cedure to use include the sources of financing and actual capital expenditures. If fi-
nancing normally takes place in the PC country and funds are sent to the affiliate, the
former approach—freezing the exchange rate—may be an adequate and simpler pro-
cedure. If the affiliate is essentially self-financing, reporting budget appropriations at
current rates rather than fixed exchange rates provides a more accurate and mean-
ingful presentation; moreover, in dealing with hyperinflationary countries, a fixed ex-
change rate approach is entirely unrealistic and leads to distorted results.
25.7 BUILDING THE PROFIT PLAN
(a) Income Forecasting: The Profit Plan. In the preceding sections, we observed the
close relationship between the long-range objectives and the capital budgets, espe-
cially those for the first forward year. A full set of objectives contains not only capi-
tal projections for the next three to five years but also income levels and cash flow
forecasts. Here we want to concentrate on income forecasting.
While it was appropriate and time saving to use the first year of the objectives as
both the starting and ending point for the capital budget, this approach does not work
equally well for the profit plan or operating budget. A top-down/bottom-up dialogue
was used to pass down guidance from the corporate level via division and region to
the various affiliates, with the affiliates building up the details of capital projects and
programs to “meet” the corporate guidelines. The affiliates, no doubt, participated in
establishing income levels in the objectives, but other than agreeing on broad eco-
nomic perimeters—revenues, total costs and expenses, margins, taxes, and the re-
sulting net income—a detailed buildup of all data does not normally occur.
(b) Development of the Profit Plan. In building a profit plan for the next forward year,
it is important to establish the reasons for this exercise. The profit plan is frequently
used as a target for, and commitment by, management. It is a vital forecast for the com-
pany’s cash management, overall operating decisions, and maximizations of intracor-
porate transactions, and it frequently serves as a yardstick against which bonuses are
calculated. It is, therefore, necessary to be as specific as possible within each affiliate
when establishing underlying assumptions. It is often advisable to start literally from
the bottom up, that is, involving the lowest level of the organization in determining re-
alistic estimates for such data as volumes, prices, new products, and recurring and non-
recurring expenses, which, in turn, may be variable or nonvariable (fixed), and so on.
Also, the likely economic conditions for each country—and sometimes for areas
within a country—as well as income and other tax rates must be established by the var-
ious levels within each affiliate’s organization. These assumptions are then presented
to region management for its concurrence or suggested changes. As was the case in es-
tablishing capital budget details, there is an almost continuous negotiation process
going on to make sure that region and affiliates think along the same lines.
(i) Local Currency-Based Income Statement. The affiliate’s profit plan is then fleshed
out and cast into a local income statement format. At this stage, we have monetary
and volumetric data in the detail required by local management to run the local op-
eration efficiently, but, because of the use of LC and local accounting conventions,
higher management levels, for example, the region, will be unable to understand and
to evaluate the profit plan. Some additional procedures must now be carried out.
25.7 BUILDING THE PROFIT PLAN 25 • 11