Financial Planning & Analysis – Moving from lagging to leading indicators
Financial Planning & Analysis – moving from lagging to leading indicators
Traditional accounting & finance centres on the entity concept where the firm owns assets and owes equity & liabilities. This approach has its limitations as it does not open our minds to the acquisition and application of economic resources. I prefer to use the approach I called the ”Economic Resources Approach to Accounting” (ERAA), which encapsulates funding and operating resources, the cost of resources (capital), the flow of resources, the utilization of resources, leading to the capture of business values represented by discounted cash flows generated by operating resources. The ERAA approach will enhance the understanding of Financial Planning & Analysis (FPA) from the viewpoint of economic resources.
Financial Planning & Analysis revolves around financial ratios, which are based on historical (after-the-fact) figures. Analysis and interpretation of such ratios are performed only “after the horses have bolted” – a moment too late! Fundamentally, these ratios are, at best, lagging indicators of a company’s financial health.
What is needed are leading indicators that are predictive, preventive and protective of business and financial risks, going forward. These are the “Financial limits to growth” test, and the “2-level sales analysis” which I have designed based on segmental information. These tools can be applied immediately at work!
This Talk discusses the following critical areas in FPA, viz
1. What potential risks and pitfalls a company needs to know well in advance?
To manage a company well and ensure its sustainability, the accountant/CFO/entrepreneur must know
a) whether it is expanding beyond its financial limits
b) when an industry slowdown is on the horizon, and
c) whether there are concentration risks in major product categories and/or geographic spread.
To obtain an insight into the above situations we need leading indicators, which include
a) “Financial limits to growth” test, and
b) Two-level sales analysis, and
c) Capital structure analysis.
2. What keep the accountants/CFOs and CEOs/entrepreneurs awake at night?
To avert operating and financial performance failures, the accountants/CFOs and CEOs/entrepreneurs must be aware and be in control of four critical areas in the financial statements. They are captured in the acronym V.I.S.A.,
V – Volatility of the P&L
I – Impairment of assets
S – Sustainability of operating cash flows, and
A – Adequacy of funding resources.
For each of these areas of concern, I shall discuss how and why it arises and the dire consequences if it is not resolved timely.
At the end of the Talk, you will take away a new FPA Framework, which will enhance the financial health of your firm or your entrepreneurial set-up.
Content of course
1) The accounting framework and the ERAA Diagram
2) Debit and Credit revisited
3) Financial statement interrelationships
– Special emphasis on the Cashflow Statement, which is the key statement that unlocks cashflows for the firm’s growth
4) Capital structure – how it relates to operating leverage, business risk, financial leverage and financial risk
5) Traditional financial ratio analysis (lagging indicators)
6) Leading indicators
– “Financial limits to growth” Model – application & interpretation
– 2-level sales analysis
7) VISA – how we can use both lagging and leading indicators to manage it.
8) An enhanced FPA Framework, which both the organisation and the entrepreneur must know and apply for proper risk management, cashflow sustainability and corporate growth.
———————————————MM Lee 1May20—————————————-
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