1 - Long-term financial planning. Capital investments:
1.1 - The needs of long-term investments: The long-term financial planning normally covers a period of five years and its related to long-term financial investments. The long-term investments decisions, also known as Capital budgeting, are crucial for the company’s long-term prosperity. They absorb large portions of Cash Flow and they have long-term consequences that will affect a business during a long period of time.
Nowadays, most of the projects require important investments in tangible but also in intangible assets such as R&D for new products, new IT systems, etc. Any project that involves a cash flow withdraw with the aim to get a later cash flow incomes can be understood as a capital investment, regardless of whether the use of this cash flow is invested in tangible or intangible assets.
1.2 - Potential benefits and risk assumption: Every single project has the same ultimate goal: To contribute to increase shareholders value. However, some of these projects are bets that the company does and they can literally boost a business or ruin the whole company instead.
The financial planning estimates the profitability and gives a comparable value for later decision making and, at the same time, it assesses the risks of each investment alternative. At the end, the company shall select a project/s with complete information on potential benefits and associated risks.
1.3 - Financial planning in accordance with strategic planning: The capital investments need to match the company’s strategic plans and the top management must ensure that the efforts are being concentrated in these areas where the company has a competitive advantage. As part of that project, the company must identify as well the declining business that should be either sold or abandoned. Therefore, the capital investment decisions should take into account both “increasing” and “decreasing” processes. The strategic planning and capital budget should be two complementary and reinforcing processes.
1.4 - Types of capital investments:The capital investments might refer to different concepts such as:
1.5 - Capital investments evaluation: At SMB-FINANCE we help you in the capital budgeting process by:
- Ensuring that the forecasts are consistent: Gathering data related to macroeconomic indicators such as the expected inflation, the GNP, or data related to market segments such as the forecast of car sales, forecasts on the price of raw materials and other commodities used in the production processes.
- Eliminate conflicts of interests: If managers are evaluated with short-term performance indicators, there is a risk of promoting projects with shorter payback time and better short-term cash flows but with lower long-term operating margins and shorter lifecycles than other groundbreaking long-term projects whose initial cash flows might be smaller but with much better NPV.
- Evaluating different capital investment alternatives: Through the analysis of each project cash flows, performing a sensitive, scenarios and break-event point analysis. By using different investment criteria such as the discounted cash flows (investment, finance and aggregated), Net Present Value (NPV), the Internal Tax of Return (ITR) together with other more informal methods such as the Investment Payback we will help you to determine the best possible capital investment.
- Financing plan and dividends policy: Establish the associated mix of financing resources plan to each capital investment project together with the planed dividends policy. One on hand, the complete Financial Plan underlines a strategy to increase founds for capital investment needs or for other additional needs. On the other hand, the more dividends the company pays, the bigger will be the needs of funds from other sources than the retained earnings.
- Financial structure and financial leverage: All this taking into account the financial structure and financial leverage. The financial leverage or leverage effect is the use of debt to increase the return on Equity. It is the measure of the relation between debt and return. When the cost of capital (interest) is lower than the Return On Capital Employed (ROCE), it is convenient to get external financing. In this way, the surplus or the return against the cost of capital represents a bigger returns on Equity (ROE).
1.6 - Capital investments weighting or mix of CI:If you have limited financial capacity, like the immense majority of companies, we help you to decide the best mix of capital investments. It is highly recommendable to balance investment projects in different market segments, type of assets and time horizons. The reason behind it is to reduce risk associated to each investment, renew or create assets and cover different time periods.
2.- Short-term financial planning. Annual Budgets:
The Annual Budgets outlines the incomes and expenditures expected over the next coming year and helps the organization to project its cash flows and effectively manage their money.
Unlike the capital budget where it is accepted to perform more rough calculations, the annual budget needs to be accurate and up to date as a way to maintain control over the company’s finances and investments. In other words, the company needs to control and manage how the company will finance its activities over the next year and in what will invest the funds. The annual budget also serves the company to show to the shareholders how will their money be used.
The annual budget is the most important tool for the account management at short-term. It should be defined by taking into account the following issues:
- Relevant macroeconomic and market segments indicators
- The strategic planning and the capital budget
- Acurate sales budget.
- The company's corporate objectives, strategic initiatives, action plans,...
- Historical data
The complexity of the budget will depend on the company size, the requirements of the top management, funders or shareholders, in the number of business activities the company is competing in, etc..
3 - Scenario analysis:
The financial planning must valuate different possible scenarios to see the consequences for each business plan under different scenarios. This normally involves considering an optimistic, a moderate and a pessimistic scenario and its related probabilities and associated risks. Unlike the annual budget, the scenario analysis is done with general and aggregated values, this as a first step to check the compliance of the capital budget with the business strategy.
4 - Sensitive analysis:
The financial planning concentrates efforts on analysing the most probable future. However, once the most probable scenario has been established, it is highly probable that it does not occur exactly as planned at the end. The sensitive analysis takes into account key variables and by modifying them tries to see if the fundamental hypothesis are still valid or into what extend they have changed.
Summarising, the financial planning, capital budgets and annual budgets are based on three fundamental requirements:
1.- Trustable predictions: The previsions must not be accepted by its nominal value and cannot be only based on historical data because. On one hand because the future will most likely be different that the past as the closer environment and general economic situation might have changed, on the other hand, because the company must take into account their competitor’s possible movements.
Instead, the financial planning analyses what’s behind each prediction, gathering information from different sources, establishing common and well based fundamental hypothesis and always asking: “What if..”
2.- Selection of the optimum Financial Plan: There is not a regulated procedure to choose the optimum financial plan. However, at the end of the process, the company must select the best financial plan possible taking into account the full complexity and intangible elements.
3.- Plan development control: The financial plans might be out of date right after they have been finished. As this is so, they have to be flexible in order to be changed if necessary. Otherwise, the company would be navigating with and out of date map and incorrect objectives, strategies and milestones.
The Plan development control is, therefore, essential to place the company back on the correct road.