Module 2 Financial Management

MODULE 2
Financial Planning

Performing Financial Planning is critical to the success of any organization. Usually, a

company creates a Financial Plan immediately after the vision and objectives have been
set. It is the task of determining how a business will afford to achieve its strategic goals
and objectives.
The Financial Planning activity involves the following tasks:

• Assess the business environment.

• Confirm the business vision and objectives.
• Identify the types of resources needed to achieve these objectives.
• Quantify the amount of resource (labor, equipment, materials).
• Calculate the total cost of each type of resource.
• Summarize the costs to create a budget.
• Identify any risks and issues with the budget set.

Financial Planning provides the Business Plan with thoroughness and objectivity, by
confirming that the objectives set are achievable from a financial point of view. It also
helps the Chief Executive Officer to set financial targets for the organization, and reward
staff for meeting objectives within the budget set.

The role of financial planning includes three categories:

1. Strategic role of financial management.

2. Objectives of financial management.
3. The planning cycles.

When drafting a financial plan, the company should establish the planning horizon,
which is the time period of the plan, whether it is on a short-term (usually 12 months) or
long-term (2–5 years) basis. Also, the process of aggregation is done for the individual
projects and investment proposals of each operational unit within the company and totaled
and treated as one large project.
Financial Planning - Definition, Objectives and Importance

Definition of Financial Planning

Financial Planning - is the process of estimating the capital required and determining its
competition. It is the process of framing financial policies in relation to procurement,
investment and administration of funds of an enterprise. It ensures effective and adequate
 financial and investment policies.

Objectives of Financial Planning

1. Determining capital requirements – Capital requirements have to be looked at with both

aspects of short-term and long-term requirements. This will depend upon factors like cost
of current and fixed assets, promotional expenses and long-range planning.
2. Determining capital structure - The capital structure is the composition of capital, i.e., the
relative kind and proportion of capital required in the business. This includes decisions of
debt to equity ratio, both short-term and long-term.
3. Framing financial policies - with regards to cash control, lending, borrowings, etc.
4. A finance manager ensures that the scarce financial resources are maximally utilized in
the best possible manner at least cost in order to get maximum returns on investment.

Importance of Financial Planning

Financial Planning ensures effective and adequate financial and investment policies. The
importance can be outlined as:

1. Adequate funds have to be ensured.

2. Financial Planning helps in ensuring a reasonable balance between outflow and inflow of
funds so that stability is maintained.
3. Financial Planning ensures that the suppliers of funds are easily investing in companies which
exercise financial planning.
4. Financial Planning helps in making growth and expansion programs, which helps in long-run
survival of the company.
5. Financial Planning reduces uncertainties with regards to changing market trends which can be
faced easily through enough funds.

Financial Planning helps in reducing the uncertainties which can be a hindrance to

growth of the company. This helps in ensuring stability and profitability in concern.

Financial planning is almost as important as setting up a business. This is a necessity for

any business belonging to any industry. Not all businesses adopt financial planning,
especially small businesses who have a limited budget to spend. However, financial
planning is important for the overall functioning of a business. It is almost impossible for
an organization to function and be financially stable without confiding in some sort of
financial planning.

Not all businesses are able to achieve success; one reason of this can be the lack of
financial planning. There is an urgent requirement for businesses to leverage the benefits
 of financial planning.

Here are some reasons why financial planning is important for a business:

1. Judicious Usage of Funds

A smart and powerful benefit of planning a financial program is judiciously utilizing all
the funds that you have. This can be done by looking at all the assets and liabilities of a
business. Planning well in advance all the taxes that an organization is liable to pay,
overheads, expenses, salaries, miscellaneous expenditure etc., will give you a good idea of
how to manage your funds.
2. Long-Term View
With sufficient financial planning, businesses can have a clearer long-term view of their
allocation of funds. Analyzing and deploying funds to various departments of your
business can have a positive effect in the long run. Financial reports give deep insights
into the functioning of a business.
3. Marketing Strategy
Business marketing strategies give well-framed tasks for a business, starting with
strategizing, executing and implementing. Planning your finances well will help your
business to identify the important strategies that need to be implemented. The actions that
you plan for your business should be measurable and should be able to generate more
business.
The marketing team of your business may be experts at creating campaigns, knowing all
the possible areas of marketing that are working wonderfully well and those which need
some improvement. However, in the end, it all comes down to the financial advisors who
will then research and use statistics and reports to analyze if investing such amount in a
particular strategy is even worth.

4. To Measure Liabilities and Assets

Who monitors the assets and liability of a business? What is the ratio of liabilities and
assets for your organization? For the stability of a business, the financial team regularly
monitors the assets and liabilities of a business.

5. Measuring Profit and Loss

The reports compiled by the finance team of the organization often helps to evaluate the
profits and loss of the organization. Furthermore, these help the business to evaluate
which strategy worked well for your business. This showcases the net profit a company
managed to achieve and what was the prime reason for it.

The Financial Planning Process

 The following steps make up the Financial Planning:

1. Establishing and defining the client-planner relationship – The financial planner explains
or documents the services to be provided and defines his or her responsibilities along with
the responsibilities of the client. The planner explains how he or she will be paid and by
whom. The planner and client should agree on how long the relationship will last and on
how decision will be made.
2. Gathering client data and determining goals and expectations – The financial planner asks
about the client’s financial situation, personal and financial goals and attitude about risk.
The planner gathers all necessary documents at this stage before giving advice.
3. Analyzing and evaluating the client’s financial status – The financial planner analyzes
client information to assess current situation and determine what must be done to achieve
the client’s goals. Depending on the services requested, this assessment could include
analyzing the client’s assets, liabilities and cash flow, investments or tax strategies.
4. Developing and presenting the financial planning recommendations and/or alternatives –
The financial planner offers financial planning recommendations that address the client’s
goals, based on the information the client provided. The planner reviews the
recommendations with the client to allow the client make the informed decisions. The
planner listens to client concerns and revises recommendations as appropriate.
5. Implementing the financial planning recommendations – The financial planner and client
agree on how recommendations will be carried out. The planner may carry out the
recommendations for the client or serve as a ―coach‖, coordinating the process with the
client and other professionals such as attorneys or stockbrokers.
6. Monitoring the financial planning recommendations – The client and financial planner
agree upon who will monitor the client’s progress toward goals. If the planner is involved,
he or she should report to the client periodically to review the situation and adjust
recommendations as needed.

Factors Affecting Financial Planning

Financial planning of a business is determined by the following factors:

(i) Objectives – Objectives of financial Planning should be consistent with the overall
objectives of the business. The main objectives of financial planning are to raise funds at
reasonable cost and utilize them in the best possible manner.

(ii) Requirements of the Enterprise – A good financial plan should take care of the present
and future requirements of the business. Provision of or various contingencies,
replacement of assets, and growth and diversification of business enterprise must be
made.
 (iii) Economy - Case of raising capital should be reasonable. Capital structure should be such
as to create an appropriate balance between the cost of funds and the company’s ability
to pay.

(iv) Solvency and Liquidity – The funds should be invested in those ventures which are
likely to give sufficient return on investment. Moreover, adequate cash should always be
available to meet the requirements of the enterprise. The enterprise should be solvent and
liquid not only in the short-term but also in the long-term.

(v) Flexibility - Financial planning should ensure flexibility to allow the diversion of funds
into more profitable channels. It should also make provision for raising of additional
funds at a short notice.

(vi) Optimum Capital Structure - There should be proper capitalization of the company. An
optimum mix of equity shares, preference shares and debentures should be kept in mind
while raising funds from different resources.

Estimating Financial Requirements of a Firm

A forecast of financial requirements is the core of accounting and financial decision in a

firm. There are three methods of projecting financial requirements.

1. The simple traditional method of approach to forecasting financial requirements indicates a

firm’s needs in terms of the number of days for which its sales are tied up in an individual
balance sheet item. It is a tie-in between forecasting sales and forecasting financial
requirements.

2. The second method involves an engineering analysis, which is a combination of technical

know-how and judgment.

3. The third method involves an operation analysis which is not necessarily technical in nature
and which relies mainly on judgment and on an understanding of the kinds of operations
in which a firm is engaged.

Factors to be considered while estimating financial requirements:

1. Cost – The cost of finance is an obvious consideration. Cost should be the minimum.
2. Repayment Date - Due regard should be given to the period time for which finance is required.
A scheme should be drawn up which fixes the repayment date of the debt.
3. Liquidity - Liquidity is an important consideration, as liquidity may lead to insolvency.
4. Interest Payment – Heavy interest charges are embarrassing and should be kept at the desired
level.

5. Claim on Assets – Borrowings may result in a charge on the assets and thus restrict their use.
This may seriously impair the maneuverability of the enterprise.
6. Control – Control is an important consideration for interference is likely to be increased if
many people are allowed to control the company.
7. Risk – It is better not to launch risky projects, particularly if equity finance is not available to
the desired extent.
8. Availability – Financial Planning can be affected only when finance is available.
9. Seasonality – Financial requirements influenced by seasonality or growth cannot be easily
anticipated. There are, moreover, unpredictable event strikes, product failure, changes in
the supply price, and changes in technology or consumer tastes, which significantly affect
financial requirements.
10. Requirements – The financial manager should estimate the financial requirements of his
firm before he decides whether adequate finance is available. For this purpose, he should
consider marketing, production and accounting estimates of reserve and costs, as these are
the starting point for financial planning purposes of promotion.
11. Cost of Initial Promotional Outlays – These include the cost of the development of a
product or a process, the cost of market surveys, legal and incorporation expenditure,
outlays on preliminary contract, if any, and compensation for promotion.
12. Fixed Asset Needs – Fixed Assets need should be based on estimates supplied by the
production and engineering departments.
13. Current Assets – Current asset needs should be assessed on the basis of estimated sales
and production schedules or projections. Cost budgets and inventory estimates should be
prepared and customer trade terms should be fixed.
14. Distribution Outlays – Distribution outlays should be estimated on the basis of the
distribution system to be adopted by an enterprise. For this purpose, the advertising
commission of the intermediaries etc. should be taken in to account.
15. Gestation Period – Funds are needed to absorb initial operating losses during the gestation
period of an enterprise. It may be some time before it reaches the break-even point or pay
its own way.
16. Margin of Safety – Contingent funds should be provided for a margin of safety to take
care of inaccurate projections or unforeseen events.
17. Need for Additional Funds – Financial forecasting involves the relation of sales to asset
and liabilities. The financial manager should be able to anticipate the need for additional
funds on the basis of projected income statements, projected balance sheet, cash budgets,
statements of sources and uses of funds and such other tools of financial forecasting.