CHAPTE

Financial Planning and Strategy

R 26
 LEARNING OBJECTIVES
2

 Understand the difference between financial forecasting and

financial planning
 Explain the components of a financial plan
 Discuss the technique of financial forecasting
 Develop an approach to construct a financial model
 Examine the features and implications of sustainable growth model
 Show the linkage between strategic planning and planning
 INTRODUCTION
3

 Financial planning indicates a firm’s growth,

performance, investments and requirements of funds
during a given period of time, usually three to five
years.
 It involves the preparation of projected or pro forma
profit and loss account, balance sheet and funds flow
statement.
 Financial planning help a firm’s financial manager to
regulate flows of funds which is his primary concern.
 Strategic Decision-making
Framework
4

 Strategy is the foundation for any planning

system of a firm.
 The business portfolio models are most popular
and useful to understand the firm’s strategic
concerns and choices and plan for the future.
 The market growth-market share model , popularised
by the Boston Consulting Group (BCG)
 The nine-cell matrix model developed by the General
Electric Company
 Market growth-market share
5
model
 Summary of Strategic Decision-Making
6 Framework
 A firm operates in a complex environment.
 Strategy is a central theme that establishes a match between
the firm’s competences and opportunities created by
environment changes.
 A firm is multi-directed; strategy is a link between the
multiple goals of the firm and its plans and policies.
 Product-market scope, competitive advantages, distinctive
competences and synergy are the most important components
of strategy.
 Market dominance (particularly, during the growth stage) is
the most desirable strategy.
 A firm should have a balanced portfolio of businesses.
 Strategic Financial Planning
7

 Two important tasks of the financial manager are:

 Allocation of funds (viz. investment decision).
 Generation of funds (viz. financial decision).

 The theory of finance makes two crucial assumptions:

 First, the objective of the firm is to maximise the wealth of
shareholders.
 Second, capital markets are efficient.
 Financial Planning
8

 Financing planning process involves the following

facets:
 Evaluating the current financial condition of the firm.
 Analysing the future growth prospects and options.
 Appraising the investment options to achieve the stated growth
objective.
 Projecting the future growth and profitability.
 Estimating funds requirement and considering alternative
financing options.
 Comparing and choosing from alternative growth plans and
financing options.
 Measuring actual performance with the planned performance.
 Financial Forecasting and
9
Modelling
 Financial forecasting is an integral part of financial
planning. It uses past data to estimate the future financial
requirements.
 A financial planning model establishes the relationship
between financial variables and targets, and facilitates the
financial forecasting and planning process.
 A financial planning model has the following three
components:
 Inputs
 Model
 Output
 Constructing Financial Model
10

 To prepare the next year’s proforma profit and loss statement,

balance sheet and funds flow statement, the planning team through
a consultative process in the company, made several assumptions
and models about the relationships between financial variables.

 Based on the model inputs and assumptions, the planning team

developed the model equations for proforma profit and loss
statement, funds flow statement and balance sheet.

 Prepare proforma financial statements

 Long-term Financial Plan
11

 In practice, long-term financial forecasts are prepared

by relating the items of profit and loss account and
balance sheet to sales. This is called the percentage to
sales method.
 Sensitivity Analysis
12

 Toexamine the effect of changing assumptions on

a particular firm’s funds requirement, the finance
manager can perform a sensitivity analysis.

 He/she can vary one variable at a time, and analyse

its effect.
 Steps in Financial Planning
13

 Pastperformance
 Operating characteristics
 Corporate strategy and investment needs
 Cash flow from operations
 Financing alternatives
 Consequences of financial plans
 Consistency
 PLANNING FOR
14
SUSTAINABLE GROWTH
A simple way of ascertaining the growth potential
of a company, given its current financial
conditions, is to examine the interaction between
four financial policy goals expressed as ratios:
 target sales growth
 target return on investment (net assets)
 target dividend payout and
 target debt-equity (capital structure)
Growth Potential of a Single-product
Company
15

 Sustainable growth may be defined as the

annual percentage growth in sales that is
consistent with the firm’s financial policies
(assuming no issue of fresh equity):
net margin × retention × leverage
sustainable growth 
assets turnover – (net margin × retention × leverage)
 Growth Potential of a Multi-product
16
Company
 Sustainable growth rate in the case of multi-
product or multi-division company is to calculate
the sustainable growth rate at the corporate level
in terms of growth in assets.