1. 1-1 Corporation Advantages ◦ Limited liability ◦ Unlimited life ◦ Separation of ownership and management ◦ Transfer of ownership is easy ◦ Easier to raise capital Disadvantages ◦ Separation of ownership and management ◦ Double taxation (income is taxed at the corporate rate and then dividends are taxed at the personal rate) A business created as a distinct legal entity owned by one or more individuals or entities. LO2

2. 1-2 Financial Manager Financial managers try to answer some or all of these questions The top financial manager within a firm is usually the Chief Financial Officer (CFO) ◦ Treasurer – oversees cash management, capital expenditures and financial planning ◦ Controller – oversees taxes, cost accounting, financial accounting and data processing LO1

3. 1-3 Financial Management Decisions Capital budgeting ◦ What long-term investments or projects should the business take on? Capital structure ◦ How should we pay for our assets? ◦ Should we use debt or equity? Working capital management ◦ How do we manage the day-to-day finances of the firm? LO1

4. Areas of Financial Management 4

5. 1-5 Cash Flows to and from the Firm LO5

6. FINANCIAL PLANNING AND CONTROL Chapter 17 6

7. Chapter 17 Outline 1. What is financial planning 2. Financial planning models 3. The percentage of sales approach 4. External financing and growth 5. Caveats in financial planning 7

8. What is Financial Planning? Financial planning formulates the way financial goals are to be achieved Financial plan – a statement of what is to be done in the future What is the goal of financial management? 8

9. Short vs. Long-term Financial Planning Short-term planning – analysis of decisions that affect current assets and current liabilities: o Cash and liquidity management o Credit and inventory management Long-term planning – focuses on the “big picture”: o Capital budgeting o Dividend policy o Financial structure 9

10. Dimensions of Financial Planning 1. Financial horizon – the long-range time period the financial planning process focuses on, usually the next 2-5 years 2. Aggregation – process by which smaller investment proposals of each of a firm’s operational units are added up and treated as one big unit 3. Alternative set of assumptions about important variables (scenario analysis) 10

11. Aims of Financial Planning (1) 1. Examining interactions – make explicit the linkages between investment proposals for the different operating activities of the firm and financing choices available to the firm 2. Exploring options – develop, analyze and compare many different scenarios in a consistent way 3. Avoiding surprises – identify what may happen to the firm if different events take place 11

12. Aims of Financial Planning (2) 4. Ensuring feasibility and internal consistency – are the company’s goals compatible? 5. Communication with investors and lenders 12

13. Financial Planning Model: Elements (1) 1. Sales forecast – given as a growth rate in sales 2. Pro forma statements – a financial plan has a forecasted balance sheet, an income statement, and a statement of cash flows 3. Asset requirements – firms’ total capital budget consists of changes in total fixed assets and net working capital 13

14. Financial Planning Model: Elements (2) 4. Financial requirements – how to raise the capital; dividend policy and debt policy 5. Cash surplus or shortfall (“plug”) – the designated source of external financing needed to deal with any shortfall in financing and to bring the balance sheet into balance 6. Economic assumptions – level of interest rates, the firm’s tax rate and sales forecast 14

15. Simple Financial Planning Model All variables are tied to sales and this relationship is optimal The growth in assets requires the management to decide how to finance the growth (debt vs. equity) o Dividend policy o Financing policy 15

16. Simple Balance Sheet Format 16

17. Simple Financial Planning Model: example (1) COMPUTERFIELD CORPORATION Financial Statements Income statementBalance sheet Sales$1,000Assets$500Debt$250 Costs800Equity250 Net Income$200Total$500Total$500 17

18. (2) If sales increase by 20% - income statement Pro forma income statement Sales 1200(1000) Costs 960(800) Net Income 240(200) 18

19. (3) If sales increase by 20% - balance sheet Pro forma balance sheet (dividends as the plug variable) AssetsDebt300 600Equity300 (+50) Total 600 19 Pro forma balance sheet (debt as the plug variable) AssetsDebt110 (-140) 600Equity490 (+all NI) Total600Total600

20. Dividend s as the plug variable 20 Retained earnings 50 NI=240 Dividends =190 Dividend payout ratio = Cash dividends/Net income = $ 190/$240 *100= 79.17% Retention ratio (plowback ratio) = Retained earnings/Net income = $50/$240*100 = 20.83% or retention ratio = 1- dividend payout ratio = 1-0.7917= 0.2083