Published on January 8, 2009
ABChallenge – Introduction to the Financial Planning Model : ABChallenge – Introduction to the Financial Planning Model CONFIDENTIAL May 2006 This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion. ELEMENTS OF THE ANNUAL ACCOUNTS : 1 ELEMENTS OF THE ANNUAL ACCOUNTS The financial planning model supports participants in ABChallenge 2006 in preparing the three main elements of a company's annual accounts: the profit and loss statement, the balance sheet and the cash flow calculation. The profit and loss statement (P&L) reveals the monthly/annual profit by comparing sales against the costsincurred. For each product area, the sales and the costs associated with production are calculated (grossmargin), as are the additional costs for development/engineering, marketing and sales, publicity andadministration. At company level the financial result and the tax load are also calculated The balance sheet provides information about the sources and use of company's capital. The company isfinanced with equity and debt, and invests this money in the fixed and liquid assets needed for its operations.The model calculates separately the investment in and depreciation of assets in all sectors (production,development/engineering, marketing, administration) The cash flow calculation is the most important planning tool in the start-up phase. It is derived from boththe balance sheet and the P&L statement but, unlike the P&L statement, it provides information on thecompany's liquidity. Insufficient liquidity is as much a reason for bankruptcy as excessive debt: only if there issufficient liquidity can staff, suppliers and creditors be paid at the end of the month – regardless of howprofitable the company is. Unlike the P&L statement, the cash flow calculation shows actual income andexpenditure: investments, for example, are shown at their full cost at the time the investment is made, andnot, as in the P&L statement, factoring in depreciation over a period of time These three key financial statements are at the heart of every Business plan and should be included in the “Financial planning and Financing” section of the Business plan ! OVERVIEW OF THE FINANCIAL PLANNING MODEL : 2 OVERVIEW OF THE FINANCIAL PLANNING MODEL Excel Sheets STRUCTURE OF THE MODEL : 3 STRUCTURE OF THE MODEL The model consists of 4 Excel spreadsheets: Spreadsheet 1 (Instructions) Contains the essential usage instructions Spreadsheet 2 (Assumptions) Contains the key assumptions of the model; these are not entry fields, but a summary of thedata entered in spreadsheet 3 Spreadsheet 3 (Details [P&L, balance sheet, cash flow]) Contains the three main elements of the annual accounts in detailed form, and also thesupporting calculations with the appropriate entry fields (green background); the spreadsheethas 15 pages each for 2006, 2007, and 2008–2012, i.e., a total of 45 pages. Page numbersare shown at bottom left on the print-outs and are consecutive; the contents of the first 15 pages (2006) is commented on below Spreadsheet 4 (Summary [P&L, balance sheet, cash flow]) Summarizes the three elements of the annual accounts (P&L, balance sheet, cash flow) These 3 summary financial statements need to be included in the Financial planning section STRUCTURE OF SPREADSHEET 3 (DETAILS) : 4 STRUCTURE OF SPREADSHEET 3 (DETAILS) Area Page (2006) Direct cash flow calculation Indirect cash flow calculation Profit and loss statement Balance sheet Gross margin (4 products) Personnel planning/wage costs Investments/depreciation Production/stocks/inventory Rental/tax 1 2 3–4 5 6–9 10–11 12–13 14 15 2007: Pages 16–30 2008–2012: Pages 31–45 PROCEDURE – PROFIT AND LOSS STATEMENT : 5 PROCEDURE – PROFIT AND LOSS STATEMENT Preparing the profit and lost statement (Sheet 3, pages 3–4) First, determine, for each product area, the planned sales and the related material costs, on the basis of a detailed quantity and price planning (pages 6–9). Additionally, execute an appropriate market share planning, to check that the sales development is plausible Then, determine the types of expenditure, grouped by cost centres (production, development/engineering, marketing and sales, publicity and administration). The individual types of expenditure can be broken down into personnel costs (direct) and other (indirect) costs. Therefore, you should prepare next a detailed personnel plan, including staff numbers and personnel cost planning (pages 10–11); other costs are usually calculated per person or per sale Production costs can be broken down into direct and indirect production costs (page 14). Allocate these to the individual product areas in proportion to a product's share of sales When you have deducted all costs from the sales, you have the operating profit (EBIT = Earnings Before Interest and Taxes). To determine the profit for the year, next subtract the financial result and taxes. Because of country-specific tax systems, the calculation shown here is simplified by using a tax rate of 30%. We strongly recommend that a tax advisor be consulted to enable customized tax planning, especially as regards the taxation of different appropriations of profit (retention vs. payout) PROCEDURE – BALANCE SHEET : 6 PROCEDURE – BALANCE SHEET Preparing the balance sheet (Sheet 3, page 5) First, prepare an investment plan for the fixed assets of the individual cost centres (page 12), to determinethe individual balance sheet items on the asset side. The net investments are calculated per person.Alternatively, relating investments to sales or a unit-based investment plan could prove useful, but themodel must be adjusted accordingly Determine the depreciation period for the individual fixed asset items (page 13). This is done according tothe standard operational utilization duration of the item, which for annual accounts, is fairly arbitrary. For thetax return, however, tax deduction tables, available from tax offices, must be used. Therefore, for the threegroups, replace the pre-defined depreciation period in the model with the business-specific tax tableguidelines. The difference between the gross capital investment (acquisition costs) and depreciation is thenet investment; this corresponds to the change in the yearly fixed assets For current assets or working capital, plan debts and liabilities from supplies and services and the inventory(page 14). The level of receivables, in particular, depends on the payment period chosen for customers; thisis flexible (30–90 days) and receivables will be higher, the longer the payment period. The same applies toliabilities. The objective of a young company should be to keep the receivables as low as possible andliabilities as high as possible, so that the financing costs for working capital are kept to a minimum. Forinventory, it is sufficient to determine how many months in advance the material needs to be brought in The liabilities side of a start-up's balance sheet can differ considerably, depending on the financingopportunities. Be sure that long-term investments are financed through the equity capital of the owners,business angels and venture capitalists, or through long-term loans; working capital, on the other handshould be financed through short-term operating credit or supplier liabilities. For monthly planning it iscrucial, in the event of insufficient cash inflow, that sufficient short-term credit is available to pay the monthlybills that fall due PROCEDURE – CASH FLOW CALCULATION : 7 PROCEDURE – CASH FLOW CALCULATION Determining cash flow (Sheet 3, pages 1–2) The cash flow calculation differs from the P&L statement in its orientation towards income and expenditure; i.e., expenditure and income that have no effect on liquidity are not included (e.g., not all income from sales has an effect on cash flow). Deduct unpaid bills and increases in receivables from the sales income determined in the P&L The cash flows for the period can be calculated directly (page 1) or indirectly (page 2) For the direct calculation, deduct all payments, including investments, from cash salesincome For the indirect method, based on the net profit in the P&L, add all payments that have no effect on income or deduct all income that has no effect on cash flow Results validation To check the consistency of the balance sheet/P&L and the cash flow calculation, add up the first three lines of the model. Doing this you check, whether the cash flow that results from the direct or indirect calculation and the liquidity in the current assets match, and whether the totals of the asset and liability sides of the balance sheet match too.