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Practical financial managment 7e LASHER chapter 4

Chapter 4 Financial Planning

Business Plan

A business plan is a model of what management expects a
business to become in the future
Financial statements are pro forma
Good business plans are comprehensive


Component Parts of a Business Plan
Typical outline

– Contents
– Executive summary
– Mission and strategy statement
– Market analysis
– Operations (of the business)

– Management and staffing
– Financial projections
– Contingencies


The Purpose of Planning and
Plan Information
Major audiences of business plan

– Firm’s own management

Planning process helps pull management team together
Provides a road map for running the business
Provides a statement of goals
Helps predict financing needs

– Outside investors
Tells equity investors what returns can be expected
Tells debt investors how firm will repay loans


The Purpose of Planning and
Plan Information

Planning process
Roadmap for running the business
Statement of goals
Predicting financing needs
Investor communication

Figure 4-1 Using a Plan to Guide Business Performance


Credibility and Supporting Detail

Shows enough supporting detail to indicate it is the
product of careful thinking
Displays summarized financial projections


Four Kinds of Business Plan

Kinds of planning

– Strategic Planning
– Operational Planning
– Budgeting
– Forecasting


Four Kinds of Business Plan

Strategic Planning

– Addresses broad, long-term issues,

contains summarized,

approximate financial projections
Five-year horizon is common
Concepts expressed mainly in words, not numbers
Firm analyzes itself, the industry and the competitive situation


Four Kinds of Business Plan

Operational Planning

– Translates business ideas (day-to-day operations) into concrete, shortterm projections

– Usually one year or less
– Specifies how much the firm will sell, to whom, and at what prices


Four Kinds of Business Plan


– Short-term updates of the annual plan
Usually Covers a three month quarter
Attempts a precise estimate of company expenses
Mostly financial detail with a few words


Four Kinds of Business Plan

– Very short-term projections of profit and cash flow
Where will the business’s financial momentum carry it in the next few weeks
– Consists almost entirely of numbers
– Cash forecasts are projections of short-term cash needs
Most large firms do monthly cash forecasts


Four Kinds of Business Plan
The Business Planning Spectrum

Broad, long-term planning on one end and numerical short-term forecasting
on other

Relating Planning Processes of Small and Large Businesses

Small businesses tend to develop a single business plan containing both
strategic and operating elements


Figure 4-2
The Business Planning Spectrum


Figure 4-3 Relating Business Planning in Large and Small Firms


Financial Plan as a Component of a Business Plan

Financial plan is the financial portion of the business plan

– A set of pro forma financial statements projected over a time period
– Financials are only pieces of the projection


Planning for New and
Existing Businesses

Hard to forecast a new operation

– No history on which to base projections
The typical planning task

– In ongoing businesses, based on planning assumptions such as
Unit sales will increase by 10%
Overall labor costs will rise by 4%, etc.


Figure 4-4 The Planning Task


Planning Assumptions

Planning Assumptions: expected physical or economic condition
that dictates the size of one or more financial statement items


Concept Connection Example 4-1 Planning Assumptions

This year Crumb Baking Corp. sold 1 million coffee cakes per
month at $1 each for a total of $12 million. Year-end
receivables equal to two months of sales or $2 million.


Concept Connection Example 4-1 Planning Assumptions
Crumb’s operating assumptions for sales and receivables are:
1. Price will be decreased by 10%.
2. As a result unit sales volume will increase to 15 million coffee cakes.
3. Collection efforts increased - only one month of sales in receivables at year

Forecast next year’s revenue and ending receivables balance.

Concept Connection Example 4-1 Planning Assumptions

Three interrelated planning assumptions

– a management action with respect to pricing,
– the expected customer response to that action
– 15 million coffee cakes will be sold at $.90
– Rev = 15,000,000 x $.90 = $13,500,000

Collection activities will be more effective

– one months of revenue in accounts receivable at year end.

A/R = $13,500,000/12 = $1,125,000

The General Approach, Assumptions, and the Debt/Interest
The Procedural Approach

– Financial plans are built line-by-line beginning with revenues

Debt/Interest Planning Problem

– The next items needed are interest expense and debt
– Planned debt is required to forecast interest, but interest is
required to forecast debt


An Iterative Numerical Approach

Solves the debt/interest problem

– Interest: Guess a value of interest expense
– Net Income: Complete the income statement
– Ending equity: Calculate as beginning equity plus net income
– Ending debt: Calculate as total L&E (= total assets) less current
liabilities less ending equity

– Interest:

Average beginning and ending debt then calculate interest
expense on that value

– Test the results:

Compare calculated interest to the original guess


Figure 4-5 The Debt/Interest
Planning Problem


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