Financial Planning in Business

Chapter 8: The Financial Plan

• Chapter 8 involves a detailed examination of financial risks including how to measure and articulate them
• Risk must be related to business rewards
• An evaluation helps determine if a business is viable

Key components of the Financial plan

• Cash Budgets
• Cash Inflows and Outflows
• Financing Sections
• Risk Measurement

Learning Objectives

• A financial plan and its significance to an investor should be clearly defined
• The goals of a financial plan should be stated
• Ways to determine the time frame for a cash budget must be discussed
• A clear explanation of how a cash budget supports assessing funding needs should be given
• An investment's rate of return measurements must be discussed
• Risk measurements should be thoroughly discussed

Story From Real Life 1

• Ms. Yong Suk Daley, a Korean-American, launched a clothing-alteration shop in Springboro, Ohio, in 2000, which achieved initial success
• Business declined in 2005
• In 2006, she rebranded the business as "Young's Special Occasion Apparel" with renovation
• The business centered on altering garments for events like weddings, where consumer budgets were higher
• The initial inventory and display setup were funded using personal credit cards

Story From Real Life 2

• In August 2006, Ms. Yong hired a business coach, who guided her in creating a detailed business plan
• A cash budget was prepared as part of a loan application to pay off credit card debts
• Record-keeping and financial management were improved along with marketing
• October 2006, a loan was approved
• Loan approval meant no longer using a personal credit card to finance inventory

The Financial Plan

• It is the business strategy articulated with monetary figures
• It includes cash budgets, required external funding, and a risk and reward assessment
• A convenient summary of all business plan parts expresses how high the start-up costs will be, the costs of the new factory, and the working capital required

Financial Plan Quantification

• The financial plan quantifies all plans into measurable monetary units
• It explains this year's total investment, how much is allocated to assets and capital, and labor expenses versus raw material costs

Objectives of a Good Financial Plan

• It reveals the potential gains or returns on investment
• It shows financial rewards
• It demonstrates the need for funds
• It demonstrates the reward or return of a business
• It measures financial risks

Financial Plan Components

The three components include:

• The cash budgets
• The conclusions derived from the cash budgets
• Measuring risk

Cash Budget Time Frame

• It usually spans multiple years
• Estimate how long to build a business and that the company will be stable (example: 5 years) means a cash budget should cover that long

Determining the Time Frame

• Another strategy includes taking the viewpoint of the investor who provides funds
• The time frame should be equivalent to that of an investor
• A five-year period will be a reasonable time frame for investors generally

Cash Outflows

• Costs can be split into variable and fixed
• Variable costs fluctuate based on sales volume, increasing with more units sold

Variable Costs

• Raw materials and labor are variable costs
• Are expressed as a percentage of sales due to their association with sales

Fixed Costs

• Fixed costs remain constant irrespective of fluctuations in sales volume, either across a broad range or over a specific time

Initial Years

• The first years for new businesses are dedicated to early investment resulting in net negative cash flows

Cash Balance impact & External Funding

• External Funds bring back the minimum operating cash level in the sub-period
• Small beginning cash balance and negative net cash flow mean a smaller ending cash balance -How much funding is required

Glossary: Cash Budget

• It projects incoming and outgoing cash flow over a specified future period

Glossary: Terminal Value

• The projected value of the company at a specified time, which limits the time frame

Glossary: Variable Costs

• Variable costs shift in proportion to the number of sold units
• Often represented as a percentage of sales due to relation to sales

Glossary: Fixed Costs

• Costs with an amount that does not change over a wide range of sales volume

Glossary: Minimum Operating Cash

• Required least amount of cash to cover day-to-day operations

Glossary: Payback Period

• The time needed for a business to recoup its initial investment
• Shorter payback periods indicate more businesses

Glossary: Internal Rate of Return (IRR)

• IRR represents the percentage rate that equalizes cash outflows and cash inflows
• A venture looks attractive when the internal rate of return exceeds the required rate

Glossary: Net Present Value (NPV)

• NPV is the current value of upcoming cash flows after subtracting the initial investment
• The required rate of return converts potential cash flows to present value
• A positive NPV is attractive

Glossary: Breakeven Point

• The minimum number of units a company must sell to cover all expenses so that there shall be zero profits at breakeven

Glossary: Sensitivities

• Forecasts that differ from the original because one or several variables are changed Sensitivities are used to find out the effects on the financials (like the cash budget) as a result of such changes.

Measuring Risk

• Net present value (NPV) takes into account all future cash flows minus the initial investment
• An investor wants to know if you used the required rate of return to make the money back

Attractiveness Rating & Minimum Requirement

• Required rate of return: the standard reward a business must provide for an investor to invest in it, expressed as a percentage
• This minimum reward as a positive NPV will make the business more attractive

Business Profitability

• A company must sell a certain minimum of units to cover all costs or "break even" and achieve zero profits
• Not so profitable is to be under break-even

Sensitive Financials

• Providing alternative cash budgets demonstrates sensitivities and gives options for optimistic and pessimistic situations
• Best-case and worst-case scenarios are the outcome of sales forecasts that are either higher or lower than anticipated, respectively

Explore the essentials of financial planning for businesses. Understand its components like cash budgets, inflows, and financing, and how it aids in assessing risks and rewards. Learn the importance of financial planning through practical examples.