Financial Management
1. Overview of Financial Management.
2. Financial markets & financial institutions.
3. Financial Statements Analysis. Financial Planning
and Forecasting.
Liliya N. Zhilina, World Economy and Inrernational Relations
Department, Vladivostok State University of Economic and
Services (VSUES).
liliya.zhilina@vvsu.ru
Book & Internet Resources
• Eugene F. Brigham, Joel F. Houston, Fundamentals of
Financial Management, 12th edition. South-Western
Cengage Learning, 2009. (Free PDF copy).
• http://www.wikiwealth.com/company – WACC Analysis,
Equity Stock Research and more…
• https://www.mckinseyquarterly.com/Corporate_Finance –
McKinsey Quarterly: Capital Management, M&A,
Performance, Valuation.
• www.damodaran.com – Damodaran Online,
Aswath Damodaran, Professor of Finance at the Stern
School of Business at New York University.
1. Overview of Financial
Management
Structure of National Financial System
FINANCIAL SYSTEM
Centralized Finances
State
Finances
Budgetary system
(budgets of the
country, its subjects,
municipalities)
De-Centralized Finances
Finances of
Territorial Subjects
Off-budget
Funds
Finances
of
households
Finances of
noncommercial
organizations
State and municipal
loans
Financial relations
with “Abroad”
BANK SYSTEM
Финансовые
потоки
Finances of
commercial
organizations
FINANCIAL MARKETS
(Participants: investors, borrowers,
financial intermediaries)
Source: V.Kovalev. Financial Management
Career Opportunities in Finance
• Institutions and capital markets
• Investments
• Financial management
Finance in the Organizational Structure of a Firm
Board of Directors
Chairman (CEO)
President (COO)
Vice President:
Sales
Manages Directly Cash,
marketable Securities.
2. Plans capital Structure.
3. Manages Pension Fund.
4. Manages Risks.
Credit
Manager
Inventory
Manager
Vice President: Finance
(CFO)
Treasurer
Director of
Capital
Budgeting
Vice President:
Manufacturing
Controller
Cost
Accounting
Financial
Accounting
Tax
Department
Management system of firm finances
Management Subsystem
Organizational structure
of financial management
(CFO, functions:
planning, analytical,
accounting)
Financial Staff
Financial toolkit
(methods, models,
tools).
Finance
Information
Soft- and hardware for
finance
Governance Processes
Object of Management
Financial relations Financial resources
Source: V.Kovalev. Financial Management
Sources of
financial
resources
Financial Management
System of efficient financial
administration and control in a firm.
System of actions on optimization of
the firm financial model.
Alternative Forms of
Business Organization
• Sole proprietorship
• Partnership
• Corporation
Sole Proprietorship & Partnership
• Advantages:
– Ease of formation
– Subject to few regulations
– No corporate income taxes
• Disadvantages:
– Limited life
– Unlimited liability
– Difficult to raise capital
Corporation
• Advantages:
– Unlimited life
– Easy transfer of ownership
– Limited liability
– Ease of raising capital
• Disadvantages:
– Double taxation
– Cost of set-up and report filing
What questions does financial
management seek to answer
• What causes a company to have a particular stock
value?
• How can managers make choices that add value to their
companies?
• How can managers ensure that their companies don’t run
out of cash while executing their plans?
• How can managers improve their companies investment
decisions?
• How can managers improve their companies financing
decisions (debt policy, dividend policy)?
• What should be size and structure of their companies
assets?
Hierarchy of the stakeholders goals
owners
perspectives
Growth of price of shares
and business value
top-managers
perspectives
Efficiency
Earnings
suppliers
perspectives
customs
perspectives
Profit Margin
Return on Equity
Payment discipline
Capital structure
Price policy,
Divisions'
goods quality
returns
Wages
personnel
perspectives
Source: V.Kovalev.
Financial Management
owners and
counterparties
perspectives
lenders
perspectives
divisions’
managers
perspectives
Wage
supplements
System of preferential
shares purchasing
Principles of Financial Management
•
•
•
•
Economic effectiveness.
Finance control.
Finance encouragement.
Legal liability.
Goals of a company – the world practice
Development of long-term competitive advantages
Growth of a company value
Increase of level of clients
satisfaction
Improvement of a financial
position and operating results
Innovation and training
stimulation
Optimization of business
processes
Source: T.Teplova, T.Grigoryeva.
Situational Financial Analysis
Stockholder Model of Economic:
Is maximizing stock price good for society,
employees, and customers?
• Should firms behave ethically? YES!
• Do firms have any responsibilities to
society at large? YES! Shareholders are
also members of society.
• Employment growth is higher in firms that
try to maximize stock price. Employees
like working there.
• High quality of goods and services from
customers’ view
The Global 2000. 04.21.10
Rank
Company
Country
Industry
Sales ($bil)
Profits
($bil)
Assets
($bil)
Market Value
($bil)
M/B
1
PetroChina
China
Oil & Gas Operations
157,22
16,8
174,95
333,84
1,91
2
ExxonMobil
United States
Oil & Gas Operations
275,56
19,28
233,32
308,77
1,32
3
Microsoft
United States
Software & Services
58,69
16,26
82,1
254,52
3,10
4
ICBC
China
Banking
71,86
16,27
1428,5
242,23
0,17
5
Wal-Mart Stores
United States
Retailing
408,21
14,34
170,71
205,37
1,20
6
China Mobile
HK/China
Telecommunications
66,22
16,87
104,46
199,73
1,91
7
BHP Billiton
Australia/UK
Materials
50,21
5,88
74,86
192,45
2,57
8
Berkshire Hathaway
United States
Diversified Financials
112,49
8,06
297,12
190,86
0,64
9
Petrobras-Petróleo
Brasil
Brazil
Oil & Gas Operations
104,81
16,63
198,26
190,34
10
Apple
United States
Technology, Hardware
46,71
9,36
53,93
189,51
3,51
11
Procter & Gamble
United States
Personal Products
76,78
13,05
135,29
184,47
1,36
12
China Construction
Bank
China
Banking
59,16
13,59
1106,2
184,32
13
HSBC Holdings
UK
Banking
14
Johnson & Johnson
United States
15
Nestlé
Switzerland
0,96
0,17
103,74
5,83
2355,8
178,27
0,08
Drugs & Biotechnology
61,9
12,27
94,68
174,9
1,85
Food, Drink & Tobacco
97,08
10,07
105,16
173,67
1,65
Источник: http://www.forbes.com/2010/04/21/global-2000-leading-world
Global 2000 leading companies,
values in $ bln (calculated April 2011)
Market Value
Rank
1
2
3
4
5
6
7
8
8
10
11
11
13
14
15
16
17
18
19
20
21
22
23
24
25
Company
JPMorgan Chase
HSBC Holdings
General Electric
ExxonMobil
Royal Dutch Shell
PetroChina
ICBC
Petrobras-Petróleo Brasil
Berkshire Hathaway
Citigroup
BNP Paribas
Wells Fargo
Banco Santander
AT&T
Gazprom
Chevron
China Construction Bank
Wal-Mart Stores
Total
Allianz
Bank of China
ConocoPhillips
Sinopec-China Petroleum
Volkswagen Group
Agricultural Bank of China
Country
United States
United Kingdom
United States
United States
Netherlands
China
China
Brazil
United States
United States
France
United States
Spain
United States
Russia
United States
China
United States
France
Germany
China
United States
China
Germany
China
Sales
116
103
150
342
369
222
69
121
136
112
130
93
110
124
99
190
58
422
188
143
49
176
285
168
49
Источник: http://www.forbes.com/global2000/list
Profits
17
13
12
31
20
21
19
21
13
11
11
12
13
20
26
19
16
16
14
7
12
11
11
9
10
Assets (March 11 closing prices)
2 118
182
2 468
187
751
216
303
407
317
213
251
321
1 724
240
313
239
372
211
1 914
133
2 681
88
1 258
171
1 571
95
269
168
276
173
185
201
1 408
225
181
187
193
138
838
63
1 278
143
156
109
149
108
268
70
1 298
134
System View on the Basic Concepts of FM
Fin. Statements Analysis
Forecasting
Conception of time value
of money
Adjustment
Conception of a
firm value
maximizing for
owners
(stakeholders
concept)
Choice of key financial
ratios for managers
performance evaluation:
PM, EVA, ROIC, ROE
Conception of a free
cash flow (FCF)
Operating profit;
cost of investing capital;
value of capital
Conception
of cost of
Capital structure; return
capital
on business projects;
financial risks.
Conception of financial
and operating risks
© Liliya Zhilina
Conception of risk-return
trade-off
Three Determinants of Cash Flows
• Sales
– Current level
– Short-term growth rate in sales
– Long-term sustainable growth rate in
sales
• Operating expenses
• Capital expenses
Factors that Affect the Level and
Risk of Cash Flows
• Decisions made by financial managers:
– Investment decisions (product lines, production
processes, geographic market, use of
technology, marketing strategy).
– Financing decisions (choice of debt policy and
dividend policy).
• The external environment
– Regulations.
– Use of computers and electronic transfers of
information.
– The globalization of business.
Agency Relationships
• An agency relationship exists whenever a
principal hires an agent to act on his or her
behalf.
• Within a corporation, agency relationships
exist between:
– Shareholders and managers
– Shareholders and creditors
Shareholders versus Managers
• Managers are naturally inclined to act in their own best
interests.
• But the following factors affect managerial behavior:
– Managerial compensation plans
– Direct intervention by shareholders
– The threat of firing
– The threat of takeover
Shareholders versus Creditors
• Shareholders (through managers) could take actions to
maximize stock price that are detrimental to creditors.
• In the long run, such actions will raise the cost of debt
and ultimately lower stock price.
2. Financial Environment:
Markets and Institutions
Types of Financial markets
•
•
•
•
•
•
•
•
•
•
Markets of primary financial assets (shares, bonds, bills, mortgages)
which give its owners rights to real / physical assets.
Markets of derivative tools (futures, options) which prices depend on the
prices for the goods, physical and primary financial actives .
Spots-markets (with immediate delivery) and future markets (with delivery
to the future date).
Money markets – short-term (about one year) highly-liquid and low-liquid
debt securities.
Stock / capital markets – medium- or long-term debts (one-to-five and
more years) and corporate shares.
Markets of mortgages (quoting debt tools, connected with loans on real
estate).
Markets of consumer credits.
World, national, regional, local financial markets .
Primary markets – secondary markets.
Markets of private transactions (between two parties) and public /
opened markets (trade in standard contracts).
Major Factors Affecting Stock Prices
External Constraints
- Antitrust laws.
- Environmental
Regulation.
- Product and workplace
safety regulations
- Labor law.
- Government monetary
policy.
- International rules
- And so forth
Strategic Policy
Decisions Controlled
by Management
- Types of products or
services produced
- Production methods
used
- Research and
development efforts
- Relative use of debt
financing
- Dividend policy.
- And so forth
Level of Economic
Activity and
Corporate Taxes
Source: E.Brigham, M.Ehrhardt. Financial management
Stock Market
Conditions
Expected
Cash Flows
Timing of
Cash Flows
Perceived Risk
of Cash Flows
STOCK
PRICE
Capital Formation Process
1. Direct Transfers
Securities (stocks or bonds)
Business
Savers
Cash
2. Indirect Transfers through Investment Bankers
Securities
Business
Cash
Securities
Investment Banking
Houses
Cash
Savers
3. Indirect Transfers through a Financial Intermediary
Business
Business's
Securities
Cash
Financial
Intermediary
Intermediary's
Securities
Source: E.Brigham, M.Ehrhardt. Financial management
Cash
Savers
The Top 10 Banking Companies
in the World, 2011
$ bln
Company
JPMorgan Chase
HSBC Holdings
ICBC
Country
United States
United Kingdom
China
Sales
116
103
69
Profits
17
13
19
Assets
2 118
2 468
1 724
Market Value
182
187
240
Citigroup
United States
112
11
1 914
133
BNP Paribas
France
130
11
2 681
88
Wells Fargo
United States
93
12
1 258
171
Banco Santander
China Construction
Bank
Spain
110
13
1 571
95
China
58
16
1 408
225
Bank of China
Agricultural Bank of
China
China
49
12
1 278
143
China
49
10
1 298
134
Organized Exchanges versus
Over-the-Counter Market
• Auction markets versus dealer markets
(exchanges versus the OTC market)
• NYSE versus Nasdaq system
• Differences are narrowing
• Nasdaq vs. true OTC
Dynamics of Stock Indexes
S&P 500 Index, 07/10/11: 1 155.46
Источник: http://money.cnn.com/data/markets/sandp/
Shanghai Stock Exchange
Composite Index
30/09/2011 2359.22
http://www.sse.com.cn/sseportal/en/home/home.shtml
Index MICEX 07/10/2011: 1 351,42
Source: http://www.micex.ru/marketdata/indices/shares/composite#&index=MICEXINDEXCF
Monetary Policy Instruments of the
Bank of Russia
•
•
•
•
Reserve requirements;
Interest rates;
Currency intervention
Refinancing (Lending) System
Deposit Operations
Refinancing Rate of the Bank of Russia, %
8,25
28/12/2009 – 23/02/2010
8,75
28/02/2011 – 2/05/2011
8
25/11/2009 – 27/12/2009
9
1/06/2010 – 27/02/2011
7,75
30/10/2009 – 24/11/2009
9,5
30/04/2010 – 31/05/2010
8
30/09/2009 – 29/10/2009
10
29/03/2010 – 29/04/2010
8,25
15/09/2009 – 29/09/2009
10,5
24/02/2010 – 28/03/2010
8,5
10/08/2009 – 14/09/2009
10,75
3/05/2011 –
Source: http://www.cbr.ru/print.asp?file=/statistics/credit_statistics/refinancing_rates.htm
Credit Ratings
• Measure of credit worthiness of a country, a company, or
a person.
• Is calculated on the basis of last and current financial
history, size of property and financial obligations of an
issuer.
• Rating gives investors an immediate understanding of
the level of risk associated with investing in securities
and probability of default.
• Providing independent objective assessments of the
ability to pay, a credit ratings company helps investors
decide how risky it is to invest money
• The world top three rating agencies: Moody's, Standard
and Poor's, Fitch Ratings.
• Chinese rating agencies: China Rating Agency, Dagong
Global Credit Rating Co.,
• Russian rating agencies: Expert RA, RusRating, National
Rating Agency, АК&M.
Five Classes of Credit Ratings
•
•
•
•
•
financial institutions, brokers, or dealers;
insurance companies;
corporate issuers;
issuers of asset-backed securities;
issuers of government securities,
municipal securities, or securities issued
by a foreign government
Examples of Ratings
Moody' Standard
s
& Poor's
Fitch
Aaa
AAA
AAA
Aa
AA
AA
Baa
BBB
BBB
Caa
Ca
CCC
CC
CCC
CC
Credit worthiness
An obligor has EXTREMELY STRONG capacity to meet
its financial commitments.
An obligor has VERY STRONG capacity to meet its
financial commitments. It differs from the highest
rated obligors only in small degree.
An obligor has ADEQUATE capacity to meet its
financial commitments. However, adverse economic
conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to
meet its financial commitments.
An obligor is CURRENTLY VULNERABLE, and is
dependent upon favourable business, financial, and
economic conditions to meet its financial
commitments.
An obligor is CURRENTLY HIGHLY-VULNERABLE.
Countries Ratings from Dagong
Country
Brazil
China
India
Russia
United Kingdom
United States
Germany
Japan
Rating
AAAA
BBB
A
A+
A
AA+
AA-
Outlook
Stable
Stable
Stable
Stable
Negative
Negative
Stable
Stable
Date
11.07.2010
11.07.2010
11.07.2010
11.07.2010
27.05.2011
03.08.2011
01.07.2011
02.06.2011
Bond Ratings
Moody's
Standard & Poor's
Grade
Risk
Aaa
Aa
A
Baa
Ba, B
Caa/Ca/C
C
AAA
AA
A
BBB
BB, B
CCC/CC/C
D
Investment
Investment
Investment
Investment
Junk
Junk
Junk
Lowest Risk
Low Risk
Low Risk
Medium Risk
High Risk
Highest Risk
In Default
3. Financial Statements
Analysis and Forecasting
Components of Financial Analysis
Economic and Competition Environment
Sources of Information
Approach and Methods of Analysis
Investment
Effectiveness
Financing
Effectiveness
Performance Results
and Value Creation
Effectiveness
of Operations
Erich Helfert, Financial Analysis Tools and
Techniques: A Guide for Managers
Information in the Financial Statements
Information
Earnings
Costs
Equity
Dividends
Assets
Statement of
Retained
Earnings
Income
Statement
Net Profit
Source: T.Teplova, T.Grigoryeva.
Situational Financial Analysis
Liabilities
Balance
Sheet
Equity at the
year end
Financial Statements
• A firm’s balance sheet is a statement of the firm’s financial position
at a specific point in time. It specifically lists the firm’s assets on the
left-hand side of the balance sheet, while the right-hand side shows
its liabilities and equity, or the claims against these assets.
• An income statement is a statement summarizing the firm’s
revenues and expenses over an accounting period. Net sales are
shown at the top of each statement, after which various costs,
including income taxes, are subtracted to obtain the net income
available to common stockholders. The bottom of the statement
reports earnings and dividends per share.
• The statement of retained earnings shows how much of the firm’s
earnings were retained in the business rather than paid out in
dividends. Note that retained earnings represents a claim against
assets, not assets per se. Firms retain earnings primarily to expand
the business, not to accumulate cash in a bank account.
• The statement of cash flows reports the impact of a firm’s
operating, investing, and financing activities on cash flows over an
accounting period.
Balance Sheet Equation
А = E + LTL + STL
А – Assets
E – Common Equity
LTL – Long-Term Liabilities
STL – Shot-Term Liabilities
• Stock - The capital that a corporation raises
through the sale of shares entitling the
stockholder to dividends and to other rights of
ownership, such as voting rights.
• Shares - the equal parts into which the capital
stock of a corporation is divided.
• Dividends - a part of profits of a corporation
received by a stockholder on his shares
• The Balance Sheet is a snapshot of Microdrive's
financial position for a particular point in time.
Some Notions to Analysis
•
•
•
•
•
•
•
•
•
•
•
•
•
Net Operating Cash Flow = Net Profit + Depreciation
Operating Current Assets.
Operating Current Liabilities.
Net Operating Working Capital.
Operating Long-Term Assets.
Total Operating Capital, Net Operating Capital.
NOPAT (Net Operating Profit After Taxes). Excludes influents of
financial decisions.
NOPAT = EBIT x (1 – Tax Rate)
Operating Cash Flow.
Operating Cash Flow = NOPAT + Amortization
Free Cash Flow : FCF = NOPAT – Investment in Total Oper.Capital
ROIC = NOPAT / Net operating capital.
MVA = Number of Shares х Market Price of Share – Book Value of
Common Equity
EVA = NOPAT – Operating Capital х WACC
Some Notions to Analysis (cont.)
•
•
•
•
•
Economic value added (EVA) represents a firm’s true profitability, the residual
income that remains after the cost of all capital, including equity capital, has
been deducted. Additional value created by managers within year. Differs
from accounting profit.
Market value added (MVA) is the difference between the market value of the
firm (i.e., the sum of the market value of common equity, the market value of
debt, and the market value of preferred stock) and the book value of the firm’s
common equity, debt, and preferred stock. It is created for all period of
existence of a common equity.
Value of any asset depends on move of after-tax cash flow, which the asset
create.
Shares, bonds, and real assets are the capital assets. If a capital asset is on
sale more expensively, than it has been got or created, the profit is called a
capital gain. If an asset is on sale more cheaply, there is a capital loss.
Assets stored more of one year, bring long-term profits or losses. The
operational profit paid in the form of dividends, is subject to the double
taxation: at first the profit is taxed at corporate level, and then shareholders
should pay individual taxes to the dividends.
Formats of Financial Statements
Analysis
• Percent Change Analysis of a profit statement
and a balance sheet: calculation of dynamics of
change of articles and sections of financial
statements.
• Common size analysis of a balance sheet:
divide all articles into a total active.
• Common size analysis of a profit statement:
divide all articles into sales.
Financial Ratios: why are ratios useful
•
•
•
•
Help to understand financial statements.
Standardize numbers.
Facilitate comparisons.
Used to highlight weaknesses and
strengths.
• For investors to evaluate risks of corporate
shares and bonds.
Five major categories of ratios, and what
questions do they answer
• Liquidity: Can we make required payments as
they fall due?
• Asset management: Do we have the right
amount of assets for the level of sales?
• Debt management: Do we have the right mix of
debt and equity?
• Profitability: Do sales prices exceed unit costs,
and are sales high enough as reflected in PM,
ROE, and ROA?
• Market value: Do investors like what they see
as reflected in P/E and M/B ratios?
Five major categories of ratios
•
•
•
Liquidity ratios show the relationship of a firm’s cash and other current
assets to its current liabilities. The current ratio is found by dividing current
assets by current liabilities. It indicates the extent to which current liabilities
are covered by those assets expected to be converted to cash in the near
future. The quick, or acid-test, ratio is found by taking current assets less
inventories and then dividing by current liabilities.
Asset management ratios show company effectiveness of operating its
funds: inventory turnover, day sales outstanding, fixed assets turnover,
and assets turnover.
Financial leverage ratios measure the use of debt financing. The debt
ratio is the ratio of total debt to total assets, it measures the percentage of
funds provided by creditors. The times-interest-earned ratio is determined
by dividing earnings before interest and taxes by the interest charges. This
ratio measures the extent to which operating income can decline before the
firm is unable to meet its annual interest costs. The EBITDA coverage ratio
is similar to the times-interest-earned ratio, but it recognizes that many firms
lease assets and also must make sinking fund payments. It is found by
adding EBITDA and lease payments then dividing this total by interest
charges, lease payments, and sinking fund payments over one minus the tax
rate.
Five major categories of ratios
• Profitability ratios are a group of ratios which show the combined
effects of liquidity, asset management, and debt on operations. The
profit margin on sales, calculated by dividing net income by sales,
gives the profit per dollar of sales. Basic earning power is
calculated by dividing EBIT by total assets. This ratio shows the raw
earning power of the firm’s assets, before the influence of taxes and
leverage. Return on total assets is the ratio of net income to total
assets. Return on common equity is found by dividing net income
into common equity.
• Market value ratios relate the firm’s stock price to its earnings and
book value per share. The price/earnings ratio is calculated by
dividing price per share by earnings per share--this shows how much
investors are willing to pay per dollar of reported profits. The
price/cash flow is calculated by dividing price per share by cash flow
per share. This shows how much investors are willing to pay per
dollar of cash flow. Market-to-book ratio is simply the market price
per share divided by the book value per share. Book value per
share is common equity divided by the number of shares outstanding.
Trend & Comparative Ratio Analysis
• Trend analysis is an analysis of a firm’s
financial ratios over time. It is used to
estimate the likelihood of improvement or
deterioration in its financial situation.
• Comparative ratio analysis is when a
firm compares its ratios to other leading
companies in the same industry. This
technique is also known as benchmarking.
Du Pont system focuses on:
• Costs control (Profit Margin).
• Assets use (Total Assets Turnover).
• Debt use (Equity Multiplier).
(
)(
Profit
Margin
)(
Total Assets
Turnover
) = ROE
Equity
Multiplier
TA__
NI _
Sales
= ROE
X
X
Equity
Sales
TA
Limits of Financial Ratio Analysis
• Comparison with industry averages is difficult if the firm
operates many different divisions.
• “Average” performance is not necessarily good.
• Seasonal and inflation factors can distort ratios.
• Window dressing techniques can make statements and
ratios look better.
• Different accounting and operating practices can distort
comparisons.
• Sometimes it is difficult to tell if a ratio value is “good” or
“bad.”
• Often, different ratios give different signals, so it is difficult to
tell, on balance, whether a company is in a strong or weak
financial condition.
Qualitative factors for evaluating a company’s
likely future financial performance
• Are the company’s revenues tied to a single customer?
• To what extent are the company’s revenues tied to a
single product?
• To what extent does the company rely on a single
supplier?
• What percentage of the company’s business is generated
overseas?
• What is the competitive situation?
• What does the future have in store?
• What is the company’s legal and regulatory
environment?
Benchmarking
(Model, or Standard for Comparison)
• Comparison a company performance with
performance of leading companies in the same
industry.
• Return of common equity (ROE) is important, but
it doesn't take into account a volume of invested
capital and project or company risks. Economic
value added (EVA) helps to consider these factors.
Finance Planning and
Forecasting
Finance planning include
1. Investment
policy:
R&D financing.
Real assets financing.
Intangible assets financing.
Long-term finance investments.
2. Working capital management:
Cash and equivalents management.
Inventories management.
Customers relationship policy and accounts receivable
management.
3. Capital source and structure management.
4. Dividend policy.
5. Financial Forecasting.
Pro Forma Financial Statements
• Managers can assess whether the supposed company
effectiveness conforms its strategic goals and
expectations of investors.
• Allows to evaluate the impact that changes in the
operating plan have on the value of the firm («what if»
analysis).
• Management can use to assess whether the initial
financial plan is feasible or whether it must be revised.
• Helps to forecast the amount of external financing that will
be required
• Helpful for estimation of future cash flows when realizing
strategic plans.
• Analysts influent investors, investors assign managers.
Steps in Financial Forecasting
• Project sales based on forecasted growth rate in sales.
• Forecast some items as percent ratios of the forecasted sales (costs,
cash, accounts receivable, inventories, net fixed assets, accounts
payable and accruals).
• Project internally generated and outside funds needed (additional
funds needed, AFN).
• Decide how to raise additional funds: debt (which determines interest),
dividends (which determines retained earnings), common stock.
• Forecast income statement.
• Forecast balance sheet.
• Take into account financing feedbacks (the effects on the income
statement and balance sheet of actions taken to finance increases / or
decreases in assets – interest charges and revenues, dividends).
• Make successive iterations to reach the balance equilibrium. But Excel
computerized financial model allows easy to reach that balance
equilibrium.
• See effects of plan on ratios and stock price.
• When necessary the percent ratios should be adjusted.