1. MIR 889: Financial Literacy for Non- Financial Managers Business Planning Tools 1

2. Plan for the Day 2 Business Planning – why and how Linking HR to the corporate plan Key Tools CBI, ROI, Payback, Break Even Business Cases

3. 3 What is a Business Plan?

4. Why Bother? Stable business Reasonable rate of return Low debt Lots of experience in the organization No clear threats, business as usual Got along without one for a long time Who needs the paper and time this is going to take? 4

5. It’s Called Survival and Sustainability If you stay the same, the market, product and service mix, technology, cost structure etc do not. Few firms survive on their own – dependencies? Employees have to know where they are going and how they will be judged against a goal. Risk and adaptability 5

6. 6 Who wants to see a business plan and who, aside from your mother, do you want to see your business plan?

7. Key Features of Business Planning Not just for start ups Understanding the business environment: history, industry overview, your position in it Your product/service – what makes it unique Your goal: sales, product launch, consolidation, aspirations with boots on What it takes to get there: money, people, infrastructure, information, systems Risks and mitigation strategies Marketing plan Financing plan 7

8. How to write a really bad business plan Unrealistic financial projections –Overestimate value of company –Underestimate costs Failure to understand target market Awash in hyperbole and self-congratulations Bad research 8

9. How to write a really bad business plan Misunderstanding the demand, markets or competitors Hiding you weaknesses Ignoring or downplaying your risks, even when they are obvious Tsunami of verbiage Inconsistency in use of facts and numbers Failure to pass the “Would my mother tell me to sharpen up and speak plainly test.” 9

10. Business Plans Bewares Projections and assumptions are just that: seldom in the end are these proven to be accurate. Lock-in on plans lock out opportunity, i.e., positive risk 10 “Everybody has a plan until they get punched in the face.” – attributed to Mike Tyson, ex-criminal

11. Some things just don’t add up!

12. 12 Key Tools for Building a Business Plan and Assessing a Business Case Quick Tour of Key Concepts

13. 13 Key Tools in Building a Business Plan Cost Benefit Analysis (CBA) Net Present Value (NPV) Sensitivity Analysis Payback Period Return on Investment All these are inter-related tools. None is fool proof.

14. 14 Steps in conducting a CBA  Identify the costs  Identify the benefits  Enter the costs and benefits into the financial calculator  Assess the financial indicators to determine if the project is financially favourable.

15. 15 Defining Costs Capital costs Operating costs Development costs Operational costs Maintenance costs By type: By behaviour:By time: By function:  Fixed costs  Variable costs  Recurring costs  Non-recurring costs There are different ways of defining costs:

16. 16 Capital Costs Capital costs are the expenses incurred in purchase of items that are recorded as assets; their value is depreciated over time and they are recorded in the Balance Sheet. *Non-consumable materials are capital costs because these are materials that persist (eg. furniture, bricks) Equipment Non-consumable Materials* Infrastructure Identify the capital costs for the project for the following items:

17. 17 Operating Costs Operating costs are expenses incurred in the execution of the project or in the operation of the business (after the project) They are not depreciated over time and are recorded in the Income Statement. Internal business resources Internal IT resources External resources Office accommodation Licenses Support Training System administration Equipment hire Consumable materials* Travel Accommodation

18. Identifying the Benefits Identify the benefits that the project will provide, and the value that can be assigned to each benefit. What are the pitfalls in identifying benefits? 18

19. 19 The Process of Cost/Benefit Analysis Calculate the costs One time costs Ongoing or Repeated Costs Opportunity costs Calculate the Benefits One time benefits Ongoing or Benefits Savings Improved Services Calculate the Return on Investment = ROI Benefits/Costs × 100% = ROI

20. 20 Time Value of Money Principle Money in hand now is worth more than the right to receive money in the future because money in hand now can be invested to earn interest.

21. 21 Time Value of Money

22. 22 Present Value Project evaluation usually requires comparing costs and benefits from different time periods Dollars across time periods are not immediately comparable, because of inflation and returns in the market.

23. 23 Present Value: Present Dollars into the Future Suppose you invest $100 today in the bank –At the end of year 1, it is worth (1+.05)x$100, or $105 –At the end of year 2, it is worth (1+.05)x$105, or $110.25 –The interest compounds over time, that is the interest is also earning interest

24. 24 Present Value: Present Dollars into the Future Define –R=initial investment amount –r=rate of return on investment –T=years of investment The future value (FV) of the investment is:

25. 25 Present Value: Future Dollars into the Present Present value is an important concept A $1,000,000 payment 20 years from now is only worth today: –$376,889 if r=.05 –$148,644 if r=.10

26. 26 Net Present Value Net Present Value (NPV) is a means to calculate whether the company will be better or worse off if it make a capital investment. It does so by adding the present value of outflows and the present value of inflows. It shows the value of a stream of future cash flows discounted back to the present by some percentage that represents the minimum desired rate of return, often called the cost of capital. NPV = PV Inflows – PV Outflows

27. 27 Sensitivity Analysis Projects do not always run to plan. Costs and benefits estimated at an early stage of a project may indicate a profitable project, but this profit could be eroded by an increase in costs or a decrease in the value of the benefits (the revenue). Sensitivity analysis provides a means of determining the financial impact of this type of fluctuation. By entering an anticipated percentage increase in costs or decrease in revenue the financial impact on the project can be identified by looking at the change to the NPV or IRR measures.

28. Need to Perform Sensitivity Analysis There is usually considerable uncertainty about predicted costs and benefits Sensitivity analysis shows how these uncertainties affect the CBA results Three types of sensitivity analysis: –worst/best case analysis –partial sensitivity analysis –Monte Carlo sensitivity analysis If the sign of the net benefits does not change after considering the range of scenarios, there can be confidence in the CBA results

29. 29 General decision rule in applying NPV

30. Payback Period When the cash generated is sufficient to repay the investment, then payback is said to have occurred. Consider the text example of the patent purchase with an initial investment of $300,000. Each year, the project’s sales revenues are $500,000, and each year the cash expenses total $425,000. Each year the project generates $75,000 in cash. Note that the amortization expense is not relevant to a payback calculation, as it is not represented by a cash flow

31. Projected Cash Flow Year 0 123456 Cash flow (’000) $(300) $ 75 $ 75 $ 75 $75 $75 $75 Cumulative cash flow $(300) $(225) $(150) $(75) nil Payback point (end of Year 4)

32. Use of Payback Analysis Time for investment to pay for itself Amount of borrowing or cash input from reserves would be needed Tolerance for slow return versus fast – look at shareholder value versus long-term sustainability investment

33. Return on Investment Traditionally focused on capital investment Ease of quantification (supposedly) ROI = (Operating Income ÷ Total Assets) × 100% ROI = (Benefit-Cost) × 100 Cost OR

34. Return on Investment Analysis Year ($ ’000) 0 1 2 3 4 56 Cash flow (300) 75 7575 757575 Amortization 50 5050 50 50 50 Operating income 25 2525 25 25 25 ROI = $25,000/$300,000 × 100% = 8.33% The return on investment for this project is 8.33%.

35. ROI The operating income from the investment in the patent is $25,000 per year for six years with a cash flow of $75,000 per year. To get from cash flow to net income, deduct amortization using a straight-line amortization approach, the entire $300,000 investment will be written off in six annual amounts of $50,000 each. Cash flow of $75,000, less $50,000 of amortization expense, leaves operating income of $25,000 per year. The return on investment for this project is 8.33%.

36. CBA, NPV, ROI etc. in HR Business Planning Used well, it can reinforce a business proposal Forces greater clarity with respect to outcomes expected Challenges of quantification HR outcomes uncertain = risk 36

37. 37 Creating a Business Case for the Financial Plan, Budget and Spending Plan for the Firm

38. A Business Case is Not a Business Plan More specific Works within business plan Works here in planning and also in budget decision making 38

39. Building the Case: Why? Business cases provide the argument for change in how your company spends money and on what. To demonstrate the strategic alignment and sense of urgency of the project in question. (Does this project make sense?) To define the scope of the proposed project. To show the financial and operational benefits associated with the proposed project. 39 A good business case or proposal should serve as the foundation for an implementation plan or roadmap.

40. Questions a good business case has to answer What exactly do you want to do? What exactly do you want to do? How does it link to what we want to do? How does it link to what we want to do? What is the history behind this idea, how does it link to what is happening now, what we have tried before? What is the history behind this idea, how does it link to what is happening now, what we have tried before? How much will it cost? Are these costs fully inclusive and for how long? How much will it cost? Are these costs fully inclusive and for how long? 40

41. Questions a good business case has to answer What are risks you are addressing? What risks does it create and how do you mitigate them? What are risks you are addressing? What risks does it create and how do you mitigate them? What are the measures of success? What are the measures of success? What is the implementation plan? When and how? What is the implementation plan? When and how? What can you stop doing that will fund this? What can you stop doing that will fund this? 41 A thick tedious manuscript, laden with consultant-speak is not a business case. It is a disaster. A business case is about communicating in the language of the decision maker.

42. Structure of a Business Case 42 Summary Write it last Provide big picture Objectives Why the change Current state/future state Alternatives Costs and benefits Comparative risks Preferred Alternative Implementation Plan Costs Timelines What decisions are needed

43. Selling the Business Case Understand the context Understand the context Never surprise the decision-makers Never surprise the decision-makers Engage supporters – what does HR say about your plans for more training in your unit? What does your corporate financial analyst think about those IT upgrades you need? Engage supporters – what does HR say about your plans for more training in your unit? What does your corporate financial analyst think about those IT upgrades you need? Compare and contrast Compare and contrast Link to known measures – where do you fit. Link to known measures – where do you fit. Never forget history – don’t look like you are asking for money your bosses or funders thought they gave you last year Never forget history – don’t look like you are asking for money your bosses or funders thought they gave you last year 43 The art of biding your time, waiting for that punctuation or window of opportunity in the established budget cycle.

44. Fault Lines and Dangers for the Budget Advocate Avoid one-time money that creates long-term commitments Avoid one-time money that creates long-term commitments Check the conditions of approvals Check the conditions of approvals What makes sense to you may be nonsense to others. What makes sense to you may be nonsense to others. Assume that the business case sells itself Assume that the business case sells itself Overpromising – you may be fooling yourself Overpromising – you may be fooling yourself Track record Track record Threats and wolf crying Threats and wolf crying 44 Be careful about what you agree to do to get more funds.

45. Quick Checklist: Winning Techniques: what you need to do to win support Start with what you have done with what you got in past years: focus on accomplishments Start with what you have done with what you got in past years: focus on accomplishments Clearly show what substantive factors are driving your current presentation Clearly show what substantive factors are driving your current presentation Address your weaknesses and risks frontally, e.g. Delayed recruitment, overtime, major incidents Address your weaknesses and risks frontally, e.g. Delayed recruitment, overtime, major incidents Avoid dramatic, crisis-oriented language – save that you may need it. Avoid dramatic, crisis-oriented language – save that you may need it. Show what has changed year to year – most budgets only have incremental changes. Show what has changed year to year – most budgets only have incremental changes. 45

46. Quick Checklist: Winning Techniques: what you need to do to win support Focus on the good management of resources and what efficiencies you have achieved – everybody but you think you can do more with what you have Focus on the good management of resources and what efficiencies you have achieved – everybody but you think you can do more with what you have Avoid detail – use graphics (but be ready with answers to questions) Avoid detail – use graphics (but be ready with answers to questions) Make it concrete – numbers scare people, but the number of new officers or cost per household of the increase are a nice focus Make it concrete – numbers scare people, but the number of new officers or cost per household of the increase are a nice focus Show the impact of what you are proposing Show the impact of what you are proposing Signal future issues – you will be back. Signal future issues – you will be back. 46