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

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 5.1

Finance for Non-Financial ManagersFifth Edition

Slides prepared by

Pierre G. BergeronUniversity of Ottawa


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 ReferenceChapter 5: Planning, Budgeting, and Controlling


Planning, Budgeting, Financial Projections, and Controlling

SWOT analysis

Planning Budgeting Business 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.


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?


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.


Hierarchy of Plans

1. Strategic plans

2. Tactical plans

3. Operational plans


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 anddoing the right things)

Efficiency (good use of

resources and doing things right)


the right things

Budgeting by Results

The aim

How

Mechanism

This meansbeing …

To reach the highest level of performance with the least expenditure of resources.

Planning

• priority setting

• objective setting

By doing ________________ By doing ________________ things right

Budgeting

Proper use of resources

________________ ________________

________________

effective economical

efficient


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


SWOTanalysis

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


3. Budgeting Within the Planning Process

Phase 1 Corporate planning

Phase 2 Management by objectives

Phase 3 Budgeting by results

Phase 4 Operational planning

Phase 5 Controlling

• Mission statement• Key success factors• Value goals• Corporate priorities• Strategic goals and plans

• Roll-down process• Objectives (on-going activities)• Objectives (projects)


Budgeting and Financial Projections

Overhead budgets

Manufacturing budgets

Sales budgets

Operating budgets

Financial projections

Projectedstatements

Cash budget

Investment plan

Financing plan


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


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


4. The Business Plan

What it isA 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.


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.


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


5. Projected Income StatementModern Industries Ltd.

Projected Income StatementFor the Period Ended December 31

2007 2006

Sales revenue $2,875,000 $2,500,000 15% increase

Cost of sales 1,553,000 1,400,000 54% of sales from 56%

Gross profit 1,322,000 1,100,000 20.2% increase

Other expenses 1,064,000 945,000 37% of sales from 37.8%

Operating income 258,000 155,000 66.4% increase

Interest income 5,000 5,000 no change

Income before taxes 263,000 160,000 64.4% increase

Income taxes 131,500 80,000 64.4% increase

Net income $ 131,500* $ 80,000 64.4% increase

*Payment of $50,000 in dividends

____% ____%3.24.6


Projected Balance SheetModern Industries Ltd.

Projected Balance SheetAs at December 31

2007 2006Current assets Cash $ 57,000 $ 50,000 2% of sales Accounts receivable 194,500 190,000 A 3-day collection improvement Marketable securities 10,000 10,000 No change Inventory 160,000 150,000 a 1.0 time turnover improvementTotal current assets 421,500 400,000

Capital assets

Capital assets (at cost) 1,200,000 900,000 Refer to capital budget for details Less: accumulated amortization 160,000 100,000 Adjusted for increase in capital assetsCapital assets (net) 1,040,000 800,000

Total assets $ 1,461,500 $ 1,200,000

Current liabilities Accounts payable $ 101,000 $ 100,000 From 7.1% of cost of goods sold to 6.5% Notes payable 79,000 80,000 Working capital loan Accruals 20,000 20,000 No changeTotal current liabilities 200,000 200,000

Long-term debts Mortgage 650,000 500,000 Increase to purchase capital assets Long-term note 130,000 100,000 Increase to purchase capital assetsTotal long-term debts 780,000 600,000

Equity

Capital shares 100,000 100,000 No changeRetained earnings 381,500 300,000 See income statement and statement of Total equity 481,500 400,000 retained earnings for details

Total liabilities & equity $ 1,461,500 $ 1,200,000


Projected Inflow and Outflow of CashModern Industries Ltd.

Projected Inflow and Outflow of Cash

2007 2006 Inflow OutflowCurrent assets Cash $ 57,000 $ 50,000 --- 7,000 Accounts receivable 194,500 190,000 --- 4,500 Marketable securities 10,000 10,000 --- --- Inventory 160,000 150,000 --- 10,000Total current assets 421,500 400,000

Capital assets

Capital assets (at cost) 1,200,000 900,000 --- 300,000 Less: accumulated amortization 160,000 100,000 60,000 ---Capital assets (net) 1,040,000 800,000

Total assets $ 1,461,500 $ 1,200,000

Current liabilities Accounts payable $ 101,000 100,000 1,000 --- Notes payable 79,000 80,000 --- 1,000 Accruals 20,000 20,000 --- ---Total current liabilities 200,000 200,000

Long-term debts Mortgage 650,000 500,000 150,000 --- Long-term note 130,000 100,000 30,000 ---Total long-term debts 780,000 600,000

Equity

Capital shares 100,000 100,000 --- ---Retained earnings 381,500 300,000 81,500 ---Total equity 481,500 400,000

Total liabilities & equity $ 1,461,500 $ 1,200,000 322,500 322,500


Projected Funds Flow StatementModern 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 1,000 --- Increase in notes payable --- 1,000Total 1,000 22,500Net change in working capital --- 21,500

Funds from operations Net income 131,500 --- Amortization 60,000 ---Net funds from operations 191,500 ---

Changes in financingProceeds from long-term note 30,000 ---Proceeds from mortgage 150,000 ---Payment of dividends --- 50,000Total 180,000 50,000

Net change in operating activities 170,000

Net change in financing activities 130,000

Net change in investing activities --- 300,000

Total 300,000 300,000

1.

2.

3.


6. 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


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 sales M = .032

2. Ratio of reinvested income to income before dividends R = .50

3. Ratio of total liabilities to net worth D/E = 2.00

4. Ratio of total assets to sales A = .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% ROS the new sustainable growth would be 20.4%


Green zone 3.0 and over

Yellow zone 1.8 to 3.0

Red zone 0 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-ScoreThis 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


Modern Industries Ltd.’s 2003 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

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


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


Types of Controls

Plans

Feedback controls

Screening controls

Results

Preventive controls

FinishActionStart

Documents

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