Chapter 21:
Strategic and Operational
Financial Planning
Corporate Finance, 3e
Graham, Smart, and Megginson
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Overview of the Planning Process
Financial
planning
activities
Long-term
financial
planning
• Setting long-run strategic goals
• Preparing quarterly and annual budgets
• Managing day-to-day fluctuations in cash
balances
• Invest in positive NPV projects
• Added complexity: CFOs usually see many
more projects that appear to have positive
NPV than they can effectively pursue, so
they must prioritize.
• Limits on capital, production capacity,
human resources and other inputs add
complexity as well.
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Long-Term Financial Planning
Strategic plan
• Multiyear action plan for the major
investment and competitive initiatives
Senior management develops strategic plan by answering
questions like:





In what emerging markets might we have a sustainable competitive
advantage?
How can we leverage our competitive strengths across existing
markets in which we currently do not compete?
How can we respond to any threats to our current business?
In which geographic regions should we produce? Where should we
sell?
Can we deploy resources more efficiently by exiting certain markets
and using those resources elsewhere?
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The Role of Finance in Strategic
Planning
Financial managers draw on a broad set of skills to assess
the likelihood that a given objective can be achieved.
Financial tools are used to determine the feasibility of a
strategic action plan, given firm’s existing and prospective
sources of funding.
Finance plays an important control function as firms
implement their strategic plans.
Financial analysts prepare cash budgets that help avoid
liquidity problems.
Finance contributes to strategic planning through risk
management.
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Sustainable Growth
 Popular
growth measures:
 Return
on Investment (ROI)
 Economic Value Added (EVA)
 Growth
can be defined by increases in
firm’s market value, its asset base, the
number of people it employs, or any
number of other metrics.
 Most
firms measure growth in terms of
sales.
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Sustainable Growth Model
Models how rapidly a firm can grow
Assumption of the model:
1.
2.
3.
4.
5.
The
The
The
The
The
firm will issue no new shares of common stock next year.
firm’s total asset turnover ratio, S/A, remains constant.
firm pays out a constant fraction, d, of its earnings as dividends.
firm maintains a constant asset-to-equity ratio, A/E.
firm’s net profit margin, m, is constant.
Firm wants to increase sales by g percent.
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Sustainable Growth Model
The model is used to derive the sustainable growth rate g*
that keeps the sources and uses of funds in balance.
g* 
The
•
•
•
•
A
m(1  d )
E
A
A
 m(1  d )
S
E
sustainable growth rate can be increased by…
an increase in the profit margin,
an increase in the ratio of assets to equity,
an increase in the total asset turnover ratio, or
a reduction in dividend payouts.
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Pro Forma Financial Statements
Forecasts of balance sheet and income
statements
“Top-down” or “bottom-up” sales forecasts:


“Top-down” approach uses macroeconomic and industry forecast to
establish sales goals.
“Bottom-up” approach forecasts sales on a customer by customer
basis.
Percentage-ofsales method
• Assumes all items grow in proportion to
sales
• One item, such as the cash balance or a
short-term liability account, is the “plug
figure,” which is adjusted after all
projections to preserve the equality of left
and right sides of the balance sheet.
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External Funds Required (EFR)
Forecast of external funds required can be modeled with
the following equation:
A
AP
EFR  S 
S  mS (1  g )(1  d )
S
S
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Planning and Control – ShortTerm Financing Strategies
Companies can adopt the following strategies to fund longterm trend and seasonal fluctuations of sales:
Conservative
strategy
Aggressive
strategy
Matching
strategy
• Use long-term financing to cover both
permanent assets and temporary assets.
• Use short-term financing to fund both
seasonal peaks and part of long-term
growth in sales and assets.
• Finance permanent assets with long-term
funding sources and temporary asset
requirement with short-term financing.
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Cash Budget
Cash budget shows firm’s planned cash
inflows and outflows.
Key input
Firm’s sales forecast
Estimate the monthly cash flows that will result from
projected sales receipts and from production-related,
inventory-related, and sales-related outlays.
Cash receipts
Cash
disbursements
• All firm’s cash inflows in a given financial
period
• All outlays of cash by the firm during a
given financial period
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Cash Disbursements
Cash disbursement items:
• Cash purchases, fixed asset outlays, payments of
accounts payable, interest payments, and rent and
lease payments
• Cash dividend payments, wages and salaries, loan
principal payments, tax payments, and repurchase or
retirement of stock
• Depreciation, though not included in the cash budget,
does have a cash outflow effect through impact on tax
payments.
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Net Cash Flow, Ending Cash,
Financing Needs and Excess Cash
Net cash flow
• Subtract cash disbursements from cash
receipts for each period.
Ending cash
balance
• Add the beginning cash balance to the
firm’s net cash flow.
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Dealing with Uncertainty

Changes in a firm’s collection or payment pattern
alter the timing and magnitude of its financing
needs.

A slowdown in collections increases the firm’s
short-term financing needs, and conversely, a
speedup in collections decreases the firm’s
financing needs.
A
speedup in payments would likely increase the
firm’s financing needs.
 A slowdown in payments would reduce financing
needs.
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