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Finance M2 Chapter 5

Ch.5 - Ex.1: Financial Planning & Amount of Funds Needed

TermDefinition
Mission Statement a condensed version of a firm’s strategic plan
Corporate Scope defines a firm’s lines of business and geographic areas of operation, which should be logical and consistent with the firm’s capabilities
Statement of Corporate Objectives sets specific goals that operating managers are expected to meet, which includes qualitative and quantitative objectives
Corporate Strategies broad approaches developed for achieving firm’s goals
Operating Plan provides management with detailed implementation guidance based on the corporate strategy to help meet the corporate objectives;
Financial Plan a document that includes assumptions, projected financial statements, projected ratios and ties the entire planning process together;
Value-Based Management effects of various decisions on the firm’s financial position and value are studied by simulating their effects within a firm’s financial model; If management decision will increase profits and shareholders’ wealth, then it should make that move.
Sales Forecast starts with the review of sales for the past 5 years; Most important input in the firm’s forecast of financial statements (including the projected EPS)
Spontaneously Generated Funds (Increases in A/P and Accruals) funds that arise out of normal business operations from its suppliers, employees, and government that reduce the need of the firm for external funding
Addition to Retained Earnings depends on the firm’s profit margins and retention ratio, which is the proportion of net income that is reinvested in the firm
Additional Funds Needed (AFN the amount of external capital (interest-bearing debt + preferred and common stocks) needed to acquire additional assets
Capital Intensity Ratio ratio of assets required per peso of sales
Excess Capacity Adjustment changes made to the existing asset forecast since the firm is not operating at full capacity
The effect of higher dividend payout ratio on AFN Increase AFN: Less retained earnings
The effect of higher capital intensity ratio on AFN Increase AFN: Need more assets for given sales
The effect of higher profit margin on AFN Decrease AFN: Higher profits, more retained earnings
The effect of paying suppliers in 60 days, rather than 30 day on AFN Decrease AFN: Trade creditors supply more capital (i.e., L*/S0 increases)
Forecasted Financial Statements Financial statements that project the company’s financial position and performance over a period of years; F/S show how good or how bad the financial ratios and its impact on EPS; helps value the firm’s stock;
Adjustable Inputs Inputs (key ratios) required for the forecast, which mgt controls and that may be adjusted in the future
Fixed Inputs required for the forecast, which are not under management’s direct control or are not expected to change
Regression Analysis a statistical technique that fits a line to observed data points so that the resulting equation can be used to forecast other data points; It is used to improve the financial forecast
The reason why the AFN equation and Financial Statement method have different results AFN Equation method assumes a constant profit margin, a constant dividend payout, and a constant capital structure, while Financial statement method is more flexible. More important, it allows different items to grow at different rates.
What does it mean the AFN were negative? The spontaneous capital and retained earnings were more than sufficient to finance the increase in assets needed; the excess capital can then be used to retire debt, repurchase stock, and raise the dividend
What does it mean the AFN were zero? The maximum achievable growth rate in assets was sustained by the firm without having to raise external funds
The AFN Equation AFN = (Required Increase in Assets) - (Spontaneous Increase in Payables + Accruals) - (Funds Obtained as new Retained Earnings based on Projected Sales) or (A) - (L) - (RE)
Created by: miko_ho
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