Introduction to Corporate Finance

16: Financial Planning

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

Financial planning is an important corporate finance activity that touches almost all functional groups in

a company. Financial planning encompasses a wide array of activities: setting long-run strategic goals,

preparing quarterly and annual budgets and managing day-to-day fluctuations in cash balances. Although

most people with corporate work experience are familiar with the budgeting process, they often know

little about how budgets and other financial plans are compiled at the corporate level, how they tie

together competing interests within the company and how they interact with the company’s strategic

objectives. In this chapter, we discuss various elements of a company’s financial planning processes. The

chapter emphasises both long-term and short-term financial planning, and demonstrates how companies’

financial plans must balance the interests and objectives of different business units and functional areas.

For example, in setting long-term strategic and financial goals, a company must prioritise its desires to

increase sales and market share; to change or maintain its exposure to financial risk; to achieve production

efficiencies; to attract and retain capable employees; and to distribute cash to shareholders. In almost every

instance, making incremental progress on one of these objectives means an incremental sacrifice on one or

more of the other goals.

Financial planning, particularly long-term planning, is more art than science: the connection between

most financial planning models and the objective of maximising shareholder wealth is at times tenuous.^1

The ‘What companies do’ box provides data that confirm the difficulty of adapting to macroeconomic

forecasts. At one level, the advice we would give to a company constructing a long-term plan is

straightforward: do whatever is necessary to invest in all positive-NPV projects. In practice, a variety of

factors make following that advice a major challenge. CFOs usually tell us that they have many more

acceptable projects than they can possibly undertake. Limits on capital, production capacity, human

resources and many other inputs make the planning process more complex than simply accepting all

projects that look promising. We concede that the theoretical underpinnings of planning models are weak,

so in this chapter we focus as much as possible on practice. We describe how companies actually build

long-term and short-term financial plans rather than argue about how they should plan.

1 A number of models – such as economic value added (EVA) and shareholder value added (SVA) – tie financial decisions and plans to
shareholder value. Those widely used models, introduced in Chapter 9, are briefly discussed later in this chapter.

understand the relationship between a

company’s strategy and its plans, and the

roles that finance plays in constructing

strategic plans

describe the impact of growth on the

company’s balance sheet and the role

of the sustainable growth model as a

planning device

discuss the role of pro forma financial

statements in the financial planning

process and the shorthand approach for

estimating external funds required

explain the ‘plug figure’ used in

constructing a pro forma balance sheet

and the information it provides in the

financial planning process

review the conservative, aggressive and

matching financing strategies that a

company might employ to fund the long-

term trend and seasonal fluctuations in its

business

describe the role of the cash budget in

planning and monitoring the company’s

cash inflows and outflows on a short-term

basis.

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