Chapter-1

Financial Planning and Forecasting of

Financial Statement
 Strategic Plans
• Strategic plans are the stream of long term plans to help
achieve corporate objectives.
• Strategic planning is a tools for organizing the present on
the basis of the projections of the desire future.
• Strategic plan is a road map to lead an organization from
where it is now to where it would like to be five or ten
years.
• Strategic planning is the process of clarifying an
orga izatio ’s issio , the ide tifyi g goals, strategies
and resources needed to achieve that mission.
• Strategic planning is an important function of top-
management.
 Strategic planning enables the
manager to answer several questions
including:
• What is the orga izatio ’s positio i the
market?
• What does the organization want the position
to be?
• What trends and changes are occurring in the
market?
• What are the best alternatives to help achieve
these goals?
 Elements of Strategic Plans
• Strategy plan
-Attaining 50% market share
-20% ROE
-10% ROE

Strategies -We exits to create

Plans value our
-Assessing situation shareholders
-SWOT analysis

-Limits its production so soft drinks, but on a global geography

scale
 Corporate Purpose
• The corporate purpose states the general
philosophy of the business.
• The corporate scope states the line of
business and geographical area of operation
of a business.
• The objectives are goals that guide
management to achieve desired outcomes.
• The strategies are broad action plans to attain
the goals.
 Operating Plans
• Operating plans provide detailed implementation
guidance, based on the corporate strategy, to
help meet the corporate objectives.
• Operating plan is a detail guideline for effective
implementation of corporate strategies, which
helps achieve corporate objectives.
• Operating plans could be formulated for any time
horizon; however, five year planning horizon is
the most common practices.
 Operating plans
Policy
-Motivated Budget
-Guidance -Statement of cost &
-Limitation of workers income

Operating
Plans
Rules Process
-No smoking -Received order
No entry with out -called tender
permission -Selection of suppler
-Send the procurement order
-Check of inventory
-Payment of bill
 Financial Plans
• The financial plan refers to the projection of
future financial course of action carried out for
efficient execution of operating plans and
effective accomplishment of corporate objectives.
• Financial plan is the important part of operating
and existence of any firm as it provides road map
for guiding, coordating a d co trolli g the fir ’s
financial action in order to achieve its objectives.
 Process of Financial Plans
Projecting financial statement

Determine Funds Required

Forecasting Funds Availability

Financial
Establishing and maintaining a
plans
system of control

Developing procedures for

adjusting the basic plans

Establishing performance
based compensation system
 Sales Forecast
• Sales forecasts are the forecast of fir ’s u its a d rupees
for some future period; it is generally based on past and
recent sales trends plus forecasts of the economic
prospects for the nation, region, industry and so forth.
• There are some of the factors which should be considered
well before making or developing sales forecast;
-Divisional forecast
-Economic activity forecast
-Forecasting marketing strategy
-Combination of inflation with sales growth
-Advertising campaigns, promotional discounts, credit terms
etc.
Financial Planning and Forecasting
• Financial planning is the projection of sales, income
and assets based on alternative production and
marketing as well as the determination of the
resources needed to achieve these projections.
• Financial forecasting is an integral part of financial
planning. It uses past data to estimates the future
financial requirements.
• The process of estimating the fund requirement of the
firm and determining the sources of fund is called
financial planning and forecasting, the implementation
of financial planning is called financial control.
 Methods of Financial Forecasting
• There are various methods of financial
forecasting. The one of the most method is
percent of sales method.
• It is one of the simple methods of forecasting
financial statement variables.
• Application of this method is based on the two
basic assumptions;
-Frist, all items of balance sheet except some
liabilities are proportionately related to sales
volume.
-Second, most of the current balance sheet items
are justifiable for the current sales volume.
 Complied by
Shiva Raj Ghimire
Saraswati Multiple Campus
Lakhanathmarg, Kathmandu
 Units: 5

Basic Capital Structure Decisions

 Meaning of Capital Structure
• A company uses different sources of capital to finance its assets.
• These sources of capital are shown in the liabilities side of the company's balance sheet.
• The entire items in the liability side of balance sheet represents the financial structure of the
firm.
• Capital structure represents the proportionate relationship among the permanent (long-
term) sources of capital.
• Such sources of capital are, broadly, divided into two groups, vis, ownership capital and
creditor ship capital.
• Supplier of ownership capital are paid dividend out of firm's earning, and suppliers of
creditor ship capital are paid interest irrespective of the earning of the firm.
• The capital structure decision involves a trade–off between risk and return. Use of debt
increase the return for equity holders. Because, interest being tax deductible expense, it
saves tax. But it also increases the financial risk. Because use of debt means creation of fixed
obligation and every increase in fixed obligation increases the financial risk. If the firm could
not meet its fixed obligation, creditor's claim may declare the firm bankrupt. Therefore
capital structure decision is one of the most critical financial decisions. The best trade–off
between risk and return produces an optimal capital structure, which will maximize the price
of the firm's stock.
 Different Between Capital Structure
and Financial Structure
Financial Structure

Liabilities Side of
Balance Sheet

Short- term Long-term

Sources Sources

Long-term
Preferred Stock Equity
Debt
Capital Structure =
Financial structure –
current liabilities
Capital Structure
 FACTOR AFFECTING THE OPTIMAL
CAPITAL STRUCTURE
Following factors should be taken into consideration
while designing the capital structures or financial
structure.
- Business risk
- The firm’s tax position
- Interest rate
- Management attitudes
- Financial flexibility
- Stability sales and earning
- Control
- Size of the company
 BUSINESS RISK
• Business risk is defined as uncertainty
inherent in projection of future return on
assets (ROA) or return on equity (ROE) if the
firm use no debt.
• Business risk refers to the uncertainly about
the operating income (EBIT) by the nature of
the business
 FACTORS OF BUSINESS RISK
• Business risk depend a number of factors the
more important of which are the following:
(a) Demand Variability
(b) Sales price variability
(c) Inputs cost variability
(d) Ability to develop new products in a timely,
cost effective manner
(e) Ability to adjust output prices for charges in
input cost
•
 FINANCIAL RISK
• Financial risk is the additional risk placed on the
common stockholders as a result of using
financial leverage, which results when a firm uses
fixed income securities (i.e. debt and preferred
stock) to raise capital.
• Financial risk is associated with the creation of
fixed obligation to the firm by using debt element
in the capital structure.
• Financial risk is introduced by the use of financial
leverage
 BREAK EVEN POINT / ANALYSIS
• The relationship between sales volume and
operating profitability is explored in cost volume
profit planning or operating break-even analysis.
• Break–even point represents the levels of
production and sales where operating income
(EBIT) is zero.
• It is the point where revenues from sales just
equal total operating cost.
• Operating break-even analysis is a method of
determining the point at which sales will just
covers operating cost.
 Condition
Result

Actual sales is equal to break-even sales No Loss, No Profit [EBIT = 0]

Actual sales exceeds to break-even sales Profit

Actual sales is less than break-even sales Loss

 ASSUMPTIONS of BEP
• Break-even analysis based on some assumptions.
They are as follows :
1.All costs are classified into fixed and variable.
2.Fixed costs will remain constant and variable costs
vary proportionately with outputs.
3.Selling price per unit remains constant.
4.The level of production and sales remain
unchanged during the period.
5.The firm's produce and sales only one product.
 LIMITATIONS OF BEP
• Limitations with break-even analysis are as follows:
(a) It is difficult to separate fixed cost and variable cost.
Semi–variable or fixed costs is difficult to separate.
(b)It is not realistic to expect variable cost per unit to be
constant at all output level. For example material cost will be
less due to purchase discount and other concessions if the
company makes bulk purchases.
(c) It is difficult to use break-even analysis for a multi
product firm.
(d) It can be applied only for short run. It is not applicable
for long run.
(e) The assumption that total fixed cost would remain
unchanged over the entire range volume may not be valid
 USES of BEP
• Firm wants to calculate break-even point because:
(a) It helps in determining the break-even point in term of units
and in rupees to avoid losses.
(b) It helps in determining reasonable price of the product.
(c) It is helpful to determine capital structure.
(d) It helps in identifying the effect of changes in prices, costs and
volume on profit.
(e) It helps in determining the margin of safety and profit at
different level of sales.
(f) It provides the information for price determination.
(g) It helps in determining the volume of sales required to achieve
the target profit.
(h) It helps in make or buy decision.
 MEANING of LEVERAGE
• Leverage is derived from the word lever.
• In physics the term leverage implies the application of lever to lift a
heavy object with a small amount of force.
• It represents somewhat similar meaning in the field of finance too.
• In finance leverage implies the impact of one financial variable over
some other variable. The advantages accomplished through the
use of fixed costs and fixed charges sources of fund is called
leverage in finance.
• The term leverage in general refers to a relationship between two
interrelated variables.
• These financial variables may be costs, output Sales, revenue,
earnings before interest and taxes (EBIT), earnings per share (EPS)
etc.
 TYPES of Leverage
• Operating Leverage
• Financial Leverage
• Combined Leverage
 Units - 6

Dividend Policy
 Meaning of dividend Policy
• Dividend is the earnings or profit distributed to the shareholders by
a company.
• It is distributed in cash and securities or combination of these.
• Dividends are paid quarterly, half yearly or annually. Similarly the
dividend is distributed to preference shareholders and equity
shareholders.
• The dividend paid to the preference shareholders is called
preference share dividend, which is generally fixed or constant and
distributed before distributing to the common shareholders.
• In general, company pays dividend in two forms; Cash and stock
dividend. A company distributes its earnings to shareholder's in
cash instead of as stock is called cash dividend.
• A stock dividend simply refers to the dividend to existing
shareholders in the form of additional share of company.
•
 Con…..
• The policy of a company on the division of its profit between distribution
to shareholders as dividend and retention for its investment is known as
dividend policy.
• Dividend policy is to determine the amount of earnings to distribute to
shareholders and the amount to be retained or reinvestment in the firms.
• Any change in dividend policy has both favorable and unfavorable effects
on the firm's stock price.
• For example shareholders get excess dividend in present that increases
market value of shares, which is favorable aspect.
• But in future, the firm can not invest in profitable project due to lack of
internal capital (Retained earnings).
• As the result the future growth rate of the firm decreases that causes
unfavorable effects in share value.
• So dividend distribution should be done being based on certain principles.
DIVIDEND PAYMENT PROCEDURES
1. Declaration date
2. Record date or holder of record date
3. Ex-dividend date
4. Payment date
 01/28 02/23 02/27 03/17
Declearation Ex-dividend date Holder or record Payment date
date
 FACTORS AFFECTING DIVIDED POLICY
1. Desire of shareholders
2. Legal rules
3. Liquidity position
4. Need to repay debt
5. Restriction in debt contracts
6. Rate of asset expansion
7. Profit rate
8. Stability of earning
9. Access to the capital market
10. Policy of Control
11. Tax position of stock holders
 DIVIDEND PAYOUT SCHEME OR
DIVIDEND PAYOUT POLICIES

• Residual dividend policy

• Constant dividend per share
• Constant payout ratio
• Low regular dividend plus extra policy
 TYPES OF DIVIDEND

• Cash Dividend
• Stock Dividend
 Stock dividend

• An issue of shares to existing shareholder instead of paying

a cash dividend is known as stock dividend. It is also known
as bonus shares. Company issues stock dividend if they
have no sufficient cash balance to pay cash dividend.
Others reason of issuing stock dividends are as follows:
– To bring the share price at reasonable ranged (or trading range)
– To provide psychological value to the investors
– To provide tax benefit to the investors
– To increase share capital
– To reserve cash in organization
 Stock Split
• A stock split occurs when a company releases additional
stock in a structured manner without decreasing
shareholder equity. For example, in a 2 for 1 stock split, an
investor who owns 100 shares of a stock valued at Rs 100
per share before the stock split will own 200 shares valued
at Rs 50 per share after the split.
• Company goes for stock split, when price of stock
exceptionally high. The basic objective of stock split is to
bring down the market price of share into the tradable (or
reasonable) range. As a result small investor can purchase
the company's shares.
 Units - 7
Working Capital Management
 Meaning of working capital
• Working capital means capital required for day to day operation of an
enterprise.
• It is concerned with current assets and current liabilities.
• The term current assets refer to those assets which can be converted into
cash with in one operating cycle or accounting period without undergoing
a diminution in value and without disrupting the operations of the firm.
• The major current assets are cash, marketable securities, account
receivable and inventory.
• Current liabilities which are payable within one operating cycle or
accounting period.
• The basic current liabilities are account payable, bills payable, bank
overdraft and outstanding expenses.
• Therefore the goal of working capital management is to manage the firm's
current assets and liabilities in such a way that satisfactory level of
working capital is minted
 Types of Working Capital
Gross Working Capital
Gross working capital refers to the total investment in the
current assets of the firm. Current assets refer to those assets, which
can be converted into cash within one year. For example cash
marketable securities, inventory, account receivable etc. Gross working
capital is also known as total working capital. According to gross
concept working capital = Total current assets.
Net Working Capital
Net working capital is the difference between current assets
and current liabilities, which are paid within a year, for example,
account payable, bills payable, bank overdraft and outstanding
expenses.
• Net working capital = Total current assets – Total current
liabilities
 Con…..
Permanent Working Capital
The minimum amount of current assets which
the firm has to hold for all time to come to carry an
operation at any time is termed as permanent or
regular working capital.
Temporary Working Capital
It represents the additional assets which are
required at different time during the operating year.
It is also called variable or fluctuating working
capital.
 Importance and significant of WC
• The working capital is the life blood of any business enterprise. Without
adequate working capital no business enterprise can run successfully. The
importance of working capital is as follows:
• To run the day to day operation the business activities:
• To make quick payment and helps in creating and maintaining good will of
the firm.
• To make regular and timely payment of wages, salaries as well as meet day
to day operational expense.
• To ensures regular supply of raw materials and helps to continue the
production process.
• To obtain credit facility from suppliers.
• It enables a concern to pay regular divided.
• It enables a concern to face business crisis.
• It enables to avail earn discount as purchase.
• It helps in maintaining solvency of the business.
 Factors affecting the WC
1. Size and nature of business
2. Production cycle
3. Business up-down
4. Organization's credit policy
5. Growth and expansion of attitudes
6. Profit and dividend distribution policy
7. Change in price
8. Work efficiency
Cash Conversation Cycle

Figure : Working capital management process

Raw material (Create Work in process (accrued Finished goods

Account payable ) wages /expenses) (accrued wages/expenses)

Credit sales (create

Cash
account receivable)
 Con….
• In the above figure, working capital cash flow cycle or
cash conversion cycle is the length time between the
companies makes payments and when it receives the
cash payment. The time duration required to complete
one cycle of business is called working capital cash flow
cycle. Usually a company acquires inventory on credit,
which result in account payable. A company can also
sells products on credit, which result in account
receivable. Cash therefore is not involved until the
company the accounts payable and collected accounts
receivable. So the cash conversion cycle measured the
time between outlay of cash and cash recovery.
 Con…..
1. Inventory Conversion Period (ICP)
The inventory conversion period is the average length of time required to
convert raw material into finished goods and them to sell those goods
2. Receivable Conversion or Collection Period (RCP)
The receivable conversion period is the average length of time required to
convert the firm's receivable into cash. It is also called day's sales outstanding
(DSO) or average collection period (ACP).
3. Payable Deferred Period (PDP)
The payable deferral period is the average length of time between the
purchase of raw material and labour and then payment of cash for them. It
can be calculate as under.
4. Cash Conversion Cycle (CCC) or Cash Cycle (CC)
It is the length of the time between paying for raw material and receiving
cash from the sales of finished goods.
 Con….
The CCC can be shortened by;
• Reducing the inventory conversion period by
processing and selling goods more quickly.
• Reducing the receivable collection period by
speeding up collections.
• Lengthening the payables deferral period by
slowing down, its own payments.
 ALTERNATIVE CURRENT ASSETS
INVESTMENT POLICIES

(a) Conservative current assets investment policy

Conservative current assets policy carries a high level of current assets to
support the given level of sales. It uses less short-term debt and more long-term debt
for current asset financing. Therefore conservative policy lower risk and lower
profitability than aggressive policy. This policy is also known as relaxed policy.
(b) Aggressive current asset investment policy
Aggressive current assets policy carries a low level of current assets to
support the given level of sales. It uses more short-term debt and less long-term debt
for current assets financing. Therefore aggressive policy is riskier and profitable than
conservative policy. This policy is also known as tight or restricted policy.
(c) Moderate current asset investment policy
Moderate current assets policy carries a moderate level (average level) of
current assets to given level of sales. Moderate policy uses average/ mid range of
short-term and long-term debt of the above two policies. Therefore the moderate
policy results in mid range risk and return. This policy is known as average policy.
 Short term investment
The major sources of short term financing are
trade credit (creditors and bills payable) and
outstanding expenses. Spontaneous sources of
financing are cost free therefore, a firm would
like to finance its current assets with
spontaneous sources as much as possible.
 Cash Management
The term cash includes coins, currency and cheques held by the firm
and balances in bank accounts. Sometimes near cash items (that can
easily be converted into cash), such as marketable securities or bank
time-deposits are also included in cash. Cash is the important current
assets for the operation of the business. On the other hand cash is
non-earnings asset. Therefore the firm should keep sufficient cash,
neither more or less. More cash balance earns nothing but it earns if it
is invested in marketable securities and insufficient cash balance
creates problem to run business because the firm needs cash to pay
for credit purchased, wages, salary, taxes, rent and so on. Therefore
the adequate cash balance is necessary to run business organization
efficiently and effectively. The major function of the financial manager
is to maintain a sound cash position.
 Motives for holding cash
• Transaction motive
• Compensation motive
• Precautionary motive
• Speculative motive
 Functions of Cash Management
• Cash planning
• Managing the cash flows
• Determination of optimum cash balance
• Investing surplus cash
 Cash Budget
A cash budget is schedule or statement showing
cash receipts, cash disbursement and cash balance
for a firm over a specified time period. A cash
budget is a summary statement of the firm's
expected cash inflows and outflows over a
projected time period. It gives information as the
timing and magnitude of expected cash flow and
cash balance over the projected period. This
information helps the financial manager to
determine the future cash needs of the firm, plan
for the financing of these needs and exercise
control over the cash and liquidity of the firm.
 Cash Management Techniques
1. Speedy cash collections
(a) Prompt Payment by Customers.
(b) Early Conversion of Payments into Cash:
(i) Concentration Banking
(ii) Lock Box System
 Con…
2. Slowing disbursements
(a) Avoidance of Early payment
(b) Centralized Disbursement
(c) Float
-Disbursement Float
-Collection Float
-Net Float
(d) paying from a distant bank
(e) Cheque-encashment analysis
(f) Accruals
 Inventory Management
• The word 'inventory' means the stock of various types of goods. The
various forms of material held by an enterprise are known as inventory. It
includes raw material, work in progress, finished goods, daily consuming
goods and so on. Inventories represent the major element in the working
capital of an enterprise.
• Both excessive and inadequate inventories are not desirable i.e. these are
two dangerous points within which the firm should operate. The excessive
level of inventories consume the funds of the firm, which cannot be used
for any other purposes and thus, involves an opportunity cost. Maintaining
an inadequate level of inventories is also dangerous. If the inventories are
not sufficient to meet the demand of the customers regularly, the
customers may shift to the competitors which will amount to a permanent
lose to the firm.
• The aim of inventory management, thus, should be avoid excessive and
inadequate levels of inventories and to maintain sufficient inventory for
the smooth productions and sales operations.
 TYPES OF INVENTORY

• Raw materials
• Work-in- progress
• Finished goods
OBJECTIVE OF HOLDING INVENTORIES
• Transaction motive
• Precautionary motive
• Speculative motive
 Economic Order Quantity(EOQ)
EOQ is that inventory level which minimizes the
total cost of ordering and carrying. At the
optimal order size the total ordering cost is
equal to total carrying cost. Determining an
optimum inventory level involves two types of
costs.
1. Carrying cost
2. Ordering cost
 Receivable Management
• The term receivable is defined as debt owned to the
firm by customers arising from the credit sales of goods
or services in the ordinary course of business. When a
firm makes an ordinary sales of goods or services and
does not receive payment, the firm is granting trade
credit and creates account receivable which could be
collected in the future.
• This credit is known as receivable. It is also called
book debts. The objective of receivable management is
to promote sales and profits until that point is reached
where the return on investment in further funding
receivable is less than cost of funds raised to finance
that additional credit i.e. cost of capital.
 Elements of Credit Policy
• Credit period
• Cash discount
• Credit standard
(i) The five Cs systems.
Character
Capacity
Collateral
Capital
Condition
(ii) Credit scoring system
 Collection policy
 Monitoring the credit policy
• Day sales outstanding
• Aging schedule