 FINANCIAL PLANNING

 BUDGETING AND PROCESS

 TYPES OF BUDGET
 PLANNING - simply a set of actions to achieve a certain target in
the future. It needs not be expressed in financial terms. However
many people like to associate planning with financial numbers to
make it more meaningful and measurable.

 BUDGETING - plan expressed in financial terms. For smaller

organization, the budgeting may just be expressed as single
budget. However, in big organization, budgeting can be expressed
in a number of linked budgets such as sales budget, operation
budget or more. The most important point in budgeting is that all the
actions are translated into financial numbers which set targets for
the organization to meet.

 FORECAST - is very similar to budgeting, just that it is merely a

prediction of what will happen after taking into consideration of what
had happened. The key difference between them is that a budget
sets targets but a forecast does not.
 FINANCIAL PLANNING ESTABLISHES GUIDELINES
FOR CHANGE AND GROWTH OF THE FIRM,
FOCUSES ON MAJOR ELEMENTS OF FIRM
FINANCIAL AND INVESTMENT POLICIES

 IT IS SYSTEMATICALLY THINKING THE FUTURE AND

ANTICIPATING POSSIBLE PROBLEMS BEFORE THEY
OCCUR

LACK OF PLANNING IS COMMONLY CITED AS

REASON FOR FINANCIAL DISTRESS AND
FAILURE
 Formal process for establishing goals and objectives over the
long run.

 Involves developing a mission statement that captures why the

organization exists and plans for how the organization will thrive
in the future.

 Strategic objectives and corresponding goals are developed

based on a very thorough assessment of the organization and
the external environment.

 Finally, strategic plans are implemented by developing an Operating

or Action Plan. Within this Operating Plan, a complete set of
financial plans or budgets will be included.
 Formulates way in which financial goals are to be
achieved

 A Financial Plan is a statement of what is to be

done in the future.

 It is a decision made far in advance of their

implementation
The Financial Planning Process

 Long-Term (Strategic) Financial Plans

 Long-term (strategic) financial plans lay out a
company’s planned financial actions and the
anticipated impact of those actions over periods
ranging from 2 to 10 years.
 Firms that are exposed to a high degree
of operating uncertainty tend to use shorter plans.
 These plans are one component of a company’s
integrated strategic plan (along with production
and marketing plans) that guide a company toward
achievement of its goals.
Copyright © 2001 Addison-Wesley 14-7
The Financial Planning Process

 Long-Term (Strategic) Financial Plans

 Long-term financial plans consider a number
of financial activities including:
• Proposed fixed asset investments
• Research and development activities
• Marketing and product development
• Capital structure
• Sources of financing
 These plans are generally supported by a series
of annual budgets and profit plans.
Copyright © 2001 Addison-Wesley 14-8
The Financial Planning Process

 Short-Term (Operating) Financial Plans

 Short-term (operating) financial plans specify short-
term financial actions and the anticipated impact
of those actions and typically cover a 1- to 2-year
operating period.
 Key inputs include the sales forecast and other
operating and financial data.
 Key outputs include operating budgets, the cash
budget, and pro forma financial statements.

Copyright © 2001 Addison-Wesley 14-9

`
CORPORATE GOALS OR
OBJECTIVES

CORPORATE LONG-
RANGE PLAN

LONG TERM SALES

FORECAST

TOTAL MARKET OUR SHARE OF

PRODUCT MIX STRATEGY MARKET
DEMAND

SHORT TERM SALES

FORECAST

Mfg Policies, Production Research and General

Marketing Policies, Financial Control Policies,
budget, Material budget, Management Policies,
Advertising Budget, Product Budget, Regional
Personnel budget, Capital Research Budget and
Selling Budget, Budget
Expenditures Budget Executive Budget

Budgeted Financial Statements

(Cash Flow, Income Statement, Statement of Financial
Position, Statement of Stockholders Equity)
The Financial Planning Process

 Short-Term (Operating) Financial Plans

Copyright © 2001 Addison-Wesley Figure 14.1 14-11

 ECONOMIC ENVIRONMENT ASSUMPTIONS

 SALES FORECAST

 PRO-FORMA STATEMENTS

 ASSETS REQUIREMENTS

 FINANCIAL REQUIREMENTS

 ADDITIONAL FUNDS NEEDED

 The plan will have to state explicitly the
economic environment in which the firm
expect to reside.

 Assumption on inflation rate, level of

interest rate, tax rate, new laws and
other government regulatory laws
should be defined
 Sales Forecast is considered the “driver” and
the heart of all financial plans. Planning will
focus on projected future sales, assets and
financing needed to support sales.

 Sales forecast is given as growth rate rather

the explicit sales figure.
 Financial plan will have forecast
statement of financial position, income
statement, statement of cash flow and
statement of Stockholders equity.

 These are called pro forma or projected

statements which will summarize
different events projected in the future.
 The financial plan will describe the
projected capital spending.

 At a minimum, the projected statement

of financial position will contain
changes in total fixed assets, and net
working capital
 Financial plan will include a section
about the necessary financing
arrangement. This part of the plan
should discuss dividend policy and debt
policy.

 Sometimes the company will expect to

raise cash by selling new shares of
stock or by borrowing.
 After the sales forecast and an estimate
of the required spending on assets,
some amount of new financing will often
be necessary because projected total
assets will exceed the projected total
liabilities and equity. In other words, the
statement of financial position will now
longer balance.
 Projected Financial Statement Method

 Procedures in preparing are as follows:

1. Forecast the Income Statement
2. Forecast the Statement of Financial Position
3. Raising the additional funds needed
4. Consider Financing Feedbacks
 Provides a RATIONAL WAY OF PLANNING
OPTIONS OR ALTERNATIVE

 Interactions or LINKAGES between

Investment are carefully examined

 Problems related to the proposal are

identified, address and studied

 Managers are forced to think of GOALS and

PRIORITIES

 Feasibility and internal CONSISTENCY are

assured
 IT IS A FINANCIAL PLAN OF THE
RESOURCES NEEDED TO CARRY OUT
TASKS AND FINANCIAL GOALS

 IT IS ALSO A QUANTITATIVE
EXPRESSION OF GOALS OF THE
ORGANIZATION WISHES TO ACHIEVE
AND THE COST ATTAINING THESE
GOALS

 THE USE OF BUDGETS TO CONTROL

COMPANY’S ACTIVITIES IS KNOWN AS
BUDGETARY CONTROL
 Define broad Objectives

 Coordinating the Activities

 Allocating Resources

 Communicating

 Uncovering and preparing for potential

bottlenecks

 Motivating managers

 Setting Standards or benchmark for

evaluating actual performance
 FORCES PLANNING AND EXPOSES SITUATIONS
OF INADEQUACY TO ATTAIN OBJECTIVES

 ALLOWS REITARATIVE PROCESS TO BRING

GOALS OF THE ORGANIZATION

 PROVIDES MEANS OF COMMUNICATING GOALS

OF THE ORGANIZATION

 BASIS OF FINANCIAL PLANNING, RESOURCE

ACQUISITIONS, INVENTORY POLICY,
SCHEDULING OF OUTPUT

 MONITORING AND BENCHMARK

 TEND TO OVERSIMPLIFY THE REAL
SITUATION AND FAIL TO ALLOW
VARIATION OF EXTERNAL FACTORS

 DIFFICULT TO PREPARE FOR AN NEW

ORGANIZATION, DIVISION OR PRODUCT
THAT HAS NEVER EXISTED.

 LACK OF HIGHER AND LOWER

MANAGEMENT COMMITMENT DUE TO
LACK OR UNDERSTANDING OF THE
FUNDAMENTALS OF BUDGET
PREPARATION AND UTILIZATION
 OPERATING BUDGET

 FINANCIAL BUDGET

 CAPITAL BUDGET
 BUDGETED INCOME STATEMENT
1. Sales budget
2. Production budget

 COST OF SALES

 SELLING AND ADMINISTRATIVE

EXPENSES

 FINANCIAL EXPENSE
 BUGETED STATEMENT OF FINANCIAL
POSITION

 CASH BUDGET

 BUDGETED STATEMENT OF SOURCES AND

USES OF FUNDS
The first forecast we will prepare is the Sales Forecast.
In order to estimate sales, we will look at past sales histories and
various factors that influence sales.
For example, marketing research may reveal that future sales are
expected to
stabilize. Production capacity will also be considered

EXHIBIT 1 — SALES FORECAST

Product Volume Price Total Sales

Lace Shoes 16,000 $ 45.00 $ 720,000

 EXHIBIT 2 — PRODUCTION BUDGET

Planned Sales (Exhibit 1) 16,000

Desired Ending Inventory 1,500
Total Units 17,500
Less Beginning Inventory ( 3,000)

Planned Production 14,500

EXHIBIT 3 — MATERIALS BUDGET

Lace Shoes require .25 square yards of leather and leather is estimated to
costs $ 5.00 per yard next year. Materials Required = 14,500 (Exhibit 2)
x .25 = 3,625 yards.

Materials Required for Production 3,625

Desired Ending Inventory 375
Total Materials 4,000
Less Beginning Inventory ( 500)
Total Materials Required 3,500
Unit Cost for Materials x $ 5.00
Total Materials Purchased $ 17,500
EXHIBIT 4 — LABOR BUDGET

Lace Shoes require .50 hours to produce one unit.

14,500 units x .50 = 7,250 hours.
The expected hourly labor rate next year is $ 12.00.

Estimated Production Hours 7,250

Hourly Labor Rate x 12.00
Total Labor Costs $ 87,000
 EXHIBIT 5 — OVERHEAD BUDGET (Based on Unique Drivers)

Estimated for each line item as follows:

Indirect Labor Costs * $ 12,000

Utilities 5,000
Depreciation 3,000
Maintenance 1,000
Insurance and Taxes 4,000
Total Overhead Costs $ 25,000

*Production Supervision and Inspection

EXHIBIT 6 — COST OF GOODS SOLD BUDGET
Direct Work In Finished
Materials Progress Inventory
Beginning Inventory $ 2,500 $ 16,000 $ 46,000
Purchases (Exhibit 3) 17,500
Less Ending Inventory ( 1,875)
Materials Required 18,125
Direct Labor (Exhibit 4) 87,000
Overhead (Exhibit 5) 25,000
Total Manufacturing Costs $ 130,125 130,125
Total Work In Progress 146,125
Less Ending Inventory ( 12,000)
Cost of Goods Manufactured $ 134,125 134,125
Cost of Goods Available for Sale 180,125
Less Ending Inventory ( 36,000)
Cost of Goods Sold $ 144,125
EXHIBIT 7 — MARKETING BUDGET

Estimated for each line item per the Marketing Department:

Marketing Personnel $ 75,000

Advertising & Promotion 42,000
Marketing Research 12,000
Travel & Personal Expenses 6,500
Total Marketing Expenses $ 135,500
 EXHIBIT 8 — GENERAL & ADMINISTRATIVE BUDGET

Estimated for each line item per Department Managers:

Management Personnel $110,000

Accounting Personnel 55,000
Legal Personnel 40,000
Technology Personnel 45,000
Rent & Utilities 25,000
Supplies 15,000
Miscellaneous 7,500

Total G & A Expenses $ 297,500

EXHIBIT 9 — BUDGETED INCOME STATEMENT

Revenues (Exhibit 1) $720,000

Less Cost of Goods Sold (Exh 6) (144,125)
Gross Profit 575,875
Less Marketing (Exhibit 7) (135,500)
Less G & A (Exhibit 8) (297,500)
Operating Income 142,875
Less Interest on Debt ( 8,000)
Income Before Taxes 134,875
Taxes @ 37.5% ( 50,578)
Net Income $ 84,297