Assessing Compnay's Financial Health

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R E V: JANUARY 2 8 , 2 0 11

Assessing a Company's Future Financial Health

Assessing the long-term financial health of a company is an important task for management in its formulation of goals and strategies and for outsiders as they consider the extension of credit, long- term supplier agreements, or an investment in a company’s equity. History abounds with examples

of companies that embarked upon overly ambitious programs and subsequently discovered that their portfolios of programs could not be financed on acceptable terms. The outcome frequently was the abandonment of programs in mid-stream at considerable financial, organizational, and human cost.

It is the responsibility of management to anticipate future imbalance in the corporate financial system before its severity is reflected in the financials, and to consider corrective action before both time

and money
are exhausted.The
avoidance of
bankruptcy
is an insufficient standard.
Management must ensure the continuity of the flow of funds to all of its strategically important programs, even in periods of adversity.

Figure A provides a conceptualization of the corporate financial system, with a suggested step-by- step process to assess whether it will remain in balance over the ensuing 3-5 years. The remainder of

this note discusses each of the steps in the process and then provides an exercise on the various financial measures that are useful as part of the analysis. The final section of the note demonstrates the

relationship
between a
firm’s strategy and operating characteristics,
and its financial
characteristics.

Professor Thomas Piper prepared the original version of this note, “Assessing a Firm’s Future Financial Health,” HBS No. 201-077, which is being replaced by this version prepared by the same author. This note was prepared as the basis for class discussion.

Copyright © 2010, 2011 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545- 7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. 911-412Assessing a Company's Future Financial Health

Figure AThe Corporate Financial System

Goals

Step 1Strategy

Market, Competitive Technology Regulatory and Operating Characteristics

Step 2Revenue Outlook
growth rate
volatility, predictability

Step 3Step 4

Investment in AssetsEconomic Performance
to support growthprofitability
improvement/deterioration in asset management
cash flow
volatility, predictability

Step 5Step 6

External Financing NeedTarget Sources of Finance
$ amountlending/investing criteria
timing, duration
deferability
attractiveness of firm to each target source

Step 7
Viability of 3-5 Year Plan
consistency with goals
achievable operating plan
achievable financing plan

Step 8
Stress Test for Viability
Under Various scenarios

Step 9
Financing and Operating Plan for Current Year

Steps 1, 2: Analysis of Fundamentals

The corporate financial system is driven by the goals, business unit choices and strategies, market conditions and the operating characteristics....
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