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Steve Paulone Facilitator

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Financial Management Decisions The financial manager is concerned with three primary categories of financial decisions: 1.Capital budgeting process of planning and managing a firms investments in fixed assets. The key concerns are the size, timing and riskiness of future cash flows.

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Financial Management Decisions #2 Capital structure mix of debt (borrowing) and equity (ownership interest) used by a firm. What are the least expensive sources of funds? Is there an optimal mix of debt and equity? When and where should the firm raise funds?

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Financial Management Decisions 3.Working capital management managing short-term assets and liabilities. How much inventory should the firm carry? What credit policy is best? Where will we get our short-term loans?

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Finances Responsibility A More General Financial Management Goal is to maximize the market value of owners equity. Market Value is usually determined by stock price

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Cost Accounting Tracking direct and indirect costs to cost drivers Inputs versus outputs efficiency Profitability at all stages of the process Inventory valuation and basis of working capital management

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Managerial Accounting Using measures of efficiency to judge if management is meeting the stockholders goals Budgets and forecasts Goal setting and attainment

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Financial Flows

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Why Forecast? Your financial statements indicate past performance. This information will certainly interest potential investors. What's more important, they'll look to your company's projected financial statements to see whether your business is a good investment: one that will generate a return on their investment. Two types of projected financial statements are usually prepared to give investors a clear understanding of where your business is heading: annual projections for a period ranging from one to five years and a detailed monthly cash budget for the first year.

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What Can Planning Accomplish? Provide a better understanding of the interactions between investments and financing Identify options Help with contingency planning Check for feasibility and internal consistency among goals

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A Financial Planning Model: The Ingredients Sales Forecast most other considerations depend upon the sales forecast, so it is said to drive the model Pro Forma Statements the output summarizing different projections Asset Requirements investment needed to support sales growth Financial Requirements debt and dividend policies The Plug designated source(s) of external financing Economic Assumptions state of the economy, anticipated changes in interest rates, inflation, etc.

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Making Reliable Financial Forecasts Trust is something that is earned, not given. You have to build a relationship with investors, even before they invest in your business. You do this, partly, by presenting reasonable and credible forecasts. Show that you understand and are comfortable with your forecasts. Financial forecasting must be based on your company's vision, moderated by the experience and insight of your management team. And your forecasts must be supported by reasonable assumptions.

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Here is an overview of the process: Review your past operating results. Analyze expected future market conditions for your various products or services. Estimate your future sales volume, price and revenue for each product. Estimate future costs based on forecast sales volume and expected cost relationships. Deduct income taxes. Make accounting adjustments, such as depreciation and amortization. Deduct what you expect you will spend on fixed assets, working capital, and financing. Include the proposed investments in the forecast.

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Make Your Assumptions Reasonable and Explicit The assumptions used to prepare your projected financial statements must be stated clearly, reasonably and consistently. Be sure that: the working capital needs, production capacity and personnel requirements you predict are consistent with the level of growth you forecast; the growth rate you forecast is reasonable for the market you are in; and you can really achieve any gains in market share that you forecast.

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Determine Fixed Assets and Other Costs To establish your financial needs, you need to consider three other important components: fixed assets, marketing costs and a financial cushion. Remember the equation: working capital + fixed assets + marketing costs + financial cushion = your financial needs Fixed assets, or capital assets include: land buildings machinery and equipment used to make a product, provide a service or sell, store or deliver goods (e.g. office furniture, business machines, computers, display cases, store fixtures).

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The Percentage of Sales Approach The Income Statement Sales generate retained earnings (unless all income is paid out in dividends). Retained earnings, plus external funds raised, support an increase in assets. More assets lead to more sales and the cycle starts again. Given forecasted sales, a constant profit margin and a specified dividend policy, what retained earnings can be expected? here is a general formula for obtaining the solution, assuming that all costs including depreciation and interest, vary directly as a percent of sales: S = previous periods sales g = projected growth rate of sales A = pervious periods ending total assets PM = profit margin b = retention or plowback ratio Addition to retained earnings = PM * S(1+g) * b

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The Percentage of Sales Approach The Balance Sheet What assets are needed to support sales growth? If we assume that we are operating at full capacity and that fixed assets can be purchased in continuous amounts (lump-sum purchases are not required), a simplified approach can be used: A*g = Increase in assets

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Some Caveats Regarding Financial Planning Models The problem is that the models are really accounting statement generators rather than determinants of value. As we will see, value is determined by cash flows, timing and risk; and these financial planning models do not address any of these issues.