financial planning and control chapter 8. financial planning uthe projection of sales, income, and...
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Financial Planning Financial Planning and Controland Control
Chapter 8
Financial PlanningFinancial Planning
The projection of sales, income, and assets based on alternative production and marketing strategies, as well as the determination of the resources needed to achieve these projections
Financial ControlFinancial Control
The phase in which financial plans are implemented
Control deals with the feedback and adjustment process required to ensure adherence to plans and modification of plans because of unforeseen changes
Sales ForecastsSales Forecasts
A forecast of a firm’s unit and dollar sales for some future period
Sales ForecastsSales Forecasts
A forecast of a firm’s unit and dollar sales for some future period
Generally based on recent sales trends plus forecasts of the economic prospects for the nation, region, industry, and so forth
Projected (Pro Forma) Projected (Pro Forma) Financial StatementsFinancial Statements
Project the asset requirements for the coming period, then project the liabilities and equity that will be generated under normal operations, and subtract the projected liabilities and equity from the required assets to estimate the additional funds needed (AFN) to support the level of forecasted operations
Projected Projected Balance Sheet MethodBalance Sheet Method
A method of forecasting financial requirements based on forecasted financial statements 1. Forecast the Income Statement 2. Forecast the Balance Sheet
Adjust for spontaneously generated funds obtained from routine business transactions
Projected Projected Balance Sheet MethodBalance Sheet Method
A method of forecasting financial requirements based on forecasted financial statements 1. Forecast the Income Statement 2. Forecast the Balance Sheet 3. Determine how to raise the additional
funds needed
Projected Projected Balance Sheet MethodBalance Sheet Method
A method of forecasting financial requirements based on forecasted financial statements 1. Forecast the Income Statement 2. Forecast the Balance Sheet 3. Determine how to raise the additional
funds needed 4. Financing feedbacks
Projected Projected Balance Sheet MethodBalance Sheet Method
Financing feedbacks are the effects on the income statement and balance sheet of actions taken to finance forecasted increases in assets
Projected (Pro Forma) Projected (Pro Forma) Financial StatementsFinancial Statements
Analysis of the forecast determine if the forecast meets the firm’s
financial targets planned management changes must be
incorporated into the forecasts iterative process
Other ConsiderationsOther Considerationsin Forecastingin Forecasting
Excess capacity
⎟⎠⎞⎜
⎝⎛
=
level sales generate toused capacity ofPercent
level Sales sales capacity Full
Other ConsiderationsOther Considerationsin Forecastingin Forecasting
Economies of scale variable cost of goods sold ratio changes
with size of the firm this affects the addition to retained
earnings, and thus the AFN
Other ConsiderationsOther Considerationsin Forecastingin Forecasting
Lumpy assets assets that cannot be acquired in small
increments, but must be obtained in large, discrete amounts
Other ConsiderationsOther Considerationsin Forecastingin Forecasting
Lumpy assets assets that cannot be acquired in small
increments, but must be obtained in large, discrete amounts
small increase in sales can require significant increase in plant and equipment
Financial Control - Financial Control - Budgeting and LeverageBudgeting and Leverage
Relationship between sales volume and profitability under different operating conditions
Control phase and process
OperatingOperatingBreakeven AnalysisBreakeven Analysis
An analytical technique for studying the relationship among sales revenues, operating costs, and profits
Only deals with the operating section of the income statement
OperatingOperatingBreakeven AnalysisBreakeven Analysis
Operating breakeven point represents the level of production and sales
where operating income is zero the point where revenues from sales just
equal total operating costs
--------------
0 20 40 57 60 80 100 120Units Produced and
Sold(millions)QBE
1,400
1,200
000
00
00
00
100
Revenues and Costs($ millions)
Total Sales Revenues (P x
Q)
93.5Total fixed Costs (F)
Total Operating Costs (F + Q x V)
Operating Breakeven Point (EBIT = 0)
Operating Profit (EBIT > 0)
855SBE
Operating Loss
(EBIT < 0)
Breakeven GraphBreakeven Graph
Sales revenues (P x Q)
=Total
operating costs
=Total
variable costs
+Total fixed costs
(P x Q) = TOC = (V x Q) + F
margin onContributiF
V-PF
QBE ==
margin profit GrossF
PV
-1
FSBE =
⎟⎠⎞
⎜⎝⎛
=
Breakeven ComputationBreakeven Computation
Using OperatingUsing OperatingBreakeven AnalysisBreakeven Analysis
New product decisions required sales to achieve profitability
Expansion of operations increase fixed and variable costs increase sales
Modernization and automation increased fixed and reduced variable costs
Operating LeverageOperating Leverage
The existence of fixed operating costs, such that a change in sales will produce a larger change in operating income (EBIT)
Operating LeverageOperating Leverage
Degree of operating leverage (DOL) the percentage change in NOI (or EBIT)
associated with a given percentage change in sales
⎟⎠⎞
⎜⎝⎛Δ
⎟⎠⎞
⎜⎝⎛Δ
=⎟⎠⎞
⎜⎝⎛Δ
⎟⎠⎞
⎜⎝⎛Δ
==
EBITEBIT
SalesSales
EBITEBIT
sales in change PercentageNOI in change Percentage
DOL
Operating LeverageOperating Leverage
( )( ) FV-PQ
V-PQDOLQ −
=
( ) ( )( ) ( ) EBIT
profit GrossFVQPQ
VQPQDOLS =
−×−××−×
=
Operating LeverageOperating Leverage
Operating leverage and operating breakeven higher operating leverage increases
operating breakeven point
Financial LeverageFinancial Leverage
The existence of fixed financial costs such as interest
When a change in EBIT results in a larger change in EPS
Financial LeverageFinancial Leverage
Degree of financial leverage (DFL) the percentage change in EPS that results
from a given percentage change in EBIT
⎟⎠⎞
⎜⎝⎛Δ
⎟⎠⎞
⎜⎝⎛Δ
==
EBITEBITEPSEPS
EBIT in change PercentageEPS in change Percentage
DFL
Financial LeverageFinancial Leverage
( )BEP Financial-EBITEBIT
I-EBITEBIT
DFL ==
Combining Operating Combining Operating and Financial Leverageand Financial Leverage
The greater degree of operating leverage, or fixed operating costs for a particular level of operations, the more sensitive EBIT will be to changes in sales volume
Combining Operating Combining Operating and Financial Leverageand Financial Leverage
The greater degree of operating leverage, or fixed operating costs for a particular level of operations, the more sensitive EBIT will be to changes in sales volume
The greater the degree of financial leverage (or fixed financial costs for a particular level of operations), the more sensitive EPS will be to changes in EBIT
Combining Operating Combining Operating and Financial Leverageand Financial Leverage
If a firm has a considerable amount of both operating and financial leverage, then a small change in sales will lead to wide fluctuations in EPS
Degree of total leverage (DTL) the percentage change in EPS resulting
from a change in sales
Combining Operating Combining Operating and Financial Leverageand Financial Leverage
( )
( )
( )( )[ ] IFVPQ
V-PQI-EBIT
VCS
BEP Financial-EBITprofit Gross
BEP Financial-EBITEBIT
EBITprofit Gross
DTL
−−−=
−=
=
×=
Using Leverage and Using Leverage and Forecasting for ControlForecasting for Control
Changes in operations affect income, which impacts on the balance sheet and the financing needs of the firm
Forecasted results and their impact can be adjusted ahead of time
Feedback needs evaluated
Cash BudgetingCash Budgeting
Cash budget a schedule showing cash receipts, cash
disbursements, and cash balances for a firm over a specified time period
Target (minimum) cash budget the minimum cash balance a firm desires to
maintain in order to conduct business
Cash BudgetingCash Budgeting
Disbursements and receipts method (scheduling) the net cash flow is determined
by estimating the cash disbursements andthe cash receipts expected to be generated each period
End of Chapter 8End of Chapter 8
Financial Planningand Control