Question

A.   

-       Why company requires financial plan?

-       What is the difference between operating and financial plan?

-       What alternatives a company may use to finance its deficit?

-       How a company manages its surplus?

B.    

Ahmed Ebrahem, the CEO of the BIG Company, is initiating planning for the company's operations next year, and he wants you to forecast the firm's additional funds needed (AFN). The firm is operating at full capacity.  Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year?  All dollar values are in millions.

Last year's sales                      $350                Last year's accounts payable  $40

Sales growth rate                    30%                 Last year's notes payable        $50

Last year's total assets            $500                Last year's accruals                 $30

Last year's profit margin         5%                  Target payout ratio                  60%

Required? Compute the AFN and the self-supporting growth rate.

Answer 1

Answer A

-       Why company requires financial plan?

Before starting any business venture, it’s important to carefully plan its execution and management. This step – financial planning – is crucial to attaining the business’ purpose and objectives.

A financial plan ensures that the many aspects of the business such as marketing, labour, equipment and many others, have been allocated adequate funds so it continues to run smoothly. Your plan should also account for a set amount of emergency reserves to remedy unforeseen issues.

Financial planning means budgeting for your business on a grander and much more complex scale. The process includes analysing past reports, forecasting net revenue, estimating operating costs, understanding risks, and much more.

-       What is the difference between operating and financial plan?

An operational plan and a financial plan are elements of the business plan that support each other to move your business ahead in a chosen direction.

The operational plan runs the business, whereas the financial plan is the bread and butter. Operational and financial plans serve different purposes within a business plan.

The operational plan explains the daily operations of the business such as its location, equipment, people, processes and surrounding environment. In an operational plan, your focus is on how and where your products and services are produced. It identifies your location requirements, business hours, personnel, inventory and suppliers.

The financial plan forecasts over a one year period sales, the cost of goods, expenses, and reflects your monthly profit and cash flow to determine if your working capital is adequate.

-       What alternatives a company may use to finance its deficit?

Alternatives to finance the deficit:

(a) Borrowing from Bank

(b) Issue bonds

(c) Raise additional capital

(d) Liquidate some assets.

-       How a company manages its surplus?

It is important to retain enough surplus cash in the business current account or short-term deposit account to meet the company’s various liabilities as and when they fall due.

To manage the surplus of cash over its cash flow requirements, there may be various options:

• Leave the funds in short term deposit accounts
• Use higher interest paying deposit accounts or bonds
• Distribute the funds as dividends
• Make company pension contributions
• Invest the cash in longer term investments like stocks, shares and possibly property.

Answer B

Additional Funds Needed = Increase in Assets − Increase in Liabilities – Increase in Retained Earnings

Increase in Assets
= Last year's assets × sales growth rate
= $500 × 30%
= $150

Spontaneous Increase in Liabilities
= Last year's liabilities × sales growth rate
= $120 × 30%
= $36

Increase in Retained Earnings
= Last year's sales × profit margin × retention rate
= Last year's sales × (1 + sales growth rate) × profit margin × retention rate
= $350 × (1 + 30%)×5%×40% = $9.1

Additional Funds Needed= 150 - 36 - 9.1

= 104.9

Self Supporting Growth Rate= ROE: ×(1−Dividend Payout Ratio)

ROE = 22.75 / 494 = 4.6%

Self Supporting Growth Rate = 4.6* ( 1- 60%)

= 1.84%