CHAPTER 12
LONG TERM FINANCIAL
PLANNING
12-1
• The value of a firm is determined by the
size, timing, and risk of its expected
future free cash flows (FCF).
• To create value a company must have
well-designed operating and financial
plans.
• Pro forma financial statements or
projected financial statements is an
important tool for planning /
forecasting.
12-2
• Operating Plan  provide detailed
implementation guide for a firm’s
operations  usually 5 years

Forecast sales, production costs,
inventories, and other operating
items  forecast FCF
• Financial Plan  Assets can grow only
by purchasing new assets  a growing
company should therefore, continuously
obtain cash and buy new assets.
12-3
• The essence of financial planning is to
forecast the funds required to finance
the operating plan and how the FCF
generated would be utilized.
• If FCF is +ve decide how to share it
with investors (shareholders,
bondholders) and /or to put aside for
future need.
• If FCF is -ve decide how to raise the
needed funds (stocks, bonds, sale of
asset) etc.
12-4
THE FINANCIAL PLAN
The financial planning process generally
involves five steps.
1.
Forecast financial statements under
alternative versions of the operating
plans  analyze its effect on projected
profits and financial ratios.
2.
Determine the amount of capital that
would be needed to support the plan.
12-5
THE FINANCIAL PLAN
3.
Forecasts the funds that could be
generated internally. If insufficient
 identify the sources from which the
required external capital can be raised
 taking account of any constraints due to
bond covenants that limit its debt ratio and
other financial ratios.
12-6
THE FINANCIAL PLAN
4.
5.
Establish a performance-based
management compensation system.
Finally, monitor operations after
implementing the plan to spot any
deviations and then take corrective
actions.
12-7
FINANCIAL PLANNING PROCESS - EXAMPLE

We start with most recent balance sheet
 See Fig 12-1 on page 490
12-8
12-9
FINANCIAL PLANNING PROCESS - EXAMPLE

Develop basis / assumptions for financial
planning and forecast how these will
change over time.

See Fig 12-2 on page 491
12-10
12-11
FINANCIAL PLANNING PROCESS - EXAMPLE

Using 1 & 2 forecast operations and
compute value of operation.

See Fig 12-3 on page 493
12-12
12-13
FINANCIAL PLANNING PROCESS - EXAMPLE

Once we have prepared a Base Plan using
the forecasted Sales, Operating assets,
Operating liabilities, Operating income
  forecast FCF, WACC & long-term
constant growth rate (g)
  estimate intrinsic value of equity.


Prepare forecasted Financial Statements
(Income Statement, Balance Sheet, Cash
flow statements etc.)
See Fig 12-4 to 12-6  Pages 497, 500 & 502
12-14
ADDITIONAL FUNDS NEEDED
Required
Increase in
Increase
Additional
increase in - spontaneous - in retained =
funds
assets
liabilities
earnings
needed
(A0* / S0) ΔS -
(L0* / S0) ΔS
S1 x M x
- (1-Payout
ratio)
=
AFN
12-15
FINANCIAL PLANNING PROCESS - EXAMPLE

Once we have our Basic Model, it is
further refined for:

Economies of scale

Nonlinear relationships

Lumpy purchases of assets

Excess capacity adjustments
12-16
PRACTICE PROBLEMS
12-1 TO 12-7
ASSIGNMENT
12-8 , 12-9 &
MINI CASE ON PAGE 516
12-17