Steps 1, 2: Analyze Fundamentals The corporate financial system is driven by a firm's goals, business unit choices and strategies, market conditions, and operating characteristics. The firm's strategy and sales growth in each of its business units will determine the investment in assets needed to support these strategies; and the effectiveness of the strategies, combined with the response of competitors and regulators, will strongly influence the firm's competitive and profit performance, its need for external finance, and access to debt and equity markets. Clearly, many of these questions require information beyond that contained in a company's published financial reports. Step 3: Analyze Investments to Support the Business Unit(s) Strategy(ies) The business unit strategies inevitably require investments in accounts receivable, inventories, plant & equipment, and possibly, acquisitions. Step 3 of the process is an attempt to estimate the amount that will be tied up in each of the asset types by virtue of sales growth and the improvement/deterioration in asset management. An analyst can make a rough estimate by studying the past pattern of the collection period, the days of inventory, and plant & equipment as a percentage of cost of goods sold; and then applying a "reasonable value" for each category to the sales forecast or the forecast of cost of goods sold. Extrapolation of past performance assumes, of course, that the future underlying market, competitive, and regulatory "conditions" will be unchanged from those that influenced the historical performance. Step 4: Assess Future Profitability and Competitive Performance Strong sustained profitability is an important determinant of (1) a firm's access to debt and/or equity finance on acceptable terms; (2) its ability to self-finance growth through the retention of earnings; (3) its capacity to place major bets on risky new technologies, markets, and/or products; and (4) the valuation of the company. A reasonable starting point for assessing firm's future profitability is to analyze its past pattern of profitability. 1. What has been the average level, trend, and volatility of profitability? 2. Is the level of profitability sustainable, given the outlook for the market and for competitive and regulatory pressures? 3. Is the current level of profitability at the expense of future growth and/or profitability? 4. Has management initiated major profit improvement programs? Are they unique to the firm or are they industrywide and may be reflected in lower prices rather than higher profitability? 5. Are there any "hidden" problems, such as suspiciously high levels or buildups of accounts receivable or inventory relative to sales, or a series of unusual transactions and/or accounting changes? Step 1 Step 2 Step 3 Analyze Investment in Assets to support growth improvement/deterioration in asset management Step 5 Assess External Financing Need $ amount timing, duration deferability Analyze Goals ↓ Strategy Market, Competitive Technology Regulatory and Operating Characteristics Analyze Revenue Outlook growth rate volatility, predictability Step 7 Assess Viability of 3 to 5-year Plan consistency with goals achievable operating plan achievable financing plan Step 8 Perform Stress Test for Viability Under Various scenarios Step 9 Formulate Financing and Operating Plan for Current Year Step 4 Assess Economic Performance profitability cash flow volatility, predictability Step 6 Ensure Access to Target Sources of Finance lending/investing criteria attractiveness of firm to each target source