FIN 534 – Financial Planning and Agency Conflicts

FIN534_7_2_Joe-5: That is
simply the TFC way!

Don will be joining you in a bit to discuss the financial planning
piece of the project. As always, good
luck!

Slide 3

Scene 3
• Don
in conference room
•
• Go
to next slide

FIN534_7_3_Don-1: So Joe filled you in on your next part of
the project of looking at both the Operating Plan and the Financial Plan.

The Operating Plan will
look at TFC for future operations in our market segments and will focus on
our sales and marketing strategies, growth opportunities and offerings. Typically an operating plan will focus on
the immediate five years. Since we
are doing a lot in the first year, we will focus on that time horizon. A lot of what-if analyses will be done with
the operating plan.

FIN534_7_3_Don-2: The Financial
Plan will focus on projecting pro
forma financial statements. These
statements will help in deciding how much free cash flow there will be
available in future years to finance parts of the operating plan. We will again just look at the first
year. Typically, we would look at five
years but since we are doing so much in the coming year, our focus will be on
that period.

FIN534_7_3_Linda-1: There are also other reasons why we should
be forecasting free cash flows. Let’s
take a close look at these rationales.

Slide 4

Scene 4
• CYU
Narrator: In addition to forecasting
free cash flow, what are some ways in which managers should want to use pro
forma, that is projected financial statements? Select all that apply

1) The
statements can help in seeing if the company is in line with its future
financial goals (correct)
2) They
can help create “What if” analyses (correct)
3) They
will help in implementing policies (nice try – but managers need to look at
the future with pro formas for decision making
4) They
will help in planning for future
financing of projects (correct)
5) They
help in setting the capital structure (incorrect – Nice try. Capital budget is usually an internal
policy that pro formas can use in their creation but they typically don’t get
involved in setting the policy.

Slide 5

Scene 5
• Linda
In conference room
• Put
Up Operating Plan
• Linda
switches poses
• Go
to next slide

FIN534_7_5_Linda-1: There are many reasons to have pro forma
financial statements. Here at our
company, these pro forma financial statements assist with the financial
planning.. As Joe mentioned, the financial planning is composed of two parts,
the Operating Plan and the Financial Plan.

Let us look at some of the components of the Operating Plan

FIN534_7_5_Linda-2: Don previously mentioned the prime areas
that we look at when building our Operating and Financial Plans. One area in particular is forecasting revenue. We are expecting assets to double in size
with this expansion project in the first year; therefore, we have to think of
sustained growth. This, however, may
be difficult to predict.

FIN534_7_5_Linda-3: Keep in mind that our Accounting Department
has been analyzing many trends to get a forecasted revenue growth rate of ten percent. Also, in anticipation for
the cost cutting measures that is being planned, the Accounting Department
also projects that Operating Expenses
will drop from eighty two percent of
sales to seventy five percent.
With these changes the pro forma statement in the following year will
show a profit margin more than ten
percent, which will make our shareholders happy if it is met.

Slide 6

Scene 6
• Projecting
Financial Statements
Forecasting
any operating accounts;
Keeping
in line with a company’s policy on taking on debt, equity and paying
dividends and;
Making
sure the operating plan can be funded.

FIN534_7_6_Linda-1: We were able to create some pro forma
statements for TFC’s Financial Planning process. This may seem like a pretty
straightforward process but there is a lot of work that goes into the
decisions.

There are
three basic points to projecting financial statements and they consist of Forecasting any operating accounts;
Keeping
in line with a company’s policy on taking on debt, equity and paying
dividends and;
Making
sure the operating plan can be funded. But there is more.

During the
process a company can go through many iterations of scenario analysis to
determine what is best for the company. It is much like going to a show on
Broadway, as you only get to see the finished production and not all the leg
work behind the scenes. The same can
be thought of when it comes to projecting financial statements. Much analysis goes into the decision making
as the company plans around it.

Here at TFC,
we have many departments look over the projections before we sign off on
them.

Slide 7

Scene 7
• Financial
Planning
• Agency
Conflicts

FIN534_7_7_Don-1: Linda is right about the final projected
financial statements process. Since we
are a conservative company who is always thinking about how to maximize
shareholder wealth, our process takes time to go through the proper
channels. For this expansion project,
we don’t have the same luxury as other projects, but we still have to look at
each area before making an informed decision.

FIN534_7_7_Don-2: As a publicly
traded company, we have an obligation to do the right thing for many
stakeholders including shareholders, creditors, employees, and others who
have a vested interest in TFC. With
that comes Agency Conflicts.

FIN534_7_7_Linda-1: Oh, yes.
Agency Conflicts. Do you think this will hurt our chances to
expand?

FIN534_7_7_Don-3: Before we think that way, let’s have Joe
talk to us about Agency Conflicts. He
has first-hand experience in the area.

Slide 8

Scene 8
• Joe
in Conference Room
•
• Next
slide

FIN534_7_8_Joe-1: Agency Conflicts is an area that I am
involved with on a daily basis.

To better understand it, TFC sets up agency relationships by hiring
Agents to act on behalf of the company. The typical agency relationships
include stockholders versus creditors; controlling interest owners versus
non-controlling interest owners; and stockholders versus managers.

We try to keep agency conflicts down as we have a set of rules that
managers need to follow; however,
there are always exceptions.

Our belief is if we can keep agency conflicts down, the costs around
those conflicts, called agency costs,
will be lower. And, we all know that
lower costs means more profit for TFC!

Let’s look at each of the agency relationships and see if we are
doing an adequate job of keeping agency costs down.

Slide 9

Scene 9 –
·
Joe in room
·
Conflicts between
Stockholders and Creditors on slide

SHOW OON THE SCREEN for EMPHASIS…… One choice would be to have our creditors raise the
interest rate they are charging us to do the project.
Second choice:
to spell
out in detail what the increased debt will be used for as well as put in
place company performance measures.

FIN534_7_9_Joe-1: When looking at stockholder versus creditorsthere is a difference in points of
views. Creditors are lending to TFC so
they have a vested interest in seeing the investment pay off. Our creditors want to make sure we don’t
default on our loans. But the decision
making is not coming from the creditors but instead our mangers, acting for
our shareholders. In other words, the Creditors lend to TFC and our managers
are responsible for keeping the company growing. The potential agency
conflicts arise because Creditors want to get paid, but managers are making
decisions with company assets that can potentially affect the Creditors
payment schedule.

FIN534_7_9_Joe-2: Our expansion
project is a great example of this.
Based on our capital structure for this project, we are going to have
to take on a lot of new debt. So, TFC
will be taking on more risk in doing the project, which is what we saw with
our cash account, but creditors would rather have risk minimized. Hence, an agency conflict.

So what can be done? One
choice would be to have our creditors raise the interest rate they are
charging us to do the project.
That is not TFC’s first choice as it can raise our debt expense
considerably; thereby, increasing risk for us.

The second approach and the one that has been adopted by TFC is to spell
out in detail what the increased debt will be used for as well as put in
place company performance measures.
These debt covenants act as a watch guard for TFC. We understand that
our Creditors want to see risk kept low, but we also want to grow.

Slide 10

Scene 10
•
Joe in room
• controlling interest owners versus non-controlling
interest owners
• Next
screen
•

FIN534_7_10_Joe-1: With the second agency conflict of inside
owners versus outside owners,
it results to who is bearing the cost.
Take for example, when TFC was a private company, My family bore all the
costs but also reaped the benefits.
This included some well-deserved vacations at the company’s expense.
When we decided to go public, we now took on outside owners. We still had the company pay for
well-deserved company vacations, but the expense was now also being consumed
by our external owners. As a result,
our external owners demanded a higher rate of return. Financially, we were doing fine, but the external
owners felt that the money should have gone back into the business.

FIN534_7_10_Joe-2: What did we do? Well, my family met and decided that it was
in the best interest of TFC to stop having the company pay for our vacations.
We felt that when we decided to go public we gave up that luxury. We
communicated our new policy and added additional language regarding equality
across all the owners. That is why we don’t have any preferred stock or
special interest stock. We want everyone to be on the same “workout”
field.

This new policy has worked out great for the company and for
establishing relationships.

Slide 11

Scene 11
·
Joe speaking about
Managers and Shareholders conflicts
• Next
Slide
Use tablet to put the six main ways in which the actions of our managers
may affect the value that our shareholders desire.

FIN534_7_11_Joe-1: The third agency conflict is the one that we
encounter the most which is conflicts
between the decision making managers and the shareholders of TFC.

Shareholders want to see TFC’s value go up. Remember, stock price maximization? But our managers also have personal and
company goals that they want to meet as well.
And if the actions by the managers to meet their goals are not in line
with stock price maximization, conflicts can arise.

FIN534_7_11_Joe-2: There
are six main ways in which the actions of our managers may affect the value
that our shareholders desire. I’ve
created an activity for you to use on this tablet as we discuss each of the
main ways in which actions of our managers may affect the value that our
shareholders desire.

FIN534_7_11_Joe-3: First,
Efforts by TFC’s managers regarding
profit maximization. If our managers are spending more time at
“extracurricular” activities for the company instead of seeking ways to build
the company. We like it where our managers, including myself, are out there
marketing TFC, but we also need to be in house.

To try to alleviate this conflict, TFC has encouraged managers to be
selective in those additional activities. So far this initiative has really
been paying off.

FIN534_7_11_Joe-4: Second,
Managers overspending on non-essential
items. At TFC we are cash conscious so managers have to go through an
approval process to ensure they are spending within company guidelines. We
are cash focused therefore extravagant purchases are not permissible.

FIN534_7_11_Joe-5: Third,
Inability to act prudently when it
involves closer relationships. At
times our managers are put in a bind and they need to act accordingly even
though it may affect someone who is close to them. All of our managers know
that they need to separate business from their personal feelings. This is
easier said than done. However,
prudent decisions need to be made if we want to grow our business.

Our business model takes into consideration the personal side of the
business and that is why we do so several analyses before making a decision.
I am pleased to say that our model has been quite successful as we have never
laid off an employee in the history of our company.

FIN534_7_11_Joe-6: The fourth involves Risk Taking. With this conflict, managers may be reluctant to
take on a project with risk even if it is projected to be a winner. Take for
example our expansion project. It is very risky and if not successful the
result can be bleak for TFC. The blame would then go to me and the management
staff involved in the project. As a result of this managers may be reluctant
to take on the risk even though shareholders stand to benefit from it.

To alleviate this conflict, we treat it much in the same way as the
other conflicts and complete a detailed review of any high exposure project
to ensure we are comfortable.

FIN534_7_11_Joe-7: The fifth is Cash Management Decision Making. It is no secret that TFC is a
cash conscious business. Cash is good but too much cash may not be. Remember
the saying, “Cash is king”. Cash flow is important to the general
health of the business. It might sound odd but think of it from the point of
view of the shareholder. They like to
see some immediate returns on their investment. If a company is continuing to
hold on to their cash, shareholders are not reaping the benefits. Also, extra cash may entice managers to
make poor investment decisions down the road.

Cash is also important but it also needs to be regulated here. In order to regulate this cash we have a
policy in place to keep cash at an adequate level that will help us be
financially strong while also giving back to our investors in stock growth
and dividends.

FIN534_7_11_Joe-8: The
sixth and last area involves Information
Sharing. With this conflict,
managers may not share all available information in a timely manner as they
don’t want their competitors to gain an advantage. Also, if the company is not doing well,
they may delay the release of bad information or change it to not look as
bad. At TFC, we are an open book company. Our policy is to share all
available information as soon as possible. We are more focused on our company
image and believe that being up front is the best way to go.

Slide 12

Scene 12

• Joe
and Linda finishing up Agency Conflicts

FIN534_7_12_Linda-1: Joe, thank you so much for explaining the
potential agency conflicts. I never realized how much there is to this
concept.

FIN534_7_12_Joe-1: You are welcome Linda and I am always
learning something new every day. That is why we are putting so much effort
into analyzing this expansion project. We still have not made a final
decision, but the numbers may speak
for themselves. However, we have to consider the effects on the interested
parties.

FIN534_7_12_Linda-2: I guess you can say it is a continuous
learning process.

Slide 13

Scene 13
• CYU
As
part of your understanding about Agency Conflicts, please select all those
that can be considered potential Agency Conflicts between managers and
shareholders

(1) Manager
finds out that company will not meet expected earnings and put a different
spin on the earnings so it doesn’t look as bad
(2) Manager’s
best friend is part of a division that is scheduled to be closed but the
manager lobbies to keep it open even though it is hurting company profits.
(3) Manager
decides to invest extra cash in stocks or bonds instead of giving some of the
cash back to the shareholders
(4) Manager
decides to take the entire staff on an all-inclusive trip to Hawaii with
everyone in first class staying at the most expensive hotel
Answer – They all
can be considered potential agency costs. Shareholders want managers to
maximize their wealth but managers also have their own goals which can cause
conflicts.

Next
Slide

Slide 14

Scene 14
• Conference
room
• Summary
Slide –

FIN534_7_14_Don-1: Wow
– great information by everyone. We
first learned that pro forma statements are an important part of Financial
Planning which includes the Operating and Financial Plans. A lot of research is needed in developing
these statements as company projections which then help in establishing
projected cash flows which in turn assist in valuation projections.

We also learned about Agency conflicts. The three typical Agency Conflicts are stockholders versus creditors;
controlling interest owners versus non-controlling interest owners; and
stockholders versus managers.

The conflicts can arise as profit maximization measures may not be
implemented to the fullest due to a number of factors. Interested parties are
then faced with some decisions. If the core values of the company are kept in
mind, this may help in the decision making process.

FIN534_7_14_Linda-1: While we did not do a lot of calculations
this time around, we did do a lot of examination of policies and
procedures. These are also very
important whenever we evaluate a project not to mention one as big as this
expansion project.

All of this hard work has really made me ready to join one of those
TFC Intense Exercise classes. One of them is starting in a few minutes. Let’s
go exercise!

Slide 15

Scene 15
• Closing
slide

Closing slide

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