The Long-range Financial Plan

Long-range financial planning is concerned with ensuring the continuing soundness of the financial structure of the firm, maintaining adequate working capital, and providing additional capital for expansion from earnings, borrowings or by the issue of new shares.

The essential components of the long-range financial plan are a projected income statement, a projected cash flow statement, a capital expenditure forecast, a financing plan and a projection of the capital structure. We shall briefly examine each of these components of the financial plan.

(a) The projected income statement

The projected income forecast for the long-range planning period will be set out in the traditional manner.

(b) The projected cash flow

The accountant will be particularly concerned with ensuring that the company remains solvent, that it has no liquidity problems and that financial resources for growth are provided. He will be required to estimate the financial needs of the long-range plan and advise on the financing arrangements which may be made to meet these needs.

An estimate of the cash flow pattern broken down over the long-range plan will show when shortages and surpluses of cash are likely to occur, and hence will enable plans to be drawn up to arrange the firm's finances to best advantage.

The long-range cash flow profile is a very useful tool of analysis in a number of ways. Firstly, it indicates whether or not fresh injections of cash will be necessary to finance the long-range plan, or whether future capital expenditure and the planned expansion of operations can be financed from retained income after taking into account anticipated tax liabilities and dividend payments. Secondly, the long-range cash flow will point out when deficits and surpluses will occur, and so assist in the formulation of a financial strategy over time. Thirdly, the cash flow plan will establish the relative duration of deficits and surpluses, and this information will likewise be most useful from a financing point of view.

(c) The capital expenditure forecast

The capital expenditure forecast will be simply the annual financial requirement to support this expenditure.

(d) The financing plan The financing plan is concerned with ensuring that the necessary finance will be available to support the long-range plan. If, as a result of the planned activities for the period, a deficit is forecast and it is likely to be of short duration, it may be financed from a number of different sources, for example, by means of a bank overdraft or a temporary run-down of stocks. If, however, the deficit is likely to exist for a longer period, it may be necessary to raise new capital. The financing plan considers the manner in which a financial deficit is to be covered.

(e) The capital structure projection

It is clear from the foregoing that the financial plan which is devised to support the long-range plan may have important implications for the capital structure of the firm in a number of ways.

First, the company will have to form a view as to the merits or otherwise of altering the gearing of the company. As we saw in Part 2, the gearing represents the ratio of fixed interest stock as against equity capital, and the reader will recall that if a company is highly geared and profit fluctuates over time, the rate of return payable to ordinary shareholders will fluctuate to a proportionately greater extent with consequential effects on the value of the ordinary shares on the market.

Secondly, the management of working capital will be a critical success factor, particularly should the economic climate change during the period, with adverse effects on liquidity and credit facilities. Working capital is defined as the excess of current assets over current liabilities, and is regarded as being available for supporting current operations as distinct from the financing of capital expenditure.

Thirdly, a decision to finance capital expenditure by means of new share or debenture issues will also affect share prices unless dividend rates can be maintained through increased profits. The outcome, in any event, will largely depend upon management's previous record and the firm's standing in the market.

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We have seen how the main objectives of the firm are expressed in financial form. Detailed financial analysis is necessary to support these financial targets. Since this type of analysis is dealt with throughout this book, this webpage is not detailed in this respect. Indeed, the purpose of this webpage is to emphasize the necessity of setting long-run objectives and of relating short-term decisions to these objectives.

In the field of long-range planning, the accountant's role is to contribute to the management team. The importance of this role should be apparent from our discussions... see: Financial Planning