1. Financial Planning and Control Chapter 8

2. Financial Planning uThe 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

3. Financial Control uThe phase in which financial plans are implemented uControl deals with the feedback and adjustment process required to ensure adherence to plans and modification of plans because of unforeseen changes

4. Sales Forecasts uA forecast of a firm’s unit and dollar sales for some future period

5. Sales Forecasts uA forecast of a firm’s unit and dollar sales for some future period uGenerally based on recent sales trends plus forecasts of the economic prospects for the nation, region, industry, and so forth

6. Projected (Pro Forma) Financial Statements uProject 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

7. Projected Balance Sheet Method uA method of forecasting financial requirements based on forecasted financial statements F 1. Forecast the Income Statement F 2. Forecast the Balance Sheet v Adjust for spontaneously generated funds obtained from routine business transactions

8. Projected Balance Sheet Method uA method of forecasting financial requirements based on forecasted financial statements F 1. Forecast the Income Statement F 2. Forecast the Balance Sheet F 3. Determine how to raise the additional funds needed

9. Projected Balance Sheet Method uA method of forecasting financial requirements based on forecasted financial statements F 1. Forecast the Income Statement F 2. Forecast the Balance Sheet F 3. Determine how to raise the additional funds needed F 4. Financing feedbacks

10. Projected Balance Sheet Method uFinancing feedbacks are the effects on the income statement and balance sheet of actions taken to finance forecasted increases in assets

11. Projected (Pro Forma) Financial Statements uAnalysis of the forecast F determine if the forecast meets the firm’s financial targets F planned management changes must be incorporated into the forecasts F iterative process

12. Other Considerations in Forecasting uExcess capacity

13. Other Considerations in Forecasting uEconomies of scale F variable cost of goods sold ratio changes with size of the firm F this affects the addition to retained earnings, and thus the AFN

14. Other Considerations in Forecasting uLumpy assets F assets that cannot be acquired in small increments, but must be obtained in large, discrete amounts

15. Other Considerations in Forecasting uLumpy assets F assets that cannot be acquired in small increments, but must be obtained in large, discrete amounts F small increase in sales can require significant increase in plant and equipment

16. Financial Control - Budgeting and Leverage uRelationship between sales volume and profitability under different operating conditions uControl phase and process

17. Operating Breakeven Analysis uAn analytical technique for studying the relationship among sales revenues, operating costs, and profits uOnly deals with the operating section of the income statement

18. Operating Breakeven Analysis uOperating breakeven point F represents the level of production and sales where operating income is zero F the point where revenues from sales just equal total operating costs

19. ---------------------------- 0 20 40 57 60 80 100 120 Units Produced and Sold(millions) Q BE 1,400 1,200 000 00 00 100 Revenues and Costs ($ millions) Total Sales Revenues (P x Q) 93.5 Total fixed Costs (F) Total Operating Costs (F + Q x V) Operating Breakeven Point (EBIT = 0) Operating Profit (EBIT > 0) 855 S BE Operating Loss (EBIT < 0) Breakeven Graph

20. Sales revenues (P x Q) = Total operating costs = Total variable costs + Total fixed costs (P x Q) = TOC = (V x Q) + F Breakeven Computation

21. Using Operating Breakeven Analysis uNew product decisions F required sales to achieve profitability uExpansion of operations F increase fixed and variable costs F increase sales uModernization and automation F increased fixed and reduced variable costs

22. Operating Leverage uThe existence of fixed operating costs, such that a change in sales will produce a larger change in operating income (EBIT)

23. Operating Leverage uDegree of operating leverage (DOL) F the percentage change in NOI (or EBIT) associated with a given percentage change in sales

24. Operating Leverage

25. uOperating leverage and operating breakeven F higher operating leverage increases operating breakeven point

26. Financial Leverage uThe existence of fixed financial costs such as interest uWhen a change in EBIT results in a larger change in EPS

27. Financial Leverage uDegree of financial leverage (DFL) F the percentage change in EPS that results from a given percentage change in EBIT

28. Financial Leverage

29. Combining Operating and Financial Leverage uThe 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

30. Combining Operating and Financial Leverage uThe 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 uThe 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

31. Combining Operating and Financial Leverage uIf 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 uDegree of total leverage (DTL) F the percentage change in EPS resulting from a change in sales

32. Combining Operating and Financial Leverage

33. Using Leverage and Forecasting for Control uChanges in operations affect income, which impacts on the balance sheet and the financing needs of the firm uForecasted results and their impact can be adjusted ahead of time uFeedback needs evaluated

34. Cash Budgeting uCash budget F a schedule showing cash receipts, cash disbursements, and cash balances for a firm over a specified time period uTarget (minimum) cash budget F the minimum cash balance a firm desires to maintain in order to conduct business

35. Cash Budgeting uDisbursements and receipts method (scheduling) F the net cash flow is determined by estimating the cash disbursements and the cash receipts expected to be generated each period

36. End of Chapter 8 Financial Planning and Control