Some Caveats Regarding Financial Planning Models

Financial planning models do not always ask the right questions. A primary reason is that they tend to rely on accounting relationships and not financial relationships. In particular, the three basic elements of firm value tend to get left out, namely, cash flow size, risk, and timing.

Because of this, financial planning models sometimes do not produce output that gives the user many meaningful clues about what strategies will lead to increases in value. Instead, they divert the user's attention to questions concerning the association of, say, the debt-equity ratio and firm growth.

The financial model we used for the Hoffman Company was simple—in fact, too simple. Our model, like many in use today, is really an accounting statement generator at heart. Such models are useful for pointing out inconsistencies and reminding us of financial needs, but they offer very little guidance concerning what to do about these problems.

In closing our discussion, we should add that financial planning is an iterative process. Plans are created, examined, and modified over and over. The final plan will be a result negotiated between all the different parties to the process. In fact, long-term financial planning in most corporations relies on what might be called the Procrustes approach.1 Upper-level management has a goal in mind, and it is up to the planning staff to rework and to ultimately deliver a feasible plan that meets that goal.

1In Greek mythology, Procrustes is a giant who seizes travelers and ties them to an iron bed. He stretches them or cuts off their legs as needed to make them fit the bed.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

II. Financial Statements and Long-Term Financial Planning

4. Long-Term Financial Planning and Growth

© The McGraw-Hill Companies, 2002

CHAPTER 4 Long-Term Financial Planning and Growth

The final plan will therefore implicitly contain different goals in different areas and also satisfy many constraints. For this reason, such a plan need not be a dispassionate assessment of what we think the future will bring; it may instead be a means of reconciling the planned activities of different groups and a way of setting common goals for the future.

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