What is Financial Planning?
Financial Planning implies the process of identifying the objectives, policies, and procedures to deal with the activities related to the finance of the enterprise. In short, it is all about the procurement of funds in an economical manner and its profitable use. No matter what the size of the organization is, every organization needs it.
So, it involves deciding beforehand the appropriate course of action for managing the finance of the company. It deals with:
- Estimation of total funds to be raised.
- Ascertainment of the form and the proportionate amount of securities issued to arrange capital.
- Defining the policies for the administration of the financial plan.
In addition, financial planning helps to prevent wastage, by coordinating different functions. In the absence of sound financial planning, the organization may face:
- Shortage of funds
- Misapplication of funds
- Inefficient financial management.
Advantages of Financial Planning
- Ensures sufficient capital from different sources for the continuous functioning of the enterprise.
- Facilitates stability of business operations. This is possible by minimizing uncertainty on capital availability.
- Provides liquidity all around the year. This is possible by attaining a balance between fund inflow and outflow.
- Reduces the cost of financing through the best allocation of limited financial resources.
- Facilitates structured exploration of interaction amidst investment and financing decisions.
- Makes certain of the financial viability of the financial plan.
- Brings to light the excess funds available for expansion.
- Ensures financial control
Steps in Financial Planning
Financial Planning involves four major steps:
Establishment of objectives:
The financial planning process starts with defining financial objectives. These objectives must be in alignment with the ultimate of the business. We all know that the capital employed in different firms varies. Still, their objectives are the same. Financial planners need to frame both long-term and short-term objectives. This will help in succeeding in the dynamic economic conditions.
Ascertaining the amount of capital required:
Determination of the capital requirements of the firm is the primary aim. For this purpose, the financial planners estimate both fixed and working capital required. This helps in fulfilling the financial needs of the enterprise.
Determination of Capital Structure:
It involves ascertaining the proportion of different securities, that a firm can raise. And to do so, financial planners need to find out the different securities to be issued. Also, they should determine the proportion to which these securities are to be issued.
Formulation of financial policies:
Financial Policies framed by the firm serve as a guide to various actions. Thus, these policies deal with procurement, management, and distribution of funds.
What is Financial Plan?
Long term financial plan of the firm acts as a sketch of what the company aims to do in the future. Therefore, a plan is usually created for 3-10 years. Indeed, it is usually formulated for 5 years.
Further, it is quite obvious that a plan for such a long period contains fairly aggregative terms.
Types of Financial Plan
- Long Term Financial Plan: Another name for this plan is the strategic financial plan. This is because they are a part of an integrated strategy. Therefore, the period of such plans ranges between 2 to 10 years. It lays down the planned financial actions and also identifies its effect in the long run. In addition, it determines the projected outflow of capital assets.
- Short-term Financial Plan: Alternative term for this plan is operating a financial plan. This is because it covers sales forecasting. Also, it includes different types of operating and financial data. Above all, the period for which a short-term financial plan is created ranges between 1 to 2 years. With the help of these plans, the firm can estimate outflow regarding overheads and direct expenses.
Characteristics of Ideal Financial Plan
- Simplicity: It must comprise a simple financial structure that is easy to implement and manage.
- Long-range view: Formulation of the plan should keep in view the long-term requirements, along with short-term requirements.
- Flexibility: It should not be rigid. It has to be such that the revisions and changes can be implemented, as per the changing needs of the concern.
- Foresight: The formulation of the financial plan requires foresight. In addition, a plan prepared without proper foresight may fail to meet the present and future requirements of funds.
- Optimum utilization: A financial plan should be a balanced one. In other words, neither there is a shortage of funds nor excess funds remaining idle. It must make optimum utilization of funds.
- Contingencies: Proper provisions should be made for contingencies, that may occur in the future.
- Liquidity: The financial plan should give utmost importance to liquidity. In the event of deviations of business operations from the normal course, it acts as a shock absorber.
- Easy to understand: The financial plan should not be complex. Hence, it should be easy to understand and interpret. It should avoid keywords or jargon. Also, it should not create confusion and chaos in the minds of investors and other parties.
Process of Financial Planning
Financial Planning Process begins with the preparation of strategic financial plans. These plans act as a guide for the formulation of operating plans and budgets. Further, these help in the establishing firm’s long-term objectives. The process of financial planning involves six steps which we have discussed hereunder:
Projection of Financial Statements:
The financial statement includes a balance sheet and an income statement. Projection of financial statements is vital to analyze the impact of the operating plan on projected profits.
A firm’s success relies on its ability to find out the deviations from financial plans.
Ascertainment of funds needed:
The second step to this process encompasses anticipation of the funds required. This is important to ascertain the amount to be invested in various fixed assets and current assets.
Forecasting available funds:
There are two sources from where the firm can raise funds for its operation. In this step funds to be raised from internal sources are estimated. This will help in determining the amount to be raised from outside sources.
Establishing and maintaining a control system:
The two main functions of management are planning and controlling. Controlling functions help in checking whether the use of funds is optimum or not.
Development of Procedures:
Consistency in actions is an outcome of the development of procedures. Also, framing of procedures is important with regard to the adjustment of the basic plan.
Establishment of Performance-based management compensation system:
It is important to reward the managers for performing their tasks effectively. As it is the managers who give their best to increase the wealth of the shareholders.
Therefore, are a number of factors that affect the financial plan of the concern. These factors are the nature of the industry, the status of the company, alternative sources of finance, and future plans. Also, it is affected by capital structure, dilution of control, and the magnitude of requirements of funds.