Finance Ch 4 - Long Term Financial Planning & Corp. Growth

Basic policy elements of financial planning

1. Firms needed investment in new assets - investment opportunities that the firm chooses to undertake (determined by capital budgeting decisions)

2. Degree of financial leverage the firm chooses to employ - the amount of borrowing the firm uses to finance its investments in real assets (determined by capital structure policy)

3. Amount of cash the firm thinks is necessary and appropriate to pay shareholders (dividend policy)

4. Amount of liquidity and working capital the firm needs on an ongoing basis (net working capital decision)

What is the appropriate financial management goal for the firm?

Increasing market value of the owners equity

• Growth alone is not the appropriate main goal, and could be a bad thing

Planning horizon

The coming 2-5 years in the future

• The first dimension of the planning process that must be established

Aggregation

The process by which smaller investment proposals of each of a firm’s operational units are added up and treated as one big project

• The second dimension of the planning process

Making assumptions and scenarios in financial planning

Once the planning horizon and level of aggregation have been established, a financial plan needs inputs in the form of alternative sets of assumptions about important variables.

• Each division within the company may prepare multiple alternative business plans for the next 2-5 years, including:

1. A worst case scenario (pessimistic assumptions about the company and the economy)

2. Normal case (most likely assumption about the company and economy)

3. Best case (optimistic assumptions about the company and economy, could involve new products and expansion and would need to include financing details to fund these expansions)

Cyclical businesses

Businesses with sales that are strongly affected by the overall state of the economy or business cycles

Ex: when the global oil price collapsed in 2020 due to COVID-19, many energy companies like cenovus were forced to revise their financial plans, cut spending, and shelve high-cost projects

• Scenario planning is especially important for these types of businesses

What can planning accomplish?

• Examining interactions between undertaking new investments and projects and how they will be financed (how will they be paid?)

• Exploring options: opportunity for the firm to develop, analyze, and compare many different scenarios in a consistent way (questions could concern marketing new products, closing plants, etc)

• Avoiding surprises: Identifies what could happen to the firm if different events take place (addresses what actions the firm would take if things go wrong)

• Ensuring feasibility and internal consistency: checks that the goals and plans made with regard to a specific area of the firms operations are feasible and internally consistent (conflicting goals often exist)