Which step(s) is (are) the most critical? Explain your rationale.
The financial planning process generally involves five steps.
1.The firm forecasts financial statements under alternative versions of the operating plan in order to analyze the effects of different operating procedures on projected profits and financial ratios.
2.Next, it determines the amount of capital that will be needed to support the plan; that is, it finds out how much the new assets needed to achieve the target sales will cost, since without adequate capital, the plan obviously cannot be realized.
3.Then the firm forecasts the funds that will be generated internally. If internal funds are insufficient to cover the required new investment, then it must identify sources from which the required external capital can be raised, taking account of any constraints due to bond covenants that limit its debt ratio and other financial ratios.
Market conditions must also be recognized. For example, in 2009 banks reduced many firms’lines of credit and also increased the fees and interest rates on such lines. This surprised firms that were not keeping up with conditions in financial markets.
4.The firm establishes a performance-based management compensation system that rewards employees for creating shareholder wealth. The emphasis here should be on the long run, not on profits over the next few quarters or even years. A failure in this area was perhaps the most important factor leading to the worldwide financial and economic crisis that hit in 2008 and 2009.
5.Finally, management must monitor operations after implementing the plan to spot any deviations and then take corrective actions. Computer software is helping greatly here, and it’s changing the way companies do business. In particular, corporate information systems are reducing the need for“middle managers” and flattening firms’management structures.