Financial Planning refers to – To estimate the future financing requirements in advance of when the financing will be needed. The process of planning is critical to force managers to think systematically about the future, despite the uncertainty of future.

Financial planning involves: (a) estimating the amount of capital to be raised; (b) determining the pattern of financing i.e., deciding on the form and proportion of capital to be raised; (c) and formulating the financial policies and procedures for procurement, allocation and effective utilization of funds

OBJECTIVES OF FINANCIAL PLANNING (a) To ascertain the amount of fixed capital as well as the working capital required in a given period; (b) To determine the amount to be raised through various sources using a judicious debt-equity mix; (c) To ensure that the required amount is raised on time at the lowest possible cost; (d) To ensure adequate liquidity so that there are no defaults in payments and all contingencies (any un forseen expenditure) are met without difficulty; and (e) To ensure optimal use of funds so that the business is neither starved of funds nor has unnecessary surplus funds at any point of time.

ESSENTIALS OF A SOUND FINANCIAL PLAN (a) The plan must be simple. (b) It must take a long term view. (c) It must be flexible. (d) It must ensure optimal use of funds. (e) The cost of funds raised should be fully taken into account and kept at the lowest possible level. (f) Adequate liquidity must be ensured.

TYPES OF CAPITAL REQUIREMENT 1. FIXED CAPITAL Fixed capital represents the requirement of capital for meeting the permanent or long-term financial needs of the business. It is primarily used for acquiring the fixed assets like land and buildings, plant and machinery, office equipment, furniture and fixtures etc. Fixed capital is required not only while establishing a new enterprise but also for meeting expansion requirement in the existing enterprises.

FACTORS DETERMING FIXED CAPITAL REQUIREMENT (a) Nature of business (b) Type of products (c) Size of business (d) Process of Production (e) Method of acquiring fixed assets

TYPES OF CAPITAL REQUIREMENT 2. WORKING CAPITAL Working capital represents the amount of funds invested in current assets like debtors, stock-in- trade and cash required for meeting day-to-day expenses, paying wages/salaries to its work- force and clearing dues of its creditors.

FACTORS DETERMING WORKING CAPITAL REQUIREMENT (a) Nature of business (b) Size of business (c) Length of production cycle (d) Inventory turnover rate (e) Credit policy (f) Seasonal Fluctuations

Most firms engage (use) in three types of planning: •– Strategic planning, – Long-term financial planning, and – Short-term financial planning

• Strategic plan defines, in very general terms, how the firm plans to make money in the future. It serves as a guide for all other plans. The long-term financial plan generally encompasses a period of one to three/five years and incorporates estimates of the firm’s income statements and balance sheets for each year of the planning horizon.

The short-term financial plan has got a period of one year or less and is a very detailed (particular) description of the firm’s anticipated (forecasted) cash flows. • The format typically used is a cash budget, which contains revenue projections and expenses in the month in which they are expected to occur for each operating unit of the company

Developing a Long-Term Financial Plan • Forecasting a firm’s future financing needs using a long-term financial plan can be thought of in terms of three basic steps: 1.Construct a sales forecast 2.Prepare pro-forma financial statements 3.Estimate the firm’s financing needs

Developing a Long-Term Financial Plan (cont.) • Step 1: Construct a Sales Forecast – Sales forecast is generally based on: 1. past trend in sales; and 2. the influence of any anticipated events that might affect that trend.

Step 2: Prepare Pro Forma Financial Statements – Pro forma financial statements help forecast a firm’s asset requirements needed to support the forecast of revenues (step 1). – The most common technique is percent of sales method that expresses expenses, assets, and liabilities for a future period as a percentage of sales.

• Step 3: Estimate the Firm’s Financing Needs – Using the pro forma statements we can extract (introduce) the cash flow requirements of the firm.

FINANCIAL PLANNING Financial planning involves analyzing short-term and long-term money flows to and from the company. Three key steps of financial planning: Forecasting the firm’s short-term and long-term financial needs. Developing budgets to meet those needs. Establishing financial controls to see if the company is achieving its goals. See Learning Objective 2: Outline the financial planning process and explain the three key budgets in the financial plan.

FINANCIAL FORECASTING Short-Term Forecast -- Predicts revenues, costs and expenses for a period of one year or less. Cash-Flow Forecast -- Predicts the cash inflows and outflows in future periods, usually months or quarters. Long-Term Forecast -- Predicts revenues, costs, and expenses for a period longer than one year and sometimes as long as five or ten years. See Learning Objective 2: Outline the financial planning process and explain the three key budgets in the financial plan.

BUDGETING Budget -- Sets forth management’s expectations for revenues and allocates the use of specific resources throughout the firm. Budgets depend heavily on the balance sheet, income statement, statement of cash flows and short-term and long-term financial forecasts. The budget is the guide for financial operations and expected financial needs. See Learning Objective 2: Outline the financial planning process and explain the three key budgets in the financial plan. Budgeting is critical for the organization to control expenses and to understand revenue expectations. Think of a budget as a guidepost or a reference point for the organization’s managers.

TYPES of BUDGETS Capital Budget -- Highlights a firm’s spending plans for major asset purchases that often require large sums of money. Cash Budget -- Estimates cash inflows and outflows during a particular period like a month or quarter. Operating (Master) Budget -- Ties together all the firm’s other budgets and summarizes its proposed financial activities. See Learning Objective 2: Outline the financial planning process and explain the three key budgets in the financial plan.

FINANCIAL PLANNING See Learning Objective 2: Outline the financial planning process and explain the three key budgets in the financial plan. This slide is based on Figure 18.2. The capital and cash budgets are part of the operating (master) budget.

ESTABLISHING FINANCIAL CONTROL Financial Control -- A process in which a firm periodically compares its actual revenues, costs and expenses with its budget. See Learning Objective 2: Outline the financial planning process and explain the three key budgets in the financial plan. Financial controls also help reveal which specific accounts, departments and people are varying from the financial plan.

FACTORS USED in ASSESSING FINANCIAL CONTROL Is the firm meeting its short-term financial commitments? Is the firm producing adequate operating profits on its assets? How is the firm financing its assets? Are the firms owners receiving an acceptable return on their investment? See Learning Objective 2: Outline the financial planning process and explain the three key budgets in the financial plan. This slide highlights the factors used in assessing financial control. Financial control is used in conjunction with the firm’s budget to ensure the organization is meeting its commitments and goals. Ask students: Why is it important for the CFO to maintain financial control?

KEY NEEDS for OPERATIONAL FUNDS in a FIRM Managing day-by-day needs of the business Controlling credit operations Acquiring needed inventory Making capital expenditures See Learning Objective 3: Explain why firms need operating funds.

HOW BUSINESSES CAN IMPROVE CASH FLOW Be more aggressive in collecting accounts receivable. Offer customers discounts for paying early. Take advantage of special payment terms from vendors. Raise prices. Use credit cards discriminately. See Learning Objective 3: Explain why firms need operating funds. The slide lists methods small businesses use to improve cash flow. Lack of cash flow can impact a business of any size and may lead to the business shutting its doors. It is critical that students understand cash is king for a business of any size. Source: American Express Small Business Monitor.

GOOD FINANCE or BAD MEDICINE? You are a new hospital administrator at a small hospital that, like many others, is experiencing financial problems. You suggest discontinuing the hospital’s large stockpile of drugs and shift to ordering them just when they are needed. Some like the idea, but the doctors claim you are sacrificing patients’ well-being for cash. What do you do? What could be the result of your decision? See Learning Objective 2: Outline the financial planning process and explain the three key budgets in the financial plan.

USING ALTERNATIVE SOURCES of FUNDS Debt Financing -- The funds raised through various forms of borrowing that must be repaid. Equity Financing -- The funds raised from within the firm from operations or through the sale of ownership in the firm (such as stock). See Learning Objective 3: Explain why firms need operating funds.

SHORT and LONG-TERM FINANCING Short-Term Financing -- Funds needed for a year or less. Long-Term Financing -- Funds needed for more than a year. See Learning Objective 3: Explain why firms need operating funds.

WHY FIRMS NEED FINANCING See Learning Objective 3: Explain why firms need operating funds. It is important for management to understand that they need capital for a variety of short-term and long-term situations.

TYPES of SHORT-TERM FINANCING Trade Credit -- The practice of buying goods or services now and paying for them later. Businesses often get terms such as 2/10 net 30 when receiving trade credit. Promissory Note -- A written contract agreeing to pay a supplier a specific sum of money at a definite time. See Learning Objective 4: Identify and describe different sources of short-term financing. Trade credit is the most common form of financing. 2/10 net 30 means a firm can receive a 2% discount if the bill is paid within 10 days. If they choose not to take the discount, the net amount is due in 30 days.

TYPES of SHORT-TERM FINANCING Many small firms obtain short-term financing from friends and family. If asking for help from family or friends, it’s important both parties: Agree to specific loan terms Put the agreement in writing Arrange for repayment the same way they would for a bank loan See Learning Objective 4: Identify and describe different sources of short-term financing.

DIFFICULTY of OBTAINING SHORT-TERM FINANCING Banks generally prefer to lend short- term money to larger, more established businesses. See Learning Objective 4: Identify and describe different sources of short-term financing. The recent financial crisis has made it difficult for even promising and well-organized businesses to get loans.

DIFFERENT FORMS of SHORT-TERM LOANS Commercial banks offer short-term loans like: Secured Loans -- Backed by collateral. Unsecured Loans -- Don’t require collateral from the borrower. Line of Credit -- A given amount of money the bank will provide so long as the funds are available. Revolving Credit Agreement -- A line of credit that’s guaranteed but comes with a fee. See Learning Objective 4: Identify and describe different sources of short-term financing.

FACTORING Factoring -- The process of selling accounts receivable for cash. Factors charge more than banks, but many small businesses don’t qualify for loans. See Learning Objective 4: Identify and describe different sources of short-term financing. 18-34

COMMERCIAL PAPER Commercial Paper -- Unsecured promissory notes in amounts of $100,000+ that come due in 270 days or less. Since commercial paper is unsecured, only financially stable firms are able to sell it. See Learning Objective 4: Identify and describe different sources of short-term financing. The commercial paper market is an important source of funding for financially stable companies. During the financial crisis which started in 2008, this important market completely shut down, forcing the Federal Reserve to step in and assist many companies with their short-term financing by purchasing their commercial paper.

WAYS to RAISE START-UP CAPITAL Seek out a microloan from a microlender Use asset-based lending or factoring Turn to the web and seek out peer-to-peer lending Research local banks Sweet-talk vendors you want to do business with See Learning Objective 4: Identify and describe different sources of short-term financing. This slide profiles some of the unique methods businesses can use to raise capital. Trade credit and factoring are two of the oldest methods of raising capital. To start a discussion with students ask the advantages and disadvantages of using each of these methods. Peer-to-peer lending involves individuals loaning money to other individuals or businesses thus bypassing traditional lending outlets. For more information on this new method use loan statistics from www.lendingclub.com Sources: St. Louis Small Business Monthly, January 2014 and Entrepreneur, www.entrepreneur.com, accessed November 2014.

HOW COMPANIES FAIL to RAISE CAPITAL There is no formalized business plan to show need. The company does not know how much to request from a lender. Poor credit. Management is unrealistic about growth. See Learning Objective 4: Identify and describe different sources of short-term financing.

SETTING LONG-TERM FINANCING OBJECTIVES Three questions of financial managers in setting long- term financing objectives: What are the organization’s long-term goals and objectives? What funds do we need to achieve the firm’s long-term goals and objectives? What sources of long-term funding (capital) are available, and which will best fit our needs? See Learning Objective 5: Identify and describe different sources of long-term financing.

USING LONG-TERM DEBT FINANCING Long-term financing loans generally come due within 3 -7 years but may extend to 15 or 20 years. Term-Loan Agreement -- A promissory note that requires the borrower to repay the loan with interest in specified monthly or annual installments. A major advantage of debt financing is the interest the firm pays is tax deductible. See Learning Objective 5: Identify and describe different sources of long-term financing. Lenders may also require certain restrictions to force the firm to act responsibly.

USING DEBT FINANCING by ISSUING BONDS Indenture Terms -- The terms of agreement in a bond issue. Secured Bond -- A bond issued with some form of collateral (i.e. real estate). Unsecured (Debenture) Bond -- A bond backed only by the reputation of the issuing company. See Learning Objective 5: Identify and describe different sources of long-term financing. It is critical that students understand bonds are a form of debt issued by companies. The terms debt, bond, and loan are all four letter words and basically mean the same thing. Students should walk away from this discussion knowing that the government and private industry compete insofar as the sale of bonds to the investing public. The issue of investor security can easily be addressed here, as well as the differences in interest rates paid on specific bonds depending on the issuer. Students should understand that U.S. Government bonds are considered the safest investment in the bond market. There is a high probability that students will be familiar with U.S. Government Savings Bonds, and may in fact have received such a bond as a gift. They clearly need to understand the difference between such bonds and issues involving investments in corporate bonds.

SECURING EQUITY FINANCING A company can secure equity financing by: Selling shares of stock in the company. Earning profits and using the retained earnings as reinvestments in the firm. Attracting Venture Capital -- Money that is invested in new or emerging companies that some investors believe have great profit potential. See Learning Objective 5: Identify and describe different sources of long-term financing.

DIFFERENCES BETWEEN DEBT and EQUITY FINANCING See Learning Objective 5: Identify and describe different sources of long-term financing. This slide is based on Figure 18.6. Financial managers must evaluate the benefits of issuing debt or equity and then weigh those benefits with the drawbacks.

USING DEBT vs. EQUITY FINANCING See Learning Objective 5: Identify and describe different sources of long-term financing. Financial managers must evaluate the benefits of issuing debt or equity and then weigh those benefits with the drawbacks.