Chapter 26

1. Chapter26 Financial Planning and Strategy

2. LEARNING OBJECTIVES • Understand the difference between financial forecasting and financial planning • Explain the components of a financial plan • Discuss the technique of financial forecasting • Develop an approach to construct a financial model • Examine the features and implications of sustainable growth model • Show the linkage between strategic planning and planning

3. INTRODUCTION • Financial planning indicates a firm’s growth, performance, investments and requirements of funds during a given period of time, usually three to five years. • It involves the preparation of projected or pro forma profit and loss account, balance sheet and funds flow statement. • Financial planning help a firm’s financial manager to regulate flows of funds which is his primary concern.

4. Strategic Decision-making Framework • Strategy is the foundation for any planning system of a firm. • The business portfolio models are most popular and useful to understand the firm’s strategic concerns and choices and plan for the future. • The market growth-market share model , popularised by the Boston Consulting Group (BCG) • The nine-cell matrix model developed by the General Electric Company

5. Market growth-market share model

6. Summary of Strategic Decision-Making Framework • A firm operates in a complex environment. • Strategy is a central theme that establishes a match between the firm’s competences and opportunities created by environment changes. • A firm is multi-directed; strategy is a link between the multiple goals of the firm and its plans and policies. • Product-market scope, competitive advantages, distinctive competences and synergy are the most important components of strategy. • Market dominance (particularly, during the growth stage) is the most desirable strategy. • A firm should have a balanced portfolio of businesses.

7. Strategic Financial Planning • Two important tasks of the financial manager are: • Allocation of funds (viz. investment decision). • Generation of funds (viz. financial decision). • The theory of finance makes two crucial assumptions: • First, the objective of the firm is to maximise the wealth of shareholders. • Second, capital markets are efficient.

8. Financial Planning • Financing planning process involves the following facets: • Evaluating the current financial condition of the firm. • Analysing the future growth prospects and options. • Appraising the investment options to achieve the stated growth objective. • Projecting the future growth and profitability. • Estimating funds requirement and considering alternative financing options. • Comparing and choosing from alternative growth plans and financing options. • Measuring actual performance with the planned performance.

9. Financial Forecasting and Modelling • Financial forecasting is an integral part of financial planning. It uses past data to estimate the future financial requirements. • A financial planning model establishes the relationship between financial variables and targets, and facilitates the financial forecasting and planning process. • A financial planning model has the following three components: • Inputs • Model • Output

10. Constructing Financial Model • To prepare the next year’s proforma profit and loss statement, balance sheet and funds flow statement, the planning team through a consultative process in the company, made several assumptions and models about the relationships between financial variables. • Based on the model inputs and assumptions, the planning team developed the model equations for proforma profit and loss statement, funds flow statement and balance sheet. • Prepare proforma financial statements

11. Long-term Financial Plan • In practice, long-term financial forecasts are prepared by relating the items of profit and loss account and balance sheet to sales. This is called the percentage to sales method.

12. Sensitivity Analysis • To examine the effect of changing assumptions on a particular firm’s funds requirement, the finance manager can perform a sensitivity analysis. • He/she can vary one variable at a time, and analyse its effect.

13. Steps in Financial Planning • Past performance • Operating characteristics • Corporate strategy and investment needs • Cash flow from operations • Financing alternatives • Consequences of financial plans • Consistency

14. PLANNING FOR SUSTAINABLE GROWTH • A simple way of ascertaining the growth potential of a company, given its current financial conditions, is to examine the interaction between four financial policy goals expressed as ratios: • target sales growth • target return on investment (net assets) • target dividend payout and • target debt-equity (capital structure)

15. Growth Potential of a Single-product Company • Sustainable growth may be defined as the annual percentage growth in sales that is consistent with the firm’s financial policies (assuming no issue of fresh equity):

16. Growth Potential of a Multi-product Company • Sustainable growth rate in the case of multi-product or multi-division company is to calculate the sustainable growth rate at the corporate level in terms of growth in assets.