryerson University
4.2
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Key Concepts and Skills
• Understand the financial planning process and how decisions are interrelated
• Be able to develop a financial plan using the percentage of sales approach
• Understand the four major decision areas involved in long-term financial planning
• Understand how capital structure policy and dividend policy affect a firm’s ability to grow
4.3
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Chapter Outline
• What is Financial Planning?• Financial Planning Models: A First Look• The Percentage of Sales Approach• External Financing and Growth• Some Caveats On Financial Planning Models
4.4
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Basic Elements of Financial Planning
• Investment in new assets – determined by capital budgeting decisions
• Degree of financial leverage – determined by capital structure decisions
• Cash paid to shareholders – dividend policy decisions
• Liquidity requirements – determined by net working capital decisions
4.5
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Financial Planning Process 4.1
• Planning Horizon - divide decisions into short-run decisions (usually next 12 months) and long-run decisions (usually 2 – 5 years)
• Aggregation - combine capital budgeting decisions into one big project
• Assumptions and Scenarios– Make realistic assumptions about important variables– Run several scenarios where you vary the assumptions by
reasonable amounts– Determine at least a worst case, normal case and best case
scenario
4.6
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Role of Financial Planning
• Examining interactions – helps management see the interactions between decisions
• Exploring options – gives management a systematic framework for exploring its opportunities
• Avoiding surprises – helps management identify possible outcomes and plan accordingly
• Ensuring Feasibility and Internal Consistency – helps management determine if goals can be accomplished and if the various stated (and unstated) goals of the firm are consistent with one another
4.7
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Financial Planning Model Ingredients 4.2
• Sales Forecast – many cash flows depend directly on the level of sales (often estimated using a growth rate in sales)
• Pro Forma Statements – setting up the financial plan in the form of projected financial statements allows for consistency and ease of interpretation
• Asset Requirements – how much additional fixed assets will be required to meet sales projections
• Financial Requirements – how much financing will we need to pay for the required assets
• Plug Variable – management decision about what type of financing will be used (makes the balance sheet balance)
• Economic Assumptions – explicit assumptions about the coming economic environment
4.8
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Example 1 – Historical Financial Statements
Gourmet Coffee Inc.Balance Sheet
December 31, 2001Assets 1000 Debt 400
Equity 600
Total 1000 Total 1000
Gourmet Coffee Inc.Income StatementFor Year Ended
December 31, 2001
Revenues 2000
Costs 1600
Net Income 400
4.9
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Example 1continued - Pro Forma Income Statement
• Initial Assumptions– Revenues will grow at
15% (2000*1.15)– All items are tied
directly to sales and the current relationships are optimal
– Consequently, all other items will also grow at 15%
Gourmet Coffee Inc.Pro Forma Income
StatementFor Year Ended 2002
Revenues 2,300
Costs 1,840
Net Income 460
4.10
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Example 1 continued - Pro Forma Balance Sheet
• Case I– Dividends are the plug
variable, so debt and equity increase at 15%
– Dividends = 460 NI – 90 increase in equity = 370
• Case II– Debt is the plug variable
and no dividends are paid
– Debt = 1,150 – (600+460) = 90
– Repay 400 – 90 = 310 in debt
Gourmet Coffee Inc.Pro Forma Balance Sheet
Case 1
Assets 1,150 Debt 460Equity 690
Total 1,150 Total 1,150
Gourmet Coffee Inc.Pro Forma Balance Sheet
Case 1
Assets 1,150 Debt 90
Equity 1,060
Total 1,150 Total 1,150
4.11
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Percent of Sales Approach 4.3
• Some items tend to vary directly with sales, while others do not
• Income Statement– Costs may vary directly with sales– If this is the case, then the profit margin is constant– Dividends are a management decision and generally do not vary
directly with sales – this affects the retained earnings that go on the balance sheet
• Balance Sheet– Initially assume that all assets, including fixed, vary directly with sales– Accounts payable will also normally vary directly with sales– Notes payable, long-term debt and equity generally do not vary with
sales because they depend on management decisions about capital structure
– The change in the retained earnings portion of equity will come from the dividend decision
4.12
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Example 2 – Percentage of Sales Method
Tasha’s Toy EmporiumIncome Statement, 2001
% of SalesSales 5,000
Costs 3,000 60%
EBT 2,000 40%
Taxes (40%) 800 16%
Net Income 1,200 24%
Dividends 600
Add. To RE 600
Tasha’s Toy EmporiumPro Forma Income Statement, 2002
Sales 5,500
Costs 3,300
EBT 2,200
Taxes 880
Net Income 1,320
Dividends 660
Add. To RE 660
Assume Sales grow at 10%Dividend Payout Rate = 50%
4.13
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Example 2 – Percentage of Sales Method continued
Tasha’s Toy Emporium – Balance SheetCurrent % of
SalesPro
FormaCurrent % of
SalesPro
FormaASSETS LIABILITIES & OWNERS’ EQUITY
Current Assets Current Liabilities Cash $500 10% $550 A/P $900 18% $990 A/R 2,000 40 2,200 N/P 2,500 n/a 2,500 Inventory 3,000 60 3,300 Total 3,400 n/a 3,490 Total 5,500 110 6,050 LT Debt 2,000 n/a 2,000Fixed Assets Owners’ Equity Net PP&E 4,000 80 4,400 C Shares 2,000 n/a 2,000Total Assets 9,500 190 10,450 RE 2,100 n/a 2,760
Total 4,100 n/a 4,760Total L & OE 9,500 10,250
4.14
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Example 3 – External Financing Needed
• The firm needs to come up with an additional $200 in debt or equity to make the balance sheet balance– TA – TL&OE = 10,450 – 10,250 = 200
• Choose plug variable– Borrow more short-term (Notes Payable)– Borrow more long-term (LT Debt)– Sell more common shares (C Shares)– Decrease dividend payout, which increases
Additions To RE
4.15
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Example 4 – Operating at Less than Full Capacity
• Suppose that the company is currently operating at 80% capacity.– Full Capacity sales = 5000 / .8 = 6,250– Estimated sales = $5,500, so would still only be operating at 88%– Therefore, no additional fixed assets would be required.– Pro forma Total Assets = 6,050 + 4,000 = 10,050– Total Liabilities and Owners’ Equity = 10,250
• Choose plug variable– Repay some short-term debt (decrease Notes Payable)– Repay some long-term debt (decrease LT Debt)– Buy back shares (decrease C Shares) – Pay more in dividends (reduce Additions To RE)– Increase cash account
4.16
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Work the Web Example
• Looking for estimates of company growth rates?
• What do the analysts have to say?• Check out Yahoo Finance – click the web
surfer, enter a company ticker and follow the “Research” link
4.17
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Growth and External Financing 4.4
• At low growth levels, internal financing (retained earnings) may exceed the required investment in assets
• As the growth rate increases, the internal financing will not be enough and the firm will have to go to the capital markets for money
• Examining the relationship between growth and external financing required is a useful tool in long-range planning
4.18
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
The Internal Growth Rate
• The internal growth rate tells us how much the firm can grow assets using retained earnings as the only source of financing.
%71.6
0671.6037.1041.1
6037.1041.ROA - 1
RROA RateGrowth Internal
R
4.19
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
The Sustainable Growth Rate
• The sustainable growth rate tells us how much the firm can grow by using internally generated funds and issuing debt to maintain a constant debt ratio.
%92.17
1792.6037.2517.1
6037.2517.ROE-1
RROE RateGrowth eSustainabl
R
4.20
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Determinants of Growth
• Profit margin – operating efficiency• Total asset turnover – asset use efficiency• Financial policy – choice of optimal
debt/equity ratio• Dividend policy – choice of how much to pay
to shareholders versus reinvesting in the firm
4.21
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Some Caveats 4.5
• It is important to remember that we are working with accounting numbers and ask ourselves some important questions as we go through the planning process
• How does our plan affect the timing and risk of our cash flows?
• Does the plan point out inconsistencies in our goals?
• If we follow this plan, will we maximize owners’ wealth?
4.22
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Quick Quiz
• What is the purpose of long-range planning?• What are the major decision areas involved in
developing a plan?• What is the percentage of sales approach?• How do you adjust the model when operating
at less than full capacity?• What is the internal growth rate?• What is the sustainable growth rate?• What are the major determinants of growth?
4.23
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Summary 4.6
• You should understand:– The financial planning process and how key
financial decisions are interrelated– How to use the percentage-of-sales method to
make a financial plan– How to adjust the model if the company is
operating under-capacity– How to calculate both the internal growth rate and
the sustainable growth rate– The factors that determine growth