– CORPORATE FINANCE SIMULATION
FINANCESIM is a computerized business simulation in which the decisions are primarily related to working capital management and capital budgeting. In making these decisions participants reinforce concepts, use tools, and put to practice models and techniques learned in financial management courses.
Models and techniques applied are related to the time value of money, financial analysis, financial statements projection, working capital management, financial leveraging, capital budgeting, and risk analysis. Participating students need to have a working knowledge of Excel.
The students, grouped in teams, managed
the firm for a number of weeks. The firm manufactures and sells three different
products, each with different prices, margins, and cost structures. Major decisions
made in the simulated firm correspond to the area of finance. Decisions are
made also in the areas of operations and marketing, most of them related to
Decisions include requesting short-term and long-term loans, purchasing and selling CDs, issuing bonds and stock, recalling bonds and repurchasing stock, and distributing dividends. In addition they have to forecast liquidity needs and earnings. After each simulation round, performance reports evaluate their forecast accuracy and their profitability.
To simplify the analysis and decision making process and to make learning more effective, decisions can be implemented sequentially starting with few and simple decisions. Students receive detailed instructions before each simulation round. After each round, reports and financial statements are made available to the students and the professor. The student manual is online and the outputs are in Excel format.
The simulation is entirely administered through the Web. Students enter their decisions and download their reports in the simulation website. Course professors have access to weekly instructor’s report and don’t need to get involved in the operation of the simulation. Students receive technical support from ASD Business Simulations.
Each group consists of two to five students. Up to twenty groups can participate in FINANCESIM. The simulation can last up to twelve weeks, each week simulating a quarter. The cost is $25 per student. Manuals and additional instructions are provided in our Web site.
The firm funds its operation through short-term loans, long-term loans, bonds and stock. The firm can also make short-term investments in CDs and can distribute dividends and repurchase stock.
In the area of finance the firm can request 90-day and one year loans. There is the possibility of funding from customers through price discounts for prompt payment and from suppliers using trade credit.
In the long run the firm can obtain funding through 5-year loans and 10-year bonds. It is possible also to issue common stock.
The firm can invest in 90-day, 270-day, and 360-day certificates of deposit. It can also pay in advance its loans, sell CDs before maturing and redeem in advance its outstanding bonds. Finally, it can also distribute dividends and repurchase stock from its shareholders.
Financial decisions can be subject to a transactions cost in the form of fixed and variable fees. Fees are charged for obtaining and prepaying loans, for issuing and repurchasing stock, for selling certificates of deposit, and for issuing and calling bonds. This feature is usually implemented after students are comfortable working with interest-only loans and certificates of deposit.
FinanceSim considers plant expansion through the purchase of additional equipment for each of the products it manufactures. Equipment can also be replaced with units operating a lower operating costs, but higher initial investments. Equipment costs vary as a function of the additional production capacity sought. This information together with the historical information on sales and competitors’ plans becomes an important variable in evaluating plant expansion projects. Existing equipment can be sold at a discount from its book value.
In the area of marketing participants can set prices and promotional expenditures for each of three products that the firm manufactures. Volume responses for changes in prices and promotional expenditures and the degree of competition can be controlled. These decisions are usually implemented in the last rounds of the simulation in order to focus student attention on financial decisions in the first rounds.
A decision related to finance, as mentioned before, is the possibility of giving discounts when customers make prompt payments in their purchases. However, in order to lower the complexity of the analysis, this decision does not impact the demand each firm faces.
In the area of operations participants can order production. A decision related to finance is the selection of supplier of raw material for each product. There are two suppliers for each product: one collects sales proceeds in the same quarter the raw material is purchased; the other gives a 90-day credit and charges a different price.
Different storage cost for each product influences the production decision. Management of this variable requires evaluation from a financial point of view.
Production decisions are usually implemented after students have built a financial model in which prices and sales volumes are known with certainty. This restriction makes them focus on their financial model since any error in their financial projections is not due to variability of sales, but dependent on the correctness of their financial model.
One additional characteristic of the simulator is that participants, concurrently with their decision making, can be required to make forecast of cash balances, profits, and sales. In processing the decisions, the simulator compares the forecast to the actual values and generates forecasts errors. The requirement to enter forecasts can also be implemented progressively.
After processing the decisions the simulator generates reports for each participating firm. These reports contain a sales report, an income statement, a balance sheet, and a cash flow statement. It also contains footnotes with details on all the items that appear in the financial statements. It also includes cost and profit analysis for each product and selected forecasts for the following quarter.
The instructor also receives a report containing summarized information on participant decisions and main items from the financial statements. It also includes a table with a rank of firms according to different evaluation criteria. The instructor can control the points assigned to each criteria. Output reports have an Excel format.
THE SCENARIOS – ADVANCED USERS
An additional feature of FinanceSim is that the instructor can request different scenarios before the simulation begins. He can determine the size of the firm in terms of assets and sales, its capital structure and the level of profits at the beginning of the simulation. By way of determining its size, its financial structure and its profits, it determines also its beginning liquidity and profitability, assets utilization, and debt ratios. These variables combined with the economic environment may determine the future financial performance and financial condition of the firms.
As mentioned before, the instructor can determine the degree of response of sales volumes to the change of prices and promotional expenditures. In determining this response the instructor determines also the degree of competition.
Future behavior of fixed and variable costs, as well as equipment costs and selling prices can be defined by the instructor. Finally, fees for financial transactions can be also modified. All this has an impact on future profitability.
In the aspect of economic environment, the instructor can define the behavior of the economic variables that will have an impact on market sales and funding. He can determine the level sales growth, price and cost inflation and the interest rate for each financial instrument.
Participants receive at the beginning of the simulation historical information encompassing market sales volumes and prices together with information about macroeconomic variables: GDP, inflation, and interest rates. This allows them to detect trends and develop strategies for funding, production, investments, and sales. This information is usually used when participants begin to set prices and expenditures in promotion.
FINANCIAL MODELING AND FINANCESIM
Participating in FinanceSim is an opportunity for students to improve their Excel skills. Having to forecasting liquidity and earnings requires them to build a financial model to be able to make accurate forecasts. This is an opportunity for them to improve their modeling skills in Excel.
The fact that forecasts and decisions are implemented gradually determines that students also develop their financial models gradually. As the decisions increase in number and complexity the need to rely on more refined ways to project financial statements also increases. Formulas become more complex and more Excel functions are used. This enhances the overall learning process.
It is recommended that decisions and forecasts are implemented gradually, increasing the number and complexity of the decisions as the simulation progresses, quarter after quarter. In a typical decision schedule the first decision usually involves projecting short-term funding needs. The second decision requires projecting earnings; the third one, deciding on whether to use trade credit or a bank loan.
The fourth decision requires participant to decided extending price discounts for prompt payment. Up to this round of decisions, production and marketing decisions have been automatic to allow students to concentrate on short-term funding decisions and in building their financial model in Excel. The fifth decision is about setting production orders under uncertain sales conditions.
The sixth decision allows participants to consider replacing equipments with equipments of different price and productivity. Since this requires decisions that will have long-term effects, students are allowed to make any decision other than pricing and expenses in promotion. Starting in the seventh decision students are allowed to make any decision in the following quarters including pricing and setting promotional expenditures. Decisions are cumulative: once a decision is required or allowed in a certain quarter, it is required or allowed in the following quarters.
FINANCESIM has been developed by
Fernando E. Arellano. He holds an MS degree in Business and a Ph.D. in Economics