Finance for Non-Financial Managers , 6 th edition

Copyright © 2011 Nelson Education Limited

Finance for Non-Financial Managers, 6th edition

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Prepared by Pierre Bergeron, University of Ottawa


Finance for Non-Financial Managers, 6th edition

CHAPTER 7

PLANNING, BUDGETING, AND CONTROLLING


Chapter Objectives

1. Describe the meaning of planning, its process and how to measure organizational performance.

2. Explain why the SWOT analysis and planning assumptions are important for formulating goals, preparing plans, budgets and projected financial statements.

3. Show how budgeting fits within the overall planning process, the different types of budgets and how to make budgeting a meaningful exercise.

4. Explain the nature of a business plan, its benefits and contents.

5. Describe projected financial statements and how to measure financial performance.

6. Comment on the importance of controlling, the control system, and the different types of controls.

Planning, Budgeting and Controlling

Chapter ReferenceChapter 7: Planning, Budgeting and Controlling


Planning, Budgeting, Financial Projections and Controlling

SWOT analysis

Planning Budgeting Business Plans & Financial Projections

Controlling

A. Planning assumptions

• Mission• Value goals• Corporate priorities• Strategic goals and plans

• Operational priorities• Tactical and operational goals• Tactical and operational plans

SWOT analysis

Operating budgets• sales• manufacturing• staff

• Consolidated budget

• Capital budget

• Cash budget

• Consolidated business plan • Financial projections

• Divisional business plans • Financial projections

Results and monitoring corporate

performance

Results and monitoring operational

performance

Corporate level

Divisional level

B.

C.

D.

E.

H.

G.

F.

I. K.

J.


SWOT

Goals

Planning

Implementation

Controlling

1. The Planning Process

Activities Decisions

What have we achieved so far and what are our strengths, weaknesses, opportunities and threats?

What do we want to accomplish and what impact will these goals have on the profile of our financial statements?

How and when are we going to implement our plans? Who is going to implement them? How much will these plans cost and what are the financial benefits?

What should we do to ensure that we will be on course and that the goals and plans will materialize as planned?

Did we reach our goals and implement our plans? Are the financial results in line with our financial projections?


Why Planning is Important

1. Creative, innovative, resourceful.

2. Goal congruence.

3. Sense of purpose and direction.

4. Cope with change.

5. Simplifies managerial control.


Hierarchy of Plans

1. Strategic plans

2. Tactical plans

3. Operational plans


Performance Indicators

High

Low

Pursuing the wrong goals but

not wasting resources

Pursuing the wrong goals and wasting resources

Pursuing the right goals and

not wasting resources

Pursuing the right goals but

wasting resources

Low High

Effectiveness (goal achievement anddoing the right things)

Efficiency (good use of

resources and doing things right)


the right things

Budgeting by Results

The aim

How

Mechanism

This meansbeing …

To reach the highest level of performance with the least expenditure of resources.

Planning

• priority setting

• objective setting

By doing ________________ By doing ________________ things right

Budgeting

Proper use of resources

________________ ________________

________________

effective economical

efficient


Budgeting by Results

1. ___________________________________

2. ___________________________________

3. ___________________________________

4. ___________________________________

5. ___________________________________

6. ___________________________________

7. ___________________________________

8. ___________________________________

9. ___________________________________

10. ___________________________________

11. ___________________________________

12. ___________________________________

Demassing

Planned downsizing

Reengineering (activity based budgeting)

Reward simplification

Productivity indicators

Cut useless activities

Reward quality

Employee empowerment

Balanced scorecard

Reward good behaviour

Cut salaries and benefits

Arbitrary cuts


SWOTanalysis

Planning assumptions

Goals and

Plans

Operating budgets

and consolidated

budgets

Projected statement of

income and

statement of financial position

What are our strengths,

weaknesses, opportunities and threats?

What are the boundaries

within which we should set our priorities, goals

and plans?

What should we try to accomplish (goals) and how

should we implement them

(plans)?

How much does it cost to realize our goals

and implement our plans?

How will the planning

assumptions impact on our

revenue, expense,

asset, equity and liability accounts?

2. SWOT Analysis and Planning Assumptions


3. Budgeting Within the Planning Process

Phase 1 Corporate planning

Phase 2 Management by objectives

Phase 3 Budgeting by results

Phase 4 Operational planning

Phase 5 Controlling

• Mission statement• Key success factors• Value goals• Corporate priorities• Strategic goals and plans

• Roll-down process• Objectives (on-going activities)• Objectives (projects)


Budgeting and Financial Projections

Staff budget

Manufacturing budget

Sales budget

Operating budgets

Financial projections

Projectedstatements

Cash budget

Investment plan

Financing plan


Types of Budgets

Complementary budgets

Capital budgets

Comprehensive budgets

• Product budgets• Program budgets• Item-of-expenditure budgets• Cash budgets

• Sales budgets• Flexible budgets• Overhead unit budgets

• Projected financial statements

• New plants• Expansion/modernization

Operating budgets


Rules for Sound Budgeting

1. Pinpoints authority

2. Integrates all planning activities

3. Insists on sufficient and accurate information

4. Encourages participation

5. Links budgeting to monitoring

6. Tailors budgeting to the organization's needs

7. Communicates budget guidelines and planning

assumptions

8. Relates costs to benefits

9. Establishes standards for all units

10. Be flexible


4. The Business Plan

What it isA business plan is a document that gives a complete picture about an organization’s goals, plans, operating activities, financial needs and financing requirements.

Benefits - for the company• Shows how management intends to implement plans.• Forces managers to be realistic. • Helps managers to monitor plans.• Helps to pinpoint how resources should be deployed.


The Business Plan

Benefits - for the investors• Provides base for judging the company.• Assures that managers are aware of the opportunities and threats (external environment). • Shows the ability of the business to repay its debt.• Helps to analyze all components related to the company (internal and external).• Identifies the timing and nature of future cash requirements.• Helps to assess management’s ability.• Indicates funding requirements and sources.


Contents of The Business Plan

• Cover sheet• Executive summary• Company and ownership• External environment• Mission, statement of purpose and strategy

statements• Products and services• Management team• Operations• Financial projections• Appendixes


5. Projected Statement of Income

____% ____%3.24.6

Revenue

Cost of sales

Gross profit

Other income and expenses

Profit before taxes

Income tax expense

Profit for the year

$ 2,500,000

(1,400,000)

1,100,000

(940,000)

160,000

(80,000)

$ 80,000

Modern Industries Ltd.

Projected Statement of Income

For the Period ended December 31

2010

$ 2,875,000

(1,553,000)

1,322,000

(1,059,000)

263,000

(131,500)

$ 131,5 00

15% increase

54% of revenue from 56%

20.2% increase

36.8% of revenue from 37.6%

64.4% increase

64.4% increase

64.4% increase

2011


Projected Statement of Financial Position

Non-current assets

Property, plant and equipment Accumulated depreciationTotal non-current assets

Current assets Inventories Trade receivables Marketable securities CashTotal current assets

Total assets

Equity Share capital Retained earningsTotal equity

Non-current liabilities Mortgage Long-term borrowingsTotal non-current liabilities

Current liabilities Trade and other payables Notes payable AccrualsTotal current liabilities

Total equity & liabilities

$ 900,000

(100,000)800,000

150,000 190,000

10,000 50,000 400,000

$ 1,200,000

$ 100,000 300,000 400,000

500,000 100,000 600,000

100,000 80,000

20,000 200,000

$ 1,200,000

Modern Industries Ltd. Projected Statement of Financial Position

as at December 312010

$ 1,200,000

(160,000)1,040,000

160,000 194,500

10,000 57,000 421,500

$ 1,461,500

$ 100,000 381,500 481,500

650,000 130,000 780,000

101,000 79,000

20,000 200,000

$ 1,461,500

2011

Refer to the capital budget for details

Adjusted for increase in non-current assets

1.0 time improvement3-day collection improvementNo change2% of revenue

No changeSee the statement of income and the statement of changes in equity for details

Increase to purchase non-current assetsIncrease to purchase non-current assets

From 7.1% of cost of sales to 6.5%Working capital loanNo change


Projected Inflows and Outflows of Cash

Non-current assets

Property, plant and equipment Accumulated depreciationTotal non-current assets

Current assets Inventories Trade receivables Marketable securities CashTotal current assets

Total assets

Equity Share capital Retained earningsTotal equity

Non-current liabilities Mortgage Long-term borrowingsTotal non-current liabilities

Current liabilities Trade and other payables Notes payable AccrualsTotal current liabilities

Total equity & liabilities

$ 900,000

(100,000)800,000

150,000 190,000

10,000 50,000 400,000

$ 1,200,000

$ 100,000 300,000 400,000

500,000 100,000 600,000

100,000 80,000

20,000 200,000

$ 1,200,000

$ 1,200,000

(160,000)1,040,000

160,000 194,500

10,000 57,000 421,500

$ 1,461,500

$ 100,000 381,500 481,500

650,000 130,000 780,000

101,000 79,000

20,000 200,000

$ 1,461,500

Modern Industries Ltd. Projected Inflows and Outflows of Cash

as at December 31

---

60,000

----- ----- -----

-----

----- 81,500

150,000 30,000

1,000 ----- -----

$ 322,500

$ 300,000

-----

10,000 4,500

----- 7,000

----- -----

----- -----

----- 1,000

-----

$ 322,500

Inflows Outflows20102011


Projected Statement of Cash FlowsModern Industries Ltd.

Projected Statement of Cash Flows

Inflows Outflows

Adjustments in working capital Increase in cash --- 7,000 Increase in trade receivables --- 4,500 Increase in inventories --- 10,000 Increase in trade and other payables 1,000 --- Increase in notes payable --- 1,000Total 1,000 22,500Net change in working capital --- 21,500

Funds from operations Profit for the year 131,500 --- Depreciation 60,000 ---Net funds from operations 191,500 ---

Changes in financingProceeds from long-term note 30,000 ---Proceeds from mortgage 150,000 ---Payment of dividends --- 50,000Total 180,000 50,000

Net change in operating activities 170,000

Net change in financing activities 130,000

Net change in investing activities --- 300,000

Total 300,000 300,000

1.

2.

3.


6. The Sustainable Growth Rate

Administrative expenses

SALES

Finance costs Cost of

goods sales

Inventories

Trade and other

payables

Non-current assets

Trade receivable

Depreciation

Distribution costs

Growth Funds

Increase profit on sales

New debt

New equity

Pay less dividends

Invest in less assets


Modern’s sales growth should not exceed 11.1% or $2,775,000.

M = Profit for the year earned on each dollar of revenue

R = Percentage of profit for the year reinvested in the business (subtract the dividend paid from profit and divide the result by the profit)

D/E = Divide total liabilities by total net worth

A = Assets needed to support each revenue dollar

Modern Industries Ltd.’s Growth Potential

1. Ratio of profit for the year to revenue M = .032

2. Ratio of reinvested profit to profit before dividends R = .50

3. Ratio of total liabilities to net worth D/E = 2.00

4. Ratio of total assets to revenue A = .48

The formula

Growth =

Growth = = = .111

Transparencies 4.4 and 4.5

(M) (R) (1 + D/E)

(A) – (M) (R) (1+ D/E)

(.032) (.50) (1 + 2.00)

(.48) – (.032) (.50) (1+ 2.00)

.048

.432

With 4.6% ROR the new sustainable growth would be 20.4%


Green zone 3.0 and over

Yellow zone 1.8 to 3.0

Red zone 0 to 1.8

Z = 1.2 ( a ) + 1.4 ( b ) + 3.3 ( c ) + 0.6 ( d ) + 1.0 ( e )

a =

b =

c =

d =

e =

Altman’s Financial Z-ScoreThis is a linear analysis where five measures are objectively weighted to give an overall score that becomes the basis for classification of firms into one of three groupings:

Working capital

Total assets

Retained earnings

Total assets

Earnings before interest and taxes

Total assets

Equity

Total liabilities

Revenue

Total assets


Modern Industries Ltd.’s 2010 Z-Score

Z = 1.2 ( a ) + 1.4 ( b ) + 3.3 ( c ) + 0.6 ( d ) + 1.0 ( e )

Z = 1.2 ( .17 ) + 1.4 ( .25 ) + 3.3 ( .196 ) + 0.6 ( .50 ) + 1.0 ( 2.08 ) = 3.581

a = = = .17

b = = = .25

c = = = .196

d = = = .50

e = = = 2.08

Working capital

Total assets

Retained earnings

Total assets

Earnings before interest and taxes

Total assets

Equity

Total liabilities

Revemie

Total assets

$200,000

$1,200,000

$300,000

$1,200,000

$235,000

$1,200,000

$400,000

$800,000

$2,500,000

$1,200,000


6. The Control Process

Planning

• Objectives

• Plans

Design the subsystem

Performance indicators

Analyze variations

There is no need to do anything

Measure performance

Performance standards

Corrective action

2. 3.

1.

yes

4. 5. 6.

no


Types of Controls

Plans

Feedback controls

Screening controls

Results

Preventive controls

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Finance for Non-Financial Managers , 6 th edition

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