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Saturday, September 12, 2009

Finance Chapter 18 - Long Term Financial Planning

Short term planning <12 months < long term plannning = typically 5 years "Planning Horizon" although some look out 10 yrs+.

Why build a financial plan? What do you get out of it?
- For contingency planning (aka scenario planning). a good financial plan should help you adapt as events unfold
- To Considering options.
- To force consistent

Financial Planning Models help planners explore the consequences of alternative strategies. Models range from sinple to ones that incorporate hundreds of equations.  They support the planning process by making it eaier and cheaper to construct forecast financial statements.

Components of a FPM
  • Inputs - The inputs to the FP consist of the firms current financial statements and its forecasts about the future.  The principal forecast is the likely growth in sales.
  • The planning Model - the model calculates implications of forecasts for profits, new investment and financing.
  • Outputs - the output consists of financial statements (income, balance sheets, cash flows). These are called pro formas. Can also be 'financial ratios'.
Def - percentage of sales models - Simple planning model in which sales forecasts are the driving variables and most other vars are proportional to sales.

NOTE: Financial models ensure consistency between growth assumptions (forecasts) and financing plans, but they do NOT identify the best financing plan

NOTE: Figure 18-2 has a great model spreadsheet

NOTE: Example 18.3 is a great exercise for excess capacity

While models help managers be consistent between their growth goals, investments and financing they can obscure the basic issues... Therefore it's good to have some 'rules of thumb'

Formula - Required External Financing = new investment - reinvested earnings
= (growth rate X assets) - reinvested earnings
This equation hilittes that the amount of external financing DEPENDS on the firm's projected growth.
Formula - Internal Growth Rate = maximum rate of growth without external financing
= reinvested earnings/assets

This means that a firm with a high volume of reinvested earnings relative to its assets can generate a higher growth rate without needing to raise more capital. AHA!
Formula: IGR = plowback ratio X ROE X equity/assets
= reinvested earnings/NetIncome X net Income/equity X equity /assets
This means that a firm can achieve a higher growth rate without raising capital by 
a) increasing plowback (reinvested earnings)
b) getting a higher ROE
c) keeping a low debt to asset ratio
NOTE: Example 18.4 , how to calculate internal growth rate
Def: . Sustainable Growth Rate - The highest growth rate the firm can maintain without increasing its financial leverage.
Formula: Sustainable Growth Rate = plowback ratio X ROE
= Reinvested earnings/NetIcome X NetIncome/equity


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