Meaning of financial planning
People often confuse financial planning with financial management but financial planning is just a part of financial management. Financial management is broad; it deals with the different options available for acquiring finance and choosing the best available alternative of the same. It keeps in mind the cost and risk factor and focuses on getting the maximum returns. Main aim of financial management is to improve the financial health of the company by increasing the shareholder’s wealth. Financial planning on the other hand is narrow concept in front of financial management. Financial planning focuses on the fund requirement in an organization and its availability and at the same time ensuring that fund is not wasted by excess availability and non hindrance of the operations because of its shortage.
Objectives of financial planning
Financial planning thus has two main objectives. These objectives are important for survival of the business, decision making and creating financial discipline in the company. These objectives are as under:
Ensuring availability of funds whenever required
Financial planning revolves around the estimation of the funds required. The amount of funds that are required by the firm along with its duration is calculated under the financial planning. It also lists down the possible sources of finance which will be available to fulfil the need of funds in the firm. Estimation of requirement is done on the basis of facts, figures and forecasts done by the competent financial manager. This estimation is regarding either the long term needs of the firm such as purchase of machinery or for short term needs such as current assets or for the day to day operations.
To avoid unnecessary raising of funds
Ideal financing is the goal of financial planning. Shortage of funds is harmful for the business as it creates hindrance in completion of the activities or commitments made by the firm. Similarly, excess funds are also equally harmful because funds come with a cost and excess funds will unnecessarily raise the cost and will not even yield any return. It is quality of a good financial manager to put the idle finance to the best possible use.
Elements of financial planning
There are various elements included in the financial planning which directly help in better planning of the business finance. They are as under:
Determination of financial objectives
There are certain objectives of the business. These objectives are aligned with the main objective of the firm. One of those objectives is financial objective. This objective mainly focuses on three broad categories- financing, investment and dividend. Financing objective of the firm is regarding the quantum of finance to be raised and sources of finance which are available. Investment objective is regarding the investment of the funds raised depending upon the lowest risk, lowest possible cost and highest possible return. Dividend objective involves the decision regarding the earning of the business- how much should be distributed among the shareholders and how much should be retained.
Estimation of capital requirement
Business finance is required by the firm at each level starting from the initial stage of setting up the firm, then for day to day activities and for further investment activities. It is required for getting the resources for the firm such as man, material and machinery. Estimation for these requirements is based the forecast, facts and figures. It can be for short term or for long term. Although, estimating for long term becomes difficult and sometimes useless because of the dynamic environment of the business. Short term estimation is also called budget.
Formulation of financial policies
Financial planning in an organization helps in framing the financial policies. These policies are regarding the borrowing of funds, lending of funds, cash or credit sales, cash or credit purchase of raw material and regarding other financial activities. Such policies help in bringing the financial discipline in an organization by improving the control and coordination.
Importance of financial planning
Planning is defined as the filling up of the gap between the current position and the position we want to reach. Similarly, financial planning helps us reach the ideal position in terms of finance by fulfilling the need of funds as per the requirements and on ideal time. Thus it is very important for any organization. The importance of financial planning is as under:
Preparation for future
Financial planning is the way to predict the future. This prediction is done with the scientifically tested methods such as facts, figures and forecast. This estimation of future needs helps in avoiding the shortage of funds when required which may create hindrance in fulfilling the commitment. This helps the firm in adjusting in various situations of the environment. For example: a business organization may have predicted its profit to be 10% this year but under the change in circumstances, the profit achieved was only 7%, this may lead to different expenses and investment compared to the planned ones.
Avoiding shocks and surprises
Business brings shocks and surprises with it each time when there is any change in the business environment. These changes may affect the business positively or negatively. To be aware and respond in a prepared manner it becomes important for a business to plan for the finance. For example: a firm may have forecasted reduction in cost of the product due to improved technology but suddenly government increased the prices of the raw material and it may lead to shock for a firm.
Helps in coordination
Financial planning helps in formulating the policies and procedures for the business. These policies and procedures helps in bringing the coordination among various business activities. These activities when work according to the policies framed, brings a discipline in the organization which helps in smooth functioning of the organization. It helps in coordinating various departments such as sales and production department will get coordinated according to policy regarding purchase of raw material based on the finance available in the organization.
Reduce waste or duplication
Planning is done for reducing the wastage, if any. Financial planning on the similar lines helps in reducing the wastage of money. Excess finance leads to idle finance in the organization which cannot be used anywhere or is used in an activity which does not yield good return. This excess fund also increases the cost and risk. To avoid this wastage or duplication and to fill the gap, proper planning is required in an organization regarding the requirement of funds in quantity and the time when it is needed.
Helps in taking various decisions
There are various decisions to be taken in an organization related to marketing, production, and sales. These decisions are linked to financial decisions because finance is the blood of the business. These decisions when linked together can be performed efficiently and they give the best results possible. The decisions related to the acquiring the finance, investment to be made and dividend to be distributed are also linked together and affect each other.
Improves administration of the business
Every organization needs finance. This finance when managed properly helps in brining the sound administration in the organization due to its ability of making a sound plan and when everything is going according to the plan then processes become smooth.
Controlling becomes easy
Financial planning starts with making a plan. This plan is based on the scientific analysis of the past performance and forecast of the future position. Financial planning is a quantitative process and thus helps in recording and it is thus easy to refer to the records whenever required for analysis. When the plan is ready and processes are done according to the set plan then it becomes easy to compare the actual results with the pre planned performance and this makes the evaluation easy. This also helps in bridging the gap between the present position of the firm and future position of the firm by taking proper corrective measures.
Financial planning is thus the process in which twin objectives are to be taken care of. First, the proper analysis is to be done of the requirements of the finance in the firm. Second, availability of the funds is to be taken care by properly checking various sources of finance and selecting the best possible sources and bringing the funds whenever required without creating the excess or shortage. Excess and shortage of funds is very harmful for any organization because of the negative results they yield. Financial planning cannot be taken for granted because of the benefits it offers. It helps not only in the present situation of the firm but also helps in avoiding any shocks or surprises by improving the administration of the firm.