Financial planning formulates the way financial goals are to be achieved. A financial plan is thus a statement of what is to be done in the future. Most decisions have long lead times, which means they take a long time to implement. Our primary goal in this chapter is to discuss financial planning and to illustrate the interrelatedness of the various investment and financing decisions a firm makes. In the chapters ahead, we will examine in much more detail how these decisions are made. We first describe what financial planning usually means. For the most part, we talk about long-term planning. Short-term financial planning is discussed in a later chapter. We examine what the firm can sukanya samriddhi scheme in hindi accomplish by developing a long-term financial plan. To do this, we develop a simple, but very useful, long-range planning technique: the percentage of sales approach. We describe how to apply this approach in some simple cases, and we discuss a number of extensions. To develop an explicit financial plan, management must establish certain elements of the firm’s financial policy. These basic policy elements of financial planning are:
1. The firm’s needed investment in new assets. This will arise from the investment opportunities the firm chooses to undertake, and it is the result of the firm’s capital budgeting decisions
2. The degree of financial leverage the firm chooses to employ. This will determine the amount of borrowing the firm will use to finance its investments in real assets. This is the firm’s capital structure policy.
3. The amount of cash the firm thinks is necessary and appropriate to pay share-holders. This is the firm’s dividend policy.
4. The amount of liquidity and working capital the firm needs on an ongoing basis. This is the firm’s net working capital decision. As we will see, the decisions a firm makes in these four areas will directly affect its future profitability, its need for external financing, and its ability to exploit potential growth opportunities.
A key lesson from this chapter is that the firm’s investment and financing policies interact and thus cannot truly be considered in isolation from one another. The types and amounts of assets the firm plans on purchasing must be considered along with the firm’s ability to raise the necessary capital to fund those investments. Many business students are aware of the classic ‘four Ps’ of marketing. Not to be outdone, financial planners have no less than six Ps: Proper Prior Planning Prevents Poor Performance. Financial planning forces the company to think about goals. A goal sukanya samriddhi yojana form frequently espoused by companies is growth, and almost all firms use an explicit, company-wide growth rate as a major component of their long-run financial planning. There are direct connections between the growth a company can achieve and its financial policy. In the following sections, we show how financial planning models can be used to better understand how growth is achieved. We also show how such models can be used to establish the limits on possible growth.
A good case can be made that preference shares are really debt in disguise, a kind of equity bond. Preference shareholders receive a stated dividend only, and if, the company is liquidated, preference shareholders get a stated value. Furthermore, preference shares are sometimes convertible into ordinary shares and preference shares are often callable. Preference shares with adjustable dividends (effectively participating preference shares) have been offered in recent years. There are various types of floating-rate preference shares in the US, some of which are quite innovative in the way the dividend is determined. For all these reasons, preference shares seem to be a lot like debt. Unlike debt, however, preference share dividends cannot be deducted as interest expense when determining taxable corporate income. For tax purposes preference mobile number tracker dividends received are treated the same way as ordinary dividends. Overall, there are thus two offsetting tax effects to consider in evaluating preference share: 1. Unlike interest paid, dividends paid on preference shares are not deducted from corporate income in computing corporate taxes. This is a significant disadvantage. 2. When preference shares are held as an asset, all dividends received are exempt from corporate taxation. With interest received, all of it is fully taxable. This is a significant advantage.
THE PREFERENCE SHARE PUZZLE
Given the non-deductibility of preference share dividends and the fact that they require a regular dividend payment and thus lack the flexibility of ordinary shares, why then do firms issue preference shares? For most industrial firms, the fact that dividends are not an allowable deduction from taxable profits is the most serious obstacle to issuing preference shares, but there are several reasons why preference shares are issued. First, firms issuing preference shares can avoid the threat of insolvency that might otherwise exist if debt were relied on. Unpaid preference dividends are not debts of a company, and preference shareholders cannot force a company into insolvency because of unpaid dividends. Further, the tax advantage to interest and the disadvantage to dividends only exists for companies with significant tax liabilities, so companies with trace mobile number current location large accumulated tax losses sometimes issue preference shares. For them the tax destructibility feature of interest is not appealing. This is particularly true when the firm essentially cannot borrow on a long-term basis. A second reason for issuing preference shares concerns control of the firm. Since preference shareholders usually cannot vote, preference shares may be a means of raising equity without surrendering control. Remember, however, that if the preference dividends are in arrears, the preference shareholders do get a vote. Thirdly, companies in a low profitability situation may choose to issue preference shares rather than debt, since the risk associated with an inability to service the security is lower in the case of the preference shares. From the lenders’ perspective, they would expect to get a higher return on preference shares than on debt because of the higher risks they face. In addition, the income am they receive, being dividends, is not taxed in the hands of the lenders.
Internal Uses Financial statement information has a variety of uses within a firm. Among the most important of these is performance evaluation. For example, managers are frequently evaluated and compensated on the basis of accounting measures of performance such as profit margin and return on equity. Also, firms with multiple divisions frequently compare the performance of those divisions using financial statement information. Another important internal use that we will explore in the next chapter is planning for the future. As we will see, historical financial statement information is very useful for generating projections about the future and for checking the realism of assumptions made in those protections. Finally a detailed Du Post analysis helps management to identify problem areas within the firm.
External Uses Financial statements are useful to parties outside the firm, including short-term and long-term lenders and potential investors. For example, we would find such information quite useful in deciding whether or not to grant credit to a new customer. We would also use this information to evaluate suppliers, and suppliers would use our statements before deciding to extend credit to us. Large customers use this information to decide if we are likely to be around in the future. Credit-rating agencies rely on financial statements in assessing a firm’s overall creditworthiness. The common theme here is that financial statements are a prime source of infor-mation about a firm’s financial health. We would also find such information useful in evaluating our main competitors. We might be thinking of launching a new product. A prime concern would be whether the competition would jump in shortly thereafter. In this case, we would be interested in our competitors’ financial strength to see if they can afford the necessary investment. Finally, we might be thinking of acquiring another firm. Financial statement information would be essential in identifying potential targets and deciding what to offer.
CHOOSING A BENCHMARK
Given that we want to evaluate a division or a firm based on its financial state-meets, a basic problem immediately comes up. How do we choose a benchmark or a standard of comparison? We describe some ways of getting started in this section. Time-Trend Analysis One standard we could use is history. Suppose we found the current ratio for a particular firm is 2,1 based on the most recent financial statement information. Looking back over the last 10 years, we might find this ratio has declined fairly steadily over that period. Based on this, we might wonder if the liquidity position of the firm has deteriorate rated. It could be, of course, that the firm has made changes that allow it to use more efficiently its current assets, the nature of the firm’s business has changed, or business practices have changed. If we investigate, these are all possible explanations. This is an example of what we mean by management by exception — a deteriorating time trend may not be bad, but it does merit investigation.