Planning and forecasting
Category: Corporate Banking
1. “The plan is nothing, planning is everything“
Analysing the financial statements of a company is absolutely necessary to assess its creditworthiness, but it can hardly make any sound predictions about the company’s future. Whether the company will be able to service a loan and finally repay the principal, will only unravel in the future. So, if a bank is going to decide on the creditworthiness of a company, it should actually take into consideration the future of the company rather than its past, which is reflected in the balance sheet.
Business plans and financial forecasts should be combined with the above mentioned considerations when deciding on corporate loans. Forecasts, however, are a tricky thing. Mark Twain said that he did not like them, „“especially if they dealt with the future.“ Certainly no clear predictions can be made about a company’s future, not even with the most accurate plan. But planning shows which factors management have taken into account and how it intends to adjust the company to them. When things turn out in other way than previously planned, this difference has to be discussed, in order to learn from it. This is why it is not the plan itself which is important, but the planning process itself which is paramount, that is the process of making assumptions, drawing conclusions and setting objectives.
When the former German Democratic Republic was reunited with West Germany, it was the banks who were among the first to assist in East Germany’s economic and financial reconstruction. East German companies were either giant conglomerates, which had been left over by the socialist economy, or they were start-up companies. In any case, there were no financial statements with any value, because the balance sheets which had been written under socialist accounting principles were useless in a market economy. In order to assess the creditworthiness of these new corporate clients, banks had to rely on the business plans of these companies. So, assessing a corporations creditworthiness meant analysing its business plan. In many cases, banks had to assist their clients in drawing up such plans. With no historical financial data available, the qualifications of management and tools like the SWOT-analysis or strategy portfolios became all important.
2. Strategic business planning
This is one reason why this book has given so much attention to matters like industry analysis, the product life cycle and the Boston Consulting Portfolio, which are useful tools to analyse corporate strategy. Building on the results of the SWOT-analysis, a company must decide on its strategic position within its competitive environment. For example, its product range and production facilities could encourage it to follow a strategy as a low cost producer in a mass market, while another company with very sophisticated products might choose to act as a niche player. Both strategies tend to be very profitable. The credit analyst has to discuss whether a corporate client has chosen the right competitive strategy for the specific competitive advantages of its company, and if the company’s business planning fits this strategy.
Corporate strategies should be written down. They have to be communicated to mid-level management and to staff, in order to let them readjust their work toward these strategic goals. A process of periodically undertaking strategic planning and checking its progress should be firmly established in each company.
3. Financial planning
The easiest way to do at least some basic financial planning is to project the balance sheet data of the last few years forward for the next couple of years. Such a projection draws on past data only and still neglects the future prospects of the company.
Qualified financial planning has to integrate the various operational plans, such as marketing and production plans or personnel planning, which all have impacts on the financial performance of a company. Many banks have developed elaborate computer-based planning tools, which they place at their corporate clients disposal to help them improve their planning.
The following pages contain a case study showing a detailed financial planning for a fictional company called «The Test Company, Ltd.». The spreadsheets start with a sales forecast and focus on cash flow forecasts. They give an extensive insight into balance sheet and profit and loss account projections. The case study was provided on the Internet by Keith Stern.