FinanceSim
A Business Simulation for
Corporate Finance Courses
Fernando Arellano, Ph.D.
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What is FinanceSim?
Business simulation in which decisions are mostly
related to topics covered in a corporate finance or
financial management course.
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What topics can be covered with
FinanceSim?
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Time value of money
Financial statement analysis
Pro-forma analysis
Working capital management
Operating and financial leverage
Capital structure
Capital budgeting
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What are the firm’s characteristics?
• Firms manufacture three products. Each product has its
own variable and fixed costs, and demand
characteristics.
• Firms can fund their operations through loans, bonds,
and stock.
• Excess cash can be invested in short-term CDs.
• Dividends can be distributed.
• There are transaction costs on financial operations.
• Plant capacity can be increased or reduced (per
product).
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What are the firm’s characteristics?
• The following variables can be controled in setting up
the initial firm and the economic environment during the
simulation:
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Sales and inventory volumes and prices.
Cost structure and profit margin for each product
Overall firm profitability.
Financial leverage, including the proportion of different debt and
investment instruments.
Behavior of GDP, CPI, and interest rates during simulation.
Transaction costs on loans, CDs, bonds, and stock operations.
Price and promotional elasticities.
Level of inflation affecting prices and costs.
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What are the firm’s characteristics?
Current and potential profitability is defined by:
– Current and future sales volumes and prices
– Current and future costs
– Variable and fixed cost structure
– Current and future cost of debt
– Transaction costs
– Capital structure
– Current capacity utilization and future cost of
equipment
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What are the firm’s characteristics?
Current and potential cash position is defined by (in
addition to preceding factors):
–Level of depreciation costs.
–Initial cash.
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What are other characteristics?
• Each simulated period represents one quarter.
• Up to twelve quarters can be simulated.
• Students work in teams. Up to sixteen teams
can participate.
• In addition to financial statements and
supplementary information, teams receive
historical information on sales volumes, prices,
GDP, CPI, and interest rates.
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What decisions are made?
• In the finance area:
– Request 90-day , 1-year and 5-year term loans.
– Invest in 90-day, 180-day, and 270-day certificates of
deposit.
– Issue and recall 10-year bonds.
– Issue and repurchase stock.
– Distribute dividends.
• In addition, participants have to forecast cash balances
and after-tax earnings.
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What decisions are made?
• In the production area:
– Order production.
– Select between two suppliers of raw material that offer
different terms of payment.
– Increase or decrease plant capacity.
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What decisions are made?
• In the marketing area:
– Set price and promotional expenditures
– Offer price discounts for prompt payments
• In addition, participants may be asked to forecast sales
volumes.
• At the beginning of the simulations participants may be
provided with sales volumes and prices in order to focus
on financial decisions.
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How is firm performance evaluated?
• Firm performance is evaluated on the basis of firm
profitability, product contribution margin, and forecast
errors.
• Forecast errors that are measured and reported to
participants include:
– End of quarter cash balance.
– End of quarter after tax earnings.
– Sales volumes (if participants were required to make
sales forecasts).
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What do students learn?
• They apply time value of money concepts and techniques
when they make the decision on whether to:
– Purchase raw material using cash or taking credit from
the bank or from the supplier.
– Offer discounts to clients who pay in cash rather than
take the 90-day credit.
– Calculate the effective interest rate of different loan
terms, including fixed and variable commissions.
– Request loans and schedule their reimbursements.
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What do students learn?
• They learn cash budgeting when they:
– Do pro-forma analysis every quarter to determine their
funding needs or their excess cash.
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What do students learn?
• They appreciate the importance of accurate cash
management when they:
– Underestimate their funding needs and receive
emergency funding with interest rate penalty.
• Insufficient funding was requested.
• Too much was invested in CDs.
– Overestimate their funding needs and sacrifice the
opportunity cost of cash surplus.
• Too much funding was requested.
• Insufficient amount was invested in CDs.
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What do students learn?
• They appreciate the importance of inventory management
when their forecasts:
– Overestimate sales and they are left with inventory.
– Underestimate sales and they lose sales.
• The instructor can set different storage costs per product
so as to make the carry-on of inventory profitable or
unprofitable.
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What do students learn?
• They learn the techniques of capital budgeting when they:
– Reach full capacity utilization and have to decide on
acquisition of new equipment.
• They have to forecast sales.
• Different capacities can be purchased.
• Investment cost per unit varies with equipment size.
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What do students learn?
• They appreciate the importance of adequate and timely
long-term planning when they:
– Decide to expand production and invest in additional
equipment.
– Plan one quarter ahead and issue bonds or stock to
fund the purchase of new equipment. Otherwise, they
will have to fund the acquisition with short-term funding.
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What do students learn?
• They observe the impact of financial leverage on profits:
– When they observe the impact of increased sales on
profits.
– After they request loans, issue or repurchase stock,
issue or recall bonds, or distribute dividends.
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What do students learn?
• They appreciate the importance of operating leverage
when they:
– Observe impacts in profits when sales increase or
decrease.
• The three products have different cost structures
– Decide on plant expansion.
• Different equipment sizes result in different fixed
costs.
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What do students learn?
• They appreciate the importance of capital structure when
they:
– Decide on how to fund operations or plant expansion.
– They can:
• Issue common stock.
• Issue 10-year bonds.
• Request 1-year and 5-year loans.
• Use trade credit.
• Offer discounts for prompt payment.
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What do students learn?
• They appreciate the importance of financial analysis when
they:
– Track the evolution of their financial ratios quarter after
quarter.
– Compare their ratios with other participants in the
simulation.
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How are decisions scheduled?
• To accomplish the objectives presented before, decisions
are scheduled in a way that precludes complexity at the
beginning and allows for concentration on specific topics.
• The number of decisions allowed are sequentially
increased quarter by quarter.
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How are decisions scheduled?
• First decision: Participants are asked to do a cash budget
and submit their short-term funding needs.
• Sales forecasts, prices, and costs are furnished to the
participants.
• Raw materials are paid in cash.
• Sales proceeds are collected in 90 days.
• Accurate budgeting depends on the understanding of
how a cash flow statement is constructed.
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How are decisions scheduled?
• Their report for the quarter will show a forecast error in
their projection of their cash balance at the end of the
quarter.
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How are decisions scheduled?
• Second decision: participants are asked to select between
two suppliers. One collects cash, the other collects in 90
days. They are also asked to forecast after-tax earnings
for the next quarter.
• Each supplier charges different prices.
• Participants can choose to
• pay cash.
• get credit from supplier.
• get 90-day bank loan.
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How are decisions scheduled?
• In addition to their forecast error and end of quarter cash
balance, their report will show their forecast error in their
after-tax earnings.
• First decision conditions still apply. They still have to
project cash flows and look for adequate funding for the
firm’s overall operations.
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How are decisions scheduled?
• Third decision: participants have the option of offering
price discounts to clients that make prompt payments.
• They have three preset options: i.e. 5%, 8%, 12%.
• Each option has a corresponding percentage of sales
(in units) that will be paid in cash.
• Demand is not affected by the discounts.
• First and second quarter decision conditions still apply.
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How are decisions scheduled?
• Fourth decision: Prices and sales forecasts are provided,
but the latter are no longer accurate.
• It forces participants to set production levels and
determine if they want to run the risk of running out of
inventory or being left with excess inventory.
• Storage cost, contribution margin, and financial cost will
determine the convenience of either strategy.
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How are decisions scheduled?
• Fifth decision: Participants are allowed (or required) to
distribute dividends.
• In addition they can expand their options of funding and
investing. They can:
• Request 90-day, 1-year, and 5 year loans.
• Invest in 90-day, 180-day, and 270-day CDs.
• Issue bonds and stock.
• For better decision making, they have to forecast sales
and project cash flows at least four quarters ahead.
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How are decisions scheduled?
• Fifth decision (cont.):
• Participants are informed that they will be allowed to
increase plant capacity in the following quarter.
• If they decide to purchase equipment, this
announcement will require them to issue bonds or stock
in this quarter.
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How are decisions scheduled?
• Sixth decision: Participants are allowed to increase plant
capacity.
• If they didn’t decide to issue bond or stock in the
previous quarter they will have to pay for the equipment
using other means of funding.
• They can still issue bond and stock but will not receive
the funds until the following quarter.
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How are decisions scheduled?
• Seventh decision: No sales forecasts are furnished to
participants. They can prepay loans or sell CDs before
maturing. They can recall bonds and repurchase stock.
• This allows participants to correct errors made in prior
quarters.
• Prices are furnished to participants.
• Participants have to make sales forecasts.
• Forecast errors will be notified in their reports.
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How are decisions scheduled?
• Eigth decision: Prices are no longer fixed. Participants are
allowed to change prices and promotional expenditures.
• They are also allowed to invest in expansion or reduction
of plant capacity.
• In the following four quarters they will make the same
decisions.
• The cost structure and price and promotional elasticities
will play a major role in their pricing strategy.
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Summary
• In summary, participants acquire or develop abilities and
skills in financial management.
Note: The decision schedule can be changed to
accommodate the objectives and syllabus of the course.
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