Transcript General Management Introduction

Long Term Financial
Planning & Growth
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Financial Planning System: Introduction
• Long-Range Financial Planning:
 means of systematically thinking about the future and
anticipating possible problems before they arrive.
 to avoid financial distress and failure
 establishes guidelines for change and growth in a firm
 concerned with the major elements of a firm’s financial
and investment policies
 interrelatedness of the various
financing decisions a firm makes
investment
and
2
Basic elements of firm’s financial policy
• The firm’s needed investment in new assets.
 Capital Budgeting Policy
• The degree of financial leverage the firm
chooses to employ.
 Capital Structure Policy
• The amount of cash the firm thinks is
necessary
and
appropriate
to
pay
shareholders.
 Dividend Policy
• The amount of liquidity and working capital the
firm needs on an ongoing basis.
 Working Capital Policy
3
These Policies and Decisions affect
• Future Profitability
• Need for external financing
• Opportunities for growth
Firm’s investment and financing policies interact and thus
cannot truly be considered in isolation from one another.
Most company use explicit, company wide growth rate as a
major component of their long-run financial planning
Financial Planning Models can be used to better understand
how growth shall be achieved.
4
What are 4 Ps of Marketing ?
What are 6 Ps of Financial Planning ?
Proper
Prior
Planning
Prevents
Poor
Performance
5
What is Financial Planning ?
• Making a roadmap for what is to be done in
future so as to formulate the way in which
financial goals are to be achieved.
• Remember ?
 Financial Management operates in an uncertain
world
6
Growth as a Financial Management Goal
• Growth, by itself, is not an appropriate goal for the
financial manager.
• Growth may thus be a desirable consequence of good
decision making, but it is not an end unto itself.
• But, growth rates are very commonly used in planning
process.
• Growth is a convenient means of summarizing various
aspects of a firm’s financial and investment policies.
• If we think of growth as growth in the market value of the
equity of the firm, then its equivalent to goal of
maximizing the shareholder’s wealth.
7
Dimensions of Financial Planning
1. Planning Horizon:

Short Run: 12 months

Long Run: 2 to 5 years
•
Establish the Planning Horizon
2. Aggregation:

Of all the individual projects and investments the firm will
undertake
•
Fix the Level of Aggregation
3. Assumptions regarding the important variables

Eg. Preparing alternative business plans for three scenarios:
Worst Case, Normal Case, and Best Case
•
Make realistic Assumptions regarding the forthcoming
events and variables
8
Why spend time on planning ?
What can Planning Accomplish ?
1. Examining Interactions
•
Between investment proposals and financing choices
2. Exploring Options
•
•
Various investment and financing options explored
Their impact on the firm’s shareholders can be evaluated.
3. Avoiding Surprises
•
Contingency Planning
4. Ensuring Feasibility and Internal Consistency
•
•
•
Making explicit linkages between various specific goals
Imposing unified structure for reconciling different goals and
objectives.
Establishing priorities
9
Financial Planning Models
A Financial Planning Model: Elements
1. Sales Forecast
•
•
•
It is generally the “driver”
Given as the growth rate in sales
Perfect forecast is IMPOSSIBLE.
2. Pro-forma Statements
•
•
Forecasted Balance Sheet, Income Statement and
Statement of Cash Flow
Pro formas are the output of financial planning models
3. Assets Requirements
•
Projected Capital Spending = changes in total fixed assets
and net working capital = Total Capital Budget
10
A Financial Planning Model: Elements (contd…)
4. Financial Requirements
•
What are the necessary financing arrangements
and how shall those be raised
5. The Plug
•
The plug is the designated source or sources of
external financing needed to deal with any
shortfall (or surplus) in financing and thereby
bring the balance sheet into balance.
6. Economic Assumptions
•
State explicitly the economic environment in
which the firm expects to reside over the life of
the plan
11
Example
ABC Co
Financial Statements of most recent year
Income Statement
Sales
$1,000
Costs
800
Net Income
$200
Balance Sheet
Assets
$500 Debt
Equity
Total
$500 Total
$250
$250
$500
• Assumption: All variables are tied directly to sales and
current relationships are optimal. This means that all items
will grow at exactly the same rate as sales.
• Suppose the sales increase by 20 %, rising from $ 1,000 to $
1,200.
• Make Pro forma Income Statement and Balance Sheet
12
Example (contd…)
Pro Forma
Income Statement
Sales
Costs
Net Income
$1,200
960
$240
Pro Forma Balance Sheet
Assets
$600 Debt
Equity
Total
$600 Total
$300
300
$600
• Reconcile these two pro formas
• Can net income be equal to $ 240 and equity increase by only
$ 50 ?
• ABC must have paid out the difference of $ 240 - $ 50 = $
190 possibly as cash dividend.
• In this case, dividends are the plug variable.
13
Example ( contd….)
• Suppose ABC doesn’t pay out the $ 190
• What happens to Equity ?
• It grows to $ 240 + $ 250 = $ 490
• Now everything is fine ?
• What happens to Debt ?
• Debt must be retired to keep total assets $ 600
• Debt will have to be $ 600 - $ 490 = $ 110
• Debt to be retired = $ 250 - $ 110 = $ 140
• In this case Debt is the Plug Variable
14
Example (contd…)
Pro Forma Balance Sheet
Assets
$600 Debt
Equity
Total
$600 Total
$110
490
$600
• Example shows the interaction between sales growth and
financial policy.
• As sales increase, so do total assets. WHY ?
• The firm must invest in net working capital and fixed assets to
support higher sales levels.
• Since assets are growing, total liabilities and equity will grow
as well
15
The Percentage of Sales Approach
• Every item doesn’t increase at the same rate as
sales.
• Eg: Long-Term Borrowing – something that doesn’t
necessarily relate directly to the level of sales
• The basic idea is to separate the income statement
and balance sheet accounts into two groups:
 Those that do vary directly with sales
 Those that don’t vary directly with sales.
• Given the sales forecast, calculate how much
financing the firm will need to support the predicted
sales level.
16
PoS Approach for Income Statement
• Assumes that the future relationship between
various elements of costs to sales will be
similar to their historical relationship.
• When using this method, a decision has to be
taken about which historical cost ratios to be
used.
• Should these ratios pertain to the previous
year
• OR the average of two or more years.
17
PoS Approach for Income Statement (contd….)
XYZ Corporation
Income Statement (Most Recent)
Sales
Costs (Cost + Depreciation + Interest)
Taxable Income
Taxes @ 34 %
Net Income
Dividends
Addition to Retained Earnings
$1,000
800
$200
68
$132
$44
$88
XYZ has projected a 25 % increase in sales for the coming year
18
PoS Approach for Income Statement (contd….)
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
What will be the sales for coming year ?
$ 1250
What will be the cost for coming year ?
Assuming that the ratio of cost to sales shall remain same.
80 % of $ 1250 = $ 1000
What will be the Net Income ?
$ 165
What was the percentage of NI to sales and what is it now ?
13.2 %
Now what about dividend ?
Assume that the management of XYZ pays constant rate of dividend out
of NI (Dividend payout ratio is constant)
What is dividend payout ratio of XYZ ?
$ 44 / $ 132 = 33.33 %
What is the retention or plowback ratio of XYZ ?
$ 88 / $ 132 = 66.67 % = 100 % - 33.33 %
Make pro forma income statement for coming year.
19
PoS Approach for Income Statement (contd….)
XYZ Corporation
Pro Forma Income Statement
Sales
Costs (Cost + Depreciation + Interest)
Taxable Income
Taxes @ 34 %
Net Income
Dividends
Addition to Retained Earnings
$1,250
1000
$250
85
$165
$55
$110
20
PoS Approach for Balance Sheet
• Some of the items vary directly with sales and
others do not.
• For those items that do vary with sales, we
express each as a percentage of sales for the
year just ended. For others we write “n/a”
21
PoS Approach for Balance Sheet (contd…)
XYZ Corporation
Most Recent Balance Sheet
$
% of sales
Assets
$
% of sales
Liabilities
Current Assets
Current Liabilities
Cash
160
16
Accounts payable
300
30
Accounts
Receivable
440
44
Notes payable
100
n/a
Inventory
600
60
400
n/a
Total
1200
120
800
n/a
Common stock and paid
in surplus
800
n/a
Retained Earnings
1000
n/a
1800
n/a
3000
n/a
Fixed Assets
New plant and
equipment
Total
Long term Debt
Owner's Equity
1800
180
Total
Total Assets
3000
300
Total liabilities and owner's
equity
22
PoS Approach for Balance Sheet (contd…)
•
•
•
•
Ratio of total assets to sales = 3
It is called Capital Intensity Ratio
What does this ratio tell us ?
Tells us the amount of assets needed to generate $ 1 in
sales.
• Its reciprocal of Total Assets Turnover Ratio
• On the liability side, why only A/C payable is assumed to be
varying with sales ?
• What is Notes Payable ?
 Short term debts such as bank and corporate borrowings.
• What about Retained Earning ? Does it vary with sales ?
 But we shall calculate it based on our projected net income and
dividend (governed by dividend policy)
23
PoS Approach for Balance Sheet (contd…)
• Construct a partial pro forma balance sheet
• For each items, also find out the change from
previous year in $.
• For those items that don’t vary directly with sales,
initially assume no change and simply write in the
original amounts.
• What about change in Retained Earnings ? Is it nil ?
• Assets increase by $ 750 while liabilities and equity
increase only by $ 185
• The difference $ 565 is External Financing Need
(EFN)
24
PoS Approach for Balance Sheet (contd…)
XYZ Corporation
Partial Pro Forma Balance Sheet
$
Change from
previous year
Assets
$
Change from
previous year
Liabilities
Current Assets
Current Liabilities
Cash
200
40
Accounts payable
375
75
Accounts
Receivable
550
110
Notes payable
100
0
Inventory
750
150
475
75
Total
1500
300
800
0
Common stock and paid
in surplus
800
0
Retained Earnings
1110
110
1910
110
Total liabilities and owner's
equity
3185
185
External Financing Need
565
565
Fixed Assets
New plant and
equipment
Total
Long term Debt
Owner's Equity
2250
450
Total
Total Assets
3750
750
25
Scenario 1
• Now there’s a good news and a bad news.
• Good News – We’re projecting 25 % increase in
sales.
• Bad News – This isn’t going to happen unless
XYZ can somehow raise $ 565 in new financing.
• If for eg, XYZ has goal of not borrowing any
additional funds and not selling any new equity,
then 25% increase in sales is probably not
feasible.
• This is how the planning process can point out
problems and potential conflicts.
26
Scenario 1 (contd…)
• Given the EFN $ 565, XYZ has three possible
sources:
 Short-Term borrowing
 Long-Term borrowing
 Issuance of New Equity
• Choice of any combination of above sources
is up to management.
• Lets say that XYZ decides to borrow $ 565some over the short-term and some over the
long-term
27
Scenario 1 (contd…)
– Construct Pro Forma BS
Leave net working capital unchanged
XYZ Corporation
Partial Pro Forma Balance Sheet
$
Change from
previous
year
$
Assets
Liabilities
Current Assets
Current Liabilities
Cash
200
40
Accounts payable
Accounts
Receivable
550
110
Notes payable
Inventory
750
150
Total
1500
300
Fixed Assets
New plant and
equipment
Change from
previous
year
Total
375
75
700
300
3750
750
Long term Debt
Owner's Equity
2250
450
Common stock and paid
in surplus
Retained Earnings
Total
Total Assets
3750
750
Total liabilities and owner's
equity
29
Accounts Payable rose by $ 75
How much could XYZ borrow in shortterm Notes Payable ?
XYZ Corporation
Partial Pro Forma Balance Sheet
$
Change from
previous
year
Assets
375
75
325
225
700
300
3750
750
Liabilities
Current Assets
Current Liabilities
Cash
200
40
Accounts payable
Accounts
Receivable
550
110
Notes payable
Inventory
750
150
Total
1500
300
Fixed Assets
New plant and
equipment
$
Change from
previous
year
Total
Long term Debt
Owner's Equity
2250
450
Common stock and paid
in surplus
Retained Earnings
Total
Total Assets
3750
750
Total liabilities and owner's
equity
31
How much more is needed now ?
$ 565 - $ 225 = $ 340
How will XYZ raise $ 340 ?
Long Term Borrowings
XYZ Corporation
Partial Pro Forma Balance Sheet
$
Change from
previous
year
Assets
$
Change from
previous
year
Liabilities
Current Assets
Current Liabilities
Cash
200
40
Accounts payable
375
75
Accounts
Receivable
550
110
Notes payable
325
225
Inventory
750
150
700
300
Total
1500
300
1140
340
3750
750
Fixed Assets
New plant and
equipment
Total
Long term Debt
Owner's Equity
2250
450
Common stock and paid
in surplus
Retained Earnings
Total
Total Assets
3750
750
Total liabilities and owner's
equity
33
Now fill up all the items of Pro Forma BS
How much is common stock and paidin surplus ?
XYZ Corporation
Partial Pro Forma Balance Sheet
$
Change from
previous
year
Assets
$
Change from
previous
year
Liabilities
Current Assets
Current Liabilities
Cash
200
40
Accounts payable
375
75
Accounts
Receivable
550
110
Notes payable
325
225
Inventory
750
150
700
300
Total
1500
300
1140
340
Common stock and paid
in surplus
800
0
Retained Earnings
1110
110
1910
110
3750
750
Fixed Assets
New plant and
equipment
Total
Long term Debt
Owner's Equity
2250
450
Total
Total Assets
3750
750
Total liabilities and owner's
equity
35
PoS Approach for Balance Sheet (contd…)
• Here, what have we used as plug ?
• Plug – Combo of short and long term debt
• This is just one possible strategy
• While planning, we should investigate many of
such scenarios
• Now what can be the use of Ratio analysis here ?
• We would surely like to examine the CURRENT
RATIO and TOTAL DEBT RATIO
• Now we can form projected statement of cash
flows too.
• TRY IT !
36
Alternative Scenario
What if XYZ is using operating at only
70 % capacity ?
Alternative Scenario (contd….)
• Assumption that assets are a fixed percentage
of sales is convenient, but it may not be
suitable in many cases.
• In previous example, we assumed that XYZ
was using its fixed assets at 100 % of
capacity.
• Hence, for any increase in sales, increase in
investment in fixed assets seemed realistic.
38
XYZ operating at 70 % of capacity
• It would mean that sales of $ 1000 is only 70 % of
the full capacity sales.
• Then, what is full capacity sales ?
• $1000/ 0.70 = $ 1429
• That means sales could increase by almost 43 %
before any new fixed assets would be needed.
• For our previous example, we assumed that sales
would increase by only 25 % < 43 %.
• Now what shall be EFN ? Will it still be $ 565 ?
• Hint : Now XYZ wont need $ 450 in net new assets
investment.
39
What shall be EFN in this case ?
• EFN = $ 565 - $ 450 = $ 115
• Lessons Learnt :
 It is inappropriate to blindly manipulate financial
statement information in the planning process.
 Results depend critically on the assumptions made
about the relationships between sales and assets
need.
 Projected growth rates play an important role in
the planning process.
40
External Financing and Growth
• What is the relationship between EFN and growth in
sales and assets ?
• Other things remaining constant, the relationship is
directly proportional.
Lets examine the relationship between Financial
Policy of the firm and its ability to finance new
investments and thereby grow.
i.e. The Financial Policy of the firm is given
– Sounds more practical
41
EFN and Growth (contd….) Example
PQR Co
Income Statement
Sales
$500
Costs
400
Taxable Income
100
Taxes @ 34 %
34
Net Income
66
Dividends
22
Addition to Retained Earnings
44
Balance Sheet
$
% of sales
Assets
$
% of sales
Liabilities
Current Assets
$200
40%
Total Debt
$250
n/a
Net Fixed
Assets
300
60%
Owner's Equity
250
n/a
Total Assets
500
100%
Total Liabilities and Owner's equity
500
n/a
Debt = Short Term + Long Term
42
Example (contd….)
Assumptions:
• Sales grow by 20 %
• PoS approach seems reasonable.
• Retention Ratio is same.
• PQR is operating in full capacity
• Financing Policy: NO NEW EQUITY SALE, BORROW ALL NEEDED
FUNDS AND USE ALL SURPLUS FUNDS IF ANY, TO RETIRE DEBT
Questions:
• Prepare prior Pro forma Income Statement and Balance Sheet
• How much goes as addition to Retained Earnings ?
 66.67 % of 79.2 % = $ 52.8
• How much more PQR needs to invest in new assets ?
 $ 600 - $ 500 = $ 100
• How much is EFN ?
 $ 100 - $ 52.8 = $ 47.2
43
Example (contd….)
PQR Co
Pro Forma Income Statement
Sales
$600
Costs
480
Taxable Income
120
Taxes @ 34 %
40.8
Net Income
79.2
Dividends
26.4
Addition to Retained Earnings
52.8
Pro Forma Balance Sheet
$
% of sales
Assets
$
% of sales
Liabilities
Current Assets
$240
40%
Total Debt
$250
n/a
Net Fixed
Assets
360
60%
Owner's Equity
302.8
n/a
Total Assets
600
100%
Total Liabilities and Owner's equity
552.8
n/a
External Financing Needed (EFN)
47.2
44
Example (contd….)
• Due of financing policy of PQR, all EFN are borrowed.
• What was original Debt-Equity Ratio of PQR ?
 $ 250 / 250 = 1.00
• What shall be new Debt amount of PQR ?
 $ 250 + $ 47.2 = $ 297.2
• What shall be new Debt-Equity Ratio after borrowing ?
 $ 297 / $ 302.8 = 0.98
• PQR borrowed some funds but their Debt-Equity ratio fell ?
WHY ?
 Because, for this particular example, PQR earned and retained more
than EFN which was borrowed.
 i.e. Increase in Equity was more than Increase in Debt.
45
Example (contd….)- Exploring Relationships
• What shall be Increase in Assets Required for
PQR for various growth rates ?
• What shall be Addition to Retained Earnings
for PQR for various growth rates ?
• What shall be EFN of PQR Co’ for various
growth rates ?
• What shall be Projected Debt-Equity ratio of
PQR for various growth rates, given the
Financing Policy of borrowing EFN and retiring
debt with surplus if any ?
46
Growth and Projected EFN for PQR Co’
Projected Sales
Growth
Increase in Assets
Required ($)
Addition to Retained
Earnings ($)
Projected Sales
Growth
Increase in Assets
Required ($)
Addition to Retained
Earnings ($)
EFN ($)
Projected DebtEquity Ratio
0%
0
44
-44
0.70
5
25
46.2
-21.2
0.77
10
50
48.4
1.6
0.84
15
75
50.6
24.4
0.91
20
100
52.8
47.2
0.98
EFN ($)
Projected DebtEquity Ratio
0%
5
10
15
20
47
EFN and Growth (contd….)
• Note:
 Increase in assets required = % of growth rate of
original assets.
 Addition to retained earnings = Original Retained
earnings + % of growth rate of original retained
earnings.
 For relatively low growth rates, PQR runs a surplus
and Debt-Equity ratio will decline.
 Once growth rate increases to about 10 %, surplus
becomes deficit.
 As growth rate exceeds approx 20 % the Debt
Equity ratio passes its original value of 1.0
48
EFN and Growth (contd…)
Assets needs and retained
earnings
Growth and Related Financing Needed for PQR Co
150
125
100
EFN > 0
(deficit)
75
50
25
EFN < 0
(surplus)
0
0%
5
10
15
20
25
Projected Growth in Sales
Increase in assets required
What can you infer from this diagram ?
Projected Addition to RE
49
EFN and Growth (contd…)
• The need for new assets grows at much faster
rate than the addition to retained earnings.
• Internal financing provided by the addition to
retained earnings rapidly disappears.
• Whether a firm runs cash surplus or deficit
depends upon growth.
• It is possible for a firm to experience greater
cash balance even when its growth has
slowed down.
50
Financial Policy and Growth
•
Two kinds of growth rates are particularly useful
in long-range planning.
1. Internal Growth Rate
2. Sustainable Growth Rate
1. The Internal Growth Rate
 Is the maximum growth rate that can be achieved with no
external financing of any kind
 At this point, the required increase in assets is exactly
equal to the addition to the retained earning, and EFN is
therefore, zero.
 Represented by the point, where two lines crossed.
 For PQR Co, its slightly less than 10 %
51
1. Internal Growth Rate
ROA  b
IGR 
where,b  retent ionratio
1  ROA  b
For P QR Co'
66
44 2
ROA 
 13.2%,
b

500
66 3
0.132 (2 / 3)
IGR 
 9.65%
1  0.132 (2 / 3)
Thus, PQR Co’ can expand at a maximum rate
of 9.65 % per year without external financing
52
2. The Sustainable Growth Rate
2. The Sustainable Growth Rate
 Is the maximum growth rate that can be achieved
with no external equity financing while maintaining
a constant debt-equity ratio
 i.e. this is the maximum growth a firm can sustain
without increasing its financial leverage.
 Why a firm might wish to avoid equity financing ?
 Equity sales can be very expensive
 Current owners may not wish to bring in new
owners to contribute additional equity.
53
2. The Sustainable Growth Rate (contd….)
ROE  b
SGR 
where,b  retent ionratio
1  ROE  b
For P QR Co'
66
44 2
ROE 
 26.4%,
b

250
66 3
0.264 (2 / 3)
SGR 
 21.36%
1  0.264 (2 / 3)
PQR can expand @ 21.36 % without equity financing and without
disturbing its leverage.
54
2. The Sustainable Growth Rate (contd….)
If, P M  P rofitMargin,g  growth ratein sales
b  Retent ionRatio
E  Equity,D  Debt, A  Asset s
S0  Sales for current year
S1  Sales for next year  S0 (1  g )
Incomefor thenext period P M S1  P M  S0 (1  g )
Addit ion to retainedearnings P M S0 (1  g )  b
Addit ion to borrowings P M S0 (1  g )  b 
D
E
Addit ion to Asset s  A  g
Now, Change in Asset s  Change in Equity  Change in Debt
D

A  g  P M S0 (1  g )  b  P M S0 (1  g )  b  
E

A
P M b 
E
g
A 
A
 P M b  
S0 
E
55
2. The Sustainable Growth Rate (contd….)
• How would pro forma statement for PQR look like if it exactly grows @ 21.36 % ?
PQR Co
Pro Forma Income Statement
Sales
$606.8
Costs
485.4
Taxable Income
121.4
Taxes @ 34 %
41.3
Net Income
80.1
Dividends
26.7
Addition to Retained Earnings
53.4
Pro Forma Balance Sheet
$
% of sales
Assets
$
% of sales
Liabilities
Current Assets
$242.7
40%
Total Debt
$250
n/a
Net Fixed
Assets
364.1
60%
Owner's Equity
303.4
n/a
Total Assets
606.8
100%
Total Liabilities and Owner's equity
553.4
n/a
External Financing Needed (EFN)
53.4
56
2. The Sustainable Growth Rate (contd….)
If ,
S  P reviousyear's sales
A  T ot alAsset s
D  T ot alDebt
E  T ot alEquit y
g  project edgrowt h in sales
P M  P rofitMargin
b  Ret ent ion(P lowback)Rat io
Provethefollowingrelationship,
EFN  A - PM S  b  g  PM S  b
Apply thisrelationship for PQR Co' when g  20 %
For PQR, with g  20 %,
EFN  500- 0.132 500 2/3 0.20  0.132 500 2 / 3
 $ 47.2
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Financial Policy and Growth (contd…..)
With thehelp of followingrelationship,
EFN  A - P M S  b  g  P M S  b
Prove:
ROA  b
IGR 
1 - ROA  b
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Determinants of Growth
From DuP ontIdentity,we know,
ROE  P rofitMargin  T otalAssets T urnover Equity Multiplier
And we know,
ROE  b
SGR 
1 - ROE  b
Whatcan you makeout from theserelationships ?
Anything that increases ROE and ‘b’ increases SGR.
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Determinants of Growth (contd….)
•
Firm’s ability to sustain growth depends explicitly
on the following four factors:
1. Profit Margin
2. Dividend Policy
3. Financial Policy
4. Total Assets Turnover
EXPLAIN
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Determinants of Growth (contd….)
1. Increase in profit margin will increase the firm’s ability to
generate funds internally and thereby increase its
sustainable growth rate.
2. Decrease in Dividend Ratio = Increase in Retention Ratio,
this increases internally generated equity and thus
increases sustainable growth.
3. Increase in debt-equity ratio increases the firm’s leverage.
This makes additional debt financing available, it
increases the sustainable growth rate.
4. Increase in Total Assets Turnover increases the sales
generated for each $ of assets. This decreases the firm’s
need for new assets as sales grow and thereby increases
sustainable growth rate. That is equivalent to decreasing
capital intensity of the firm.
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Determinants of Growth (contd….)
•
Hence, SGR is useful planning number, as it
illustrates the explicit relationship between firm’s
four major areas of concern:
1. Operating Efficiency (as measured by Profit Margin)
2. Assets Use Efficiency (as measured by Total Assets
Turnover)
3. Dividend Policy (as measured by Retention Ratio)
4. Financial Policy (as measured by Debt-Equity Ratio)
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Determinants of Growth (contd….)
IF A FIRM DOESNOT WISH TO SELL NEW EQUITY
AND ITS PROFIT MARGIN, DIVIDEND POLICY,
FINANCIAL
POLICY,
AND
TOTAL
ASSETS
TURNOVER (OR CAPITAL INTENSITY) ARE ALL
FIXED, THEN, THERE IS ONLY ONE POSSIBLE
GROWTH RATE.
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Determinants of Growth (contd….)
IF A FIRM WISHES TO GROW ITS SALES
AT GREATER RATE THAN SUSTAINABLE
GROWTH RATE, THE FIRM MUST :
• EITHER INCREASE PROFIT MARGINS
• OR INCREASE TOTAL ASSETS TURNOVER
• OR INCREASE FINANCIAL LEVERAGE
• OR INCREASE EARNINGS RETENTION
• OR SELL NEW SHARES
• OR ANY COMBINATION OF ABOVE
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WARNINGS REGARDING FINANCIAL PLANNING
MODELS
• Financial Planning Models don’t always ask the right
question:
 They tend to rely on accounting relationships not financial
relationships
 Cash Flow, Risk and Timing: three basic elements of firm’s value
tend to get left out
• Divert attention from strategies needed to increase firm’s
value to association of leverage and growth
• Useful for pointing out inconsistencies and reminding us of
financial needs, but they offer very little guidance
concerning what to do about these problems.
• Financial Planning should be iterative process
 Create, examine, modify over and over
 Procrustes Approach
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May the future of all of
you be a rewarding one.
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