CHAPTER 26

FINANCIAL PLANNING AND STRATEGY

Q.1.
A.1.

What is a financial planning? How does it differ from financial forecasting?

The process of estimating the funds requirements of a firm; to finance its current and fixed assets
to meet the expected growth in business; and determining the sources of funds is called financial
planning. Financial forecasting is an integral part of financial planning. Forecasting uses past
data to estimate the future financial requirements.
Forecasts are merely estimates based on the past data; planning means what a company
would like to happen in the future, and includes necessary action plans for realizing the
predetermined intensions. Financial planning is a means for achievement of growth and
profitability objectives by making planned investment and financing decisions.

Q.2.

Explain the steps involved in preparing a financial plan. What are the merits of a financial
planning?
The following steps are involved in preparing a financial plan.
(1) Analyse the firms past performance and establish relationships between financial
variables.
(2) Analyse the firms strength with respect to operating characteristics, like product, market
competition, production and operating risks.
(3) Workout the firms investment needs and its capacity to generate cash flows from
operations.
(4) Also workout the appropriate means to raise the external funds, based on investment and
dividend policies; and also the long-term financial health and survival plan.
Financial planning supports the management to ascertain the need of assets to sustain the
higher growth in sales, by taking proper investment and financing decision, based on long-term
projections (normally of three or five years).

A.2.

Q.3.
A.3.

Is there a relationship between strategic planning and financial planning? Explain.

Financial planning of a company has close links with strategic planning. Strategic planning
considers all markets, including product, labour and capital, as imperfect and changing.
Strategies are developed to manage the business firm in uncertain and imperfect market
conditions and environment and exploit opportunities. The companys strategy establishes an
effective and efficient match between its resources, opportunities and risks. Firms develop
financial plan within the overall framework of strategic plan.

Q.4.

What is a financial model? Illustrate the development of a simple financial model. What are the
advantages and limitations of a financial model?
A financial planning model establishes the relationship between financial variables and targets,
and facilitates the financial forecasting and planning process. A model makes it easy for the
financial managers to prepare financial forecasts. It makes financial forecasting automatic and
saves the financial managers time and efforts in performing a tedious activity. Financial
planning models help in examining the consequences of alternative financial strategies. A
financial planning model has three components Inputs, Model and Output.

A.4.

Q.5.
A.5.

What is meant by sustainable growth? Explain sustainable growth models with illustrations.
Sustainable growth may be defined as the annual percentage growth in sales that is consistent
with the firms financial policies (assuming no issue of fresh equity). The following model can

be used to determine the sustainable growth (gs) in sales:

net margin retention leverage
sustainable growth =
assets - to - sales (net margin retention leverage)
The net asset to sales ratio determines the requirement of funds for investing in assets to
support a given level of sales. The requirement for funds would increase with expanding sales.
The net profit minus the dividends is an internal source of funds. Thus, the product of net profit
to sales ratio and retained profit to net profit (net margin retention ratio) gives an idea of the
funds available internally to support the growth of the firm. Retained earnings increase the debt
raising capacity of the firm. Thus, given the target capital structure, the total funds would be
equal to retained earnings plus debt supported by the retained earnings. Net assets or capital
employed (viz., debt plus equity) to equity is a leverage measure, and is equal to one plus debt
equity ratio. Suppose the following information for a firm: PAT = Rs 100; Sales = Rs 5,000;
dividends = Rs 400; NA= Debt + NW (equity) = Rs 2,500; NW = Rs 1,250. The sustainable
growth is:
100/5000 60/100 2500/1250
2500/5000 (100/5000 60/100 2500/1250)
0.02 0.6 2
=
= 0.05 = 5%
0.5 (0.02 0.6 2)

sustainable growth =

A more general method of determining the sustainable growth rate in the case of multiproduct or multi-division company is to calculate the sustainable growth rate at the corporate
level in terms of growth in assets.
Sustainable growth = asset turnover profit margin income leverage

retention ratio financial leverage

S PBIT PAT RE NA
gs =

NA
S
PBIT PAT NW