Module 6--Planning and Financing the Business Flashcards
What is the PURPOSE of FINANCIAL PLANNING?
Financial Planning
■ Purpose
* Map financial direction/planning
* Determine financial control
– Compare actual to plan
– Compare forecast to goal or target
■ Plan characteristics
■ Developing financial business plans (budgeting)
* Where are we going and by what route?
■ Evaluation of capital projects
What is the Typical Planning Process?
Typical Planning Process
Vision – What does the company want to do and look like?
Mission – purpose and direction – set objectives
Situation – Understand the organization’s past, present and future. Includes financial, marketing, human resources, management capabilities, trends, etc. What is the competitive environment?
Assessment – Evaluate the organization’s strengths, weaknesses, opportunities and threats. This may require redefining the mission.
Strategies – Means to achieve the objectives. Deciding compensation and benefits philosophy is important at this stage.
Sub unit plans – general and detailed plans to implement the strategy
Types of budgets – operating, capital and cash flow
this is criticalEvaluate and control – Once the year begins, examine actual versus plan.
What is involved in DEVELOPING BUSINESS PLANS?
Developing Business Plans
■ External and Internal Factors
■ Operating budgets
* Sales
* Production
* Expenses
■ Capital budgets
* Land
* Building
* Equipment
■ Budgeted income statement, balance sheet and cash flow (pro forma)
■ Financing requirements (debt/equity)
What are the TYPES of BUDGETS?
Types of Budgets
Once operating and capital budgets are prepared, the financial or cash requirements are disclosed in the cash budget. Once cash requirements are known, the finance department can raise additional cash through debt or equity financing.
■ Operating
■ Capital
■ Cash flow
■ Pro forma – income statement and balance sheet
What are OPERATING BUDGET METHODS?
Operating Budget Methods
■ FIXED expense budgets start with last year’s budget and adjust for inflation, more activity, cost cutting, etc.
■ FLEXIBLE budgets vary based on units to be produced (e.g., cars under lease, census in hospital units)
■ ZERO-BASED budgets start with a blank sheet of paper and every expenditure must be justified every year. Activities are prioritized, and (in theory) the lowest priority items are removed from the planning.
■ DECISION PACKAGES
■ RANKING/PRIORITIZING
■ CONSOLIDATION
■ CUT OFF POINT
What are CAPITAL BUDGET METHODS
Capital Budget Methods
■ Included in capital budgets
* Land
* Building(s)
* Equipment
■ Capitalization policy determines expense versus capital items
* Dollar amount may vary from a few hundred dollars to tens of thousands depending on the company and industry. Difficult areas may be differentiating between maintenance and building enhancements.
* Useful life (at least one year)
* Should be used in operation of the business
* Usually is a tangible substance
What are you looking for when Evaluating Capital Projects?
Evaluating Capital Projects
■ Financial reasons for investment
* Sales enhancement
* Cost saving
■Methods of evaluating
* Payback time
* Net present value
Project Analysis Exercise
Project Analysis
The HR department wants to purchase a new environmental control system.
■ Old environmental control system
* Requires expensive repairs
* Incurs significant downtime reducing the efficiency of the process, impacting customers
rrrrrrrrr
■ New environmental control system
* Costs $100,000
* Company forecasts the new system will last five years
* System will save $50,000 per year (relative to the current system) due to fewer repairs and cost savings
Project Analysis Excercise (continued)
Project Analysis (continued)
■ Net present value method – compares the present value of a project’s future cash inflows to the present value of its cash outflows. The project can be considered profitable when the cash inflows are greater than the outflows or investment.
- Discount rate – interest rate set by company
- Present value – the value of an amount of money at the present time or at the beginning of a specific period, taking into account the time value of money and an assumption of a discount rate
PAYBACK = Cash Outflow = $100,000 = 2 years
——————— ————–
Annual Cash Inflow $50,000
Ignores the time value of money
What are some non-financial Reasons?
Nonfinancial Reasons Sometimes projects based on nonfinancial reasons are more difficult to sell to top management, because the payback may be difficult to estimate.
In some cases there may be little choice as in OSHA and ADA situations.
■ Morale
■ Legal (ADA, for example)
■ Marketing
■ Union
■ Intra-company politics
Why is it necessary to Finance the Business?
Why is it necessary to finance the business?
■ All companies need money
■ Money is required to produce more money
* Pay employees
* Finance benefits plans
* Secure a place to work
* Purchase raw materials
* Cover other costs
What are Financing Sources?
■ Long-term
* Equity is a source of long-term financing.
* For accounting purposes, long-term debt is due more than one year after the date of the balance sheet.
* Long-term debt (noncurrent liabilities) usually is used for financing noncurrent assets, such as land, plant property and equipment.
■ Leases
* There are financial leases and operating leases.
■ Short-term
* Short-term debt (current liabilities) usually is used for short-term cash flow needs (working capital).
* Short-term debt is due within one year of the date on the balance sheet.
* Types of short-term debt include bank loans, commercial papers, factoring, collateralized loans and accounts payable.
What is LONG-TERM EQUITY (SHAREHOLDER EQUITY)?
■ Ownership
■ Expect stock appreciation and dividends
■ Types of shareholders’ equity (aka owners’ equity)
* Preferred shares
* Common shares
* Retained earnings
What is LONG-TERM DEBT?
■ Sources of long-term debt
* Loans may have a number of different repayment provisions, such as: periodic payments of principal and interest (as a home mortgage); current payment of interest and a specified date when the entire principal is due; and accumulation of interest costs so at a specified date all principal and compounded interest must be paid.
* In a small company, the bank or other lender may require a personal guarantee from the owner(s). Some loans are not secured by specific property.
* Mortgages relate to a specific piece of property, such as machinery or plants or buildings.
* Bonds are a debt instrument issued by the organization.
■ Characteristics of long-term debt
* For a period of time
* Rent charge (interest)
* Lender gets no ownership
* Higher priority in bankruptcy or liquidation than equity
* Less risk than equity
What is retained earnings?
As part of long term equity, whatever is remaining after the payment of dividends, goes back as retained earning in the equity statement.
