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Types of Financial Planning Models

Types of Financial Planning Models
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  • 0:02 Business Financial Planning
  • 0:49 Financial Planning Models
  • 1:25 Model Elements
  • 2:10 Model in Action
  • 5:03 Lesson Summary
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Lesson Transcript
Instructor: Christian George
In this lesson, we'll discuss financial planning in business. We'll explore the use of models to create, implement, and evaluate financial plans. An example will be used to illustrate the concepts of the lesson.

Business Financial Planning

The business world is an ever-changing environment. Company executives must continuously evaluate operations and goals to determine if the company is on the right track to success. Financial planning is a tool that companies use to create, implement, and evaluate short-term and long-term goals. It allows executives to use internal and external financial information along with other relevant market data to determine business strategy.

As a company builds its financial plan, three important issues must be considered:

  • How much money the company will need to get from external sources in the future
  • How changes in operations within the company will affect its overall value
  • How employee compensation plans (dividends, stock splits, employee compensation, and such) will affect future business

Financial Planning Models

Financial planning models are created to help executives explore the results of various business strategies. These models can be simple or complex, but their essential function is to provide answers to 'what-if' financial questions posed by executives. Exploration of potential strategies ultimately leads to the creation of short-term and long-term company goals.

Financial planning models allow executives to forecast financial statements. Historical financial statements are used alongside other financial information and market data to create a model. This lesson will explore the components of a financial planning model and the part each plays in creating a company's financial plan.

Financial Planning Model Elements

Every element of a financial planning model is essential. Much like a chef needs all ingredients of a recipe to make a dish, an accountant needs all components of a financial planning model to accurately estimate a potential financial outcome.

Let's look at the necessary elements of a financial planning model:

  • A sales forecast drives a financial planning model.
  • A pro forma financial statement provides an ideal financial projection.
  • A list of asset requirements provides information about what is needed to drive sales growth.
  • A list of financial requirements details debt and dividend information.
  • A plug is a projected figure, such as a financing option, that a company could use to fund the strategies presented in the model.
  • Economic assumptions describe the economy, market sector, and other external factors.

Financial Planning Model in Action

Let's take a look at a company as it uses a financial planning model to create a financial plan for 2016.

Sales Forecast

XYZ Inc. sells data wire for communication networks. It manufactures these products in the U.S. In calendar year 2015, XYZ Inc. had $100 million dollars in total sales of all of its products. Financial growth has remained at a constant 4% over the last few years, but the company anticipates sales growth to increase to 6% in 2016. With the increase in sales growth expected to be 2%, XYZ Inc. can forecast 2016 total sales to equal $150 million dollars.

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