THE FINANCIAL PLANNING
Significance and Role of Financial Planning:
Finance is the lifeblood of any entity that exists, operates and consumes resources in our society.
Since every resource is valued in terms of money; from a single individual person and domestic household unit to gigantic multinational organizations and even governments, the questions that; what resources are required, how much do they value and from where these resources would be financed; are addressed by all entities through financial planning.
Financial planning helps them identify their planned capital and day to-day expenses to ensure their existence and operations, their planned operational revenues to ensure their sustainability, the extent to which periodic operational revenues will contribute towards the coverage of expenses and how can the deficit, if any, be eliminated or turned into surplus to generate savings to fund capital requirements.
It provides a clear picture of the forecasted inflows and outflows over a short- and long-term horizon and the resultant deficit, if any, which enables strategizing for bridging the deficit.
Financial Planning for Business Ventures:
Although, the entities that are not profit-driven also require financial planning to ensure sustainability and running of their operations but the significance of financial planning for business entities is multifold as business ventures are established with profit motives by their promotors and owners.
Business entities not only target for their operational sustainability but also strive to earn over and above their operational expenses to generate profits for their owners which serve as their return or reward from the venture they established or invested in.
The better the profits, the better the business performance and the more the funds are available for retention for future capital investment and expansion, if required.
Hence, businesses without a financial plan are entirely meaningless for the owners and potential investors who certainly are primarily interested in what profit will the business yield in return for their investment in the business under consideration.
Financial planning gives the business owners a snapshot of the existing state of its affairs, informs them about their short and long-term financial goals through projections and gives them a starting point for developing a strategy and set realistic expectations for business success.
Financial planning is not a one time activity to be done at the commencement of a business. It is an iterative process and is required to be prepared at the start of each year and many a times requires revision at the end of each month for the rest of the year.
Initial and Recurring Business Financial Planning:
Financial plan prepared immediately before the commencement of business forms an integral component of overall business plan which ensures through financial figures that the objectives as delineated in the business plan are attainable from financial standpoint and hence, validates the business plan. It, moreover, enables setting financial targets and developing compensation packages for employees tied with business performance through achievement of those financial targets.
Since, business plan envisages planned goals and activities over a long term horizon of around 10 years, financial plan also covers a horizon of around the same period.
Financial plan that is prepared at the beginning of each year is termed as annual budget (usually the ‘master budget’ which is prepared after consolidating individual budgetary components) that attaches estimated monetary values with envisaged activities of the business for the next year and sets the financial targets in terms of revenue, expenses and investment and financing cash flows.
This annual budget then forms the basis of monthly target setting for each business function through which monthly monitoring and control is enabled by comparison of actual performance with the benchmark.
Core Components & Sequence of Financial Planning:
Financial plans, whether developed at the business inception phase or periodically, constitute some key integral components that must be prepared in a systematic sequence to develop a comprehensive, well integrated and robust financial plan. Importantly, assumption set on which entire financial plan is to be structured must be logical, business specific and linked with existing variables/parameters.
- Setting business goals
- Sales/Revenue Projection (Principal Plan Factor)
- Projected Profit & Loss Statement
- Projected Balance Sheet
- Projected Cash Flow Statement
- Financial Analysis
- Monitoring and Control
Setting Business Goals:
What business wants to achieve over the period as envisioned in the business plan will be expressed in terms of overall SMART (Specific, Measurable, Attainable, Realistic and Timely) goals.
Goal setting is the pre-requisite to financial planning and serves as the first component of the financial plan. Goals defined by the pertinent stakeholders set the tone for the entire financial plan and forms the base for setting financial targets.
Sales/Revenue Projection (Principal Plan Factor):
Once the goals are set, sales will be the principal plan factor (the principal target) to steer the business towards achievement of those goals.
Sale volume and price forecasting of individual product/service/brand will be done and consolidated to develop yearly sale revenue forecasts.
Inflationary and other macro economic impacts including seasonal fluctuations will be incorporated while developing sales forecast.
Projected Profit & Loss Statement:
Sales forecast will quantitatively define how much business wants to earn in the long run and will accordingly enable the planning and forecasting of required activities to achieve the sales target and expenses associated therewith.
This forecast will also form the basis of projecting required capital assets and required capital financing over the planned horizon and their associated impact in terms of interest and depreciation will be incorporated in the projected profit and loss statement.
Jurisdictional taxation impact will be incorporated to finally compute profit after taxation which will be considered as the projected return available for shareholders.
This projected profit can either be fully or partly reinvested back into business to finance future growth prospects depending upon the planned dividend distribution and profit retention policy of the business.
Assumptions of inflation, taxation, etc. should be reviewed and carefully finalized for each year of projection to make the plan robust and realistic.
Projected Balance Sheet:
Projected financial performance of each year and future expansion plan of the business will form the basis of projecting capital expenditure plan and the sources of finance that will be utilized to fund the same.
Quantum and estimated amount of capital expenditure per year over the planned horizon will be projected and the capital structure will be estimated addressing how much of the capital will be financed through debt and equity and the extent of financing that will be available through internal profits each year.
Estimated working capital investment along with short term financing projections to support working capital requirements will be computed for each year.
Again, investment and financing assumptions and estimated
inflationary impacts must be logical and convincing. The amount of estimated cash and bank balances as at the end of each year of horizon will be computed based on the projected cash flow statement.
All these components will be consolidated to prepare projected Balance Sheet as at the end of each financial year over the planned horizon.
Projected Cash Flow Statement:
Projected cash flow statement of each year will compute estimated cash and bank balances at the end of each year of business.
It also helps the management in doing future cash flow management of the business. Increase/decrease in cash and cash equivalents for each year is projected and adjusted to opening balance of that year to compute the closing balance of each respective year.
Based on figures and workings incorporated in projected profit and loss statement and balance sheet, increase/decrease in cash and cash equivalents for each year will be estimated from each; operating, investment and financing activities.
Projected cash flows from operating activities are usually estimated by adjusting projected profit before tax with non-cash items, working capital changes and projected taxation payments for the year.
Projected cash flows from financing activities include cash flows associated with raising finance, debt servicing and dividend payments.
Projected cash flows from investing activities include cash flows associated with planned purchase or disposal of fixed assets and other miscellaneous planned investments and associated disposals.
Financial Analysis based on projected financial statements:
Once you have projected and prepared linked financial statements for the projected period, financial information/variables included therein can be used to prepare different analyses including horizontal/trend analysis, vertical analysis (common-sizing), financial ratio analysis (activity, profitability, liquidity, financing, etc.), breakeven analysis, etc.
These analyses help develop a better picture of projected financial strengths and weaknesses, performance and activity and in evaluating the possibility of achievement of targets set for the years over the planned horizon.
Monitoring and Control:
Preparation of financial plan is followed by monitoring and control phase during which actual results are compared with the results as forecasted in the plan and revisions are made, wherever possible, in face of substantial change in circumstances based on which the plan was originally developed.
As mentioned earlier as well, financial plan so developed serves as benchmark with which actual results can be compared when years are actualized so that significant deviations can be investigated and corrective measures can be taken to ensure control.
Financial experts, preferably Chartered or Public Accountants, are the preferred individuals to be taken on board to prepare financial plans for the business.
For ongoing budgets, Chief Financial Officer of the business leads this activity after input is provided by all the concerned departments of the organization.
Financial plan, if strong and realistic, can serve as a robust guide for future decision making.
Poor financial planning, on the other hand, can lead to financial adversities, can hinder overall growth of your business and can even be a main ingredient in resulting into possible collapse of your business in future.
Therefore, disregarding the significance of financial planning in helping the management in steering the future performance of the business can have irreparable repercussions.