TOPIC: LONG-TERM FINANCIAL PLANNING

1. TOPIC: LONG-TERM FINANCIAL PLANNING Objectives: • Forecast financial statements to plan for future operations and asset needs • Determine the timing and amount of possible long-term additional financing needs • Take-Away: “Failing to Plan is Planning to Fail” RW Melicher IBanking 2013

2. I. FINANCIAL PLANNING PROCESS 1. Identify Revenue Goals & Objectives: A. Products/Services B. Revenue Growth Rates & Market Shares 2. Determine Asset Investment Needed to Meet the Goals & Objectives: A. Working Capital (required cash, receivables, & inventories) B. Fixed Assets (CAPEX for PP&E)

3. Financial Planning (Cont’d) 3. Decide How to Finance the Investment in Assets: A. Use Internally Generated Funds (i.e., retained earnings) B. Use Spontaneous Short-Term Liabilities (payables & accruals) C. Determine Whether Additional Funds are Needed D. Consider Financing Alternatives E. Choose a Specific Financing Mix

8. II. FORMULA METHOD FOR ESTIMATING ADDITIONAL FUNDS NEEDED (AFN) Assumes Constant Ratio Relationships AFN = A/S(Sales) - L/S(Sales) - ProjS(PM)(1 - %Div. Payout) AFN = Increase in Assets - Spontaneous Increase in Liabilities - Internally Generated 8Funds Retained

9. Formula Method (Cont’d) Where: A= Total Assets S= Net Sales S = Change in Sales [Forecasted - Current] L = Accounts Payable and Accruals [i.e., liabilities expected to change spontaneously with change in sales] ProjS = Forecasted Sales for the Next Period PM= Profit Margin [Net Income/Net Sales] %Div. Payout = Cash Dividends/Net Income

11. III. FINANCIAL PLANNING WITH PROJECTED FINANCIAL STATEMENTS Forecasting with Spreadsheets Starting Point: Business As Usual (BAU) Case [Existing and/or Past Ratio Relationships Provide the Basis for Initial Financial Projections]

12. A. Getting Started 1. Make Sales Forecast (for 1 to 5-year plans) [Start with last year’s sales and multiply by (1 + forecasted growth rate)] 2. Establish past relationships between expenses and sales and between sales and balance sheet items 3. Prepare: (a.) an “Input Data Table” (including forecasted dollar amounts and constant ratio relationships), or (b.) past financial statements expressed as a percent of sales.

13. B. Prepare Forecasted Income Statement 1. “Circularity” problem: In order to complete the Income Statement, you need to estimate the amount of interest that will be paid on debt. However, you don’t know the amount of debt you will need until the income statement is completed.] 2. Options: a. Estimate interest based on the amount of debt outstanding at end of prior period b. Use iteration process or Excel function

14. C. Prepare Forecasted Balance Sheet 1. Project accounts that are expected to vary with sales (use constant ratio or percent of sales methods) 2. Project dollar amounts for accounts that are not expected to vary with sales 3. Add the “new” retained earnings (net income less dividends) amount to last year’s retained earnings to get new total amount

15. Forecasted Balance Sheet (cont’d) 4. Use a “plug” account (“New” Debt or AFN) in liabilities/equity section to make the Balance Sheet balance 5. Use an “IF” statement to avoid negative debt amounts a. “Excess cash” account in Assets section =IF(PLUG<0,-PLUG,0) b. “New” Debt or AFN account in Liab/Equity section =IF(PLUG>0,+PLUG,0)

16. D. Other Considerations 1. Prepare Forecasted Statement of Cash Flows [Optional: Used to make sure Income Statements and Balance Sheets are internally consistent. Also useful when valuing a firm.] 2. Conduct a Sensitivity Analysis [Objective: To identify “key” value drivers. For example, Prepare Two-Variable “Data Tables”]

17. Other Considerations (cont’d) 3. Conduct Scenario Analyses [Forecast is usually based on certain economic conditions (e.g., rapid growth, average growth, slow growth)] 4. Estimate the timing and possible range of financing needs