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Definition: Business Plan
A model of what management expect a business to become in the future. Goon plans are comprehensive and all financial statements are pro forma.
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Purposes of a Business Plan
- Planning process helps pull management together
- Provides a road map for running the business
- Provides a statment of goals.
- Tells equity investors what reutrns they can expect
- Tells debt investors how the firm will repay their loan
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Four types of Planning
- Operational
- Strategic
- Budgeting
- Forecasting
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Strategic Planning
- Deals with the overall direction of the firm
- Addresses broad, long term issues
- Contains summarized, approximate financial projections (usually 5 years)
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Operational Planning
- Subset of Strategic Planning
- Translates business ideas into concrete short term projections
- Details where the firm wants to be at some fture point in time and the resources required to get there
- Specifies how much the firm will sell to whom and at what prices
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Budgeting
- Short term updates of the annual plan - usually covers a calendar quarter
- Used in industries in which business conditions change rapidly
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Forecasting
- Very short term projections of profit and cash flow.
- Projects sale revnues and expenses in the planing period
- Estimates currrent assets and fixed assets necessary to suppport projected sales
- Determine the firms financing needs throughout the planning period
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Benefits of Financial Forecasting to Managers
- Alows managers to make educated guesses about they future financial condition of the firm
- Allows managers to be more effective in monitoring the firms financial affairs and ths lead to increase profits and reduce risk.
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When to make financial Forecasts
- Major New Investements (capital budgeting, determing profitability)
- Routine Operational Requirements (Determing short term financing needed)
- Long term financial requirements (determing total assets less existing finance)
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5 Sales Forecasting Methods
- Percentage of Sales
- Cash Budgets
- Pro Forma Financial Statements
- Computerized financial Forecasting Methods
- Regression Analysis
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External Funding Required
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Predicting Retained Earnings
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Four Steps in Percentage of Sales Method
- 1. Convert each CA and L that varies with sales to a % of current sales
- 2. Project level of each A and L by using its % of sales * projected sales (some may remain unchanged if don't vary with sales)
- 3. Project new RE
- 4. Project firms need for discretionary financing
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Spontaneous Sources of Financing
Trade Credit and other accounts payable that arise spontaneously in the firms day to day operations
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Discretionary Sources of Financing
Sources of Financing that require an explicit decision on the part of the firms management every time funds are raised.
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Formula: Total Financing Needed
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Formula: Addition Financing Needed
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Assumptions of Forecasting Financial Variables from Sales Forecasts
- 1. That most balance sheet accounts are tied directly to sales
- 2. The current levels of all assets are optimal for the current sales levels.
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Definition: Regression Analysis
- Regression analysis is the use of techniques for modeling and analyzing several variables, when the focus is on the relationship betwee a dependent and one or more independent variables.
- Helps explain how the dependent variable will change in response to a change in the independent variable.
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Weaknesses of Forecasting
- Assumes the firms past financial condition is an accurate indicator of its future
- Accounts can be manipulated to take a certain value desired
- Economies of scales can mean that an increase in sales does not require a proportional increase in assets (eg inventory)
- Lumpy Assets (eg large scale fixed assets)
- Excess Capacity - current level of assets able to generate greater sales
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4 Types of Computerized Financial Forecasting and Planning
- Deterministic
- Sensitivity Analysis
- Probabilistic
- Optimization
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Deterministic Model
Gives a single number forecast of a financial variable or variables without stating anything about its probability of occuring eg budget
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Sensitvity Analysis
Consists of rerunning the model to dtermine the effect on the output variables of changes in the input variables eg sales with/without a product
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Probabilistic Models
Provides more useful information than other models as it yields output in the form of probability distributions rather than a single estimate
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Optimization Models
Determines the values of financial decision variables that optimize some objective function such as profits or costs.
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