Reading: Financial Projections
A solid financial plan is the basis of every valuation exercise and every significant management decision. The financial plan allows us to identify the firm's capital needs as well as its ability to generate cash. It also unveils the various sources and uses of funds. This section shows how to set up a financial plan.
3. Summary
In sum, this section has shown the fundamental principles of financial planning. Together with the knowledge from above, we are now able to identify the relevant sources and uses of funds, not only for the firm's past, but also for its future.These are indispensable tools for the analysis of financial decision as well as the estimation of firm value.
Clearly, our investigation has focused on the technical aspects of financial planning. This is a first important step. The crucial challenge in the real world will be to make reasonable assumptions about the future development of the company. This requires practical experience and in-depth knowledge of the company and its environment. A detailed discussion of this fascinating topic goes beyond the scope of this introductory course.
What should be equally clear by now is that every financial plan is the result of a (fairly broad) set of assumptions. We should therefore never cosider the resulting projections as point estimates. Instead, we should acknowledge that there might be measurement error in our projections and, therefore, treat our estimates as intervals. One way to incorporate this in our analysis is to work with different scenarios (best case, expected case, worst case). Another, more powerful, way is to do simulations. For Microsoft Office, there are many simulation tools available on the market that help us conduct complex simulations without too much effort. Some of the most popular solutions are @RISK, RiskSolver, and CrystalBall. With these solutions, we can use the financial plan to (a) understand what could happen, (b) assess the probabilities of possible outcomes, and (c) assess the key financial value drivers. Thereby, we transform the financial plan into a very powerful management tool. The comprehensive case study will illustrate such a simulation in a real-life case.