Financial planning is the crux of life. It is the bridge between understanding our needs and our wants. You do not necessarily need everything you want and you must have the astuteness to understand the difference between the two in order to secure your future. Children are taught the importance of financial planning right from the time they begin earning their pocket money. This habit of saving money from an early age and spending it only when necessary comes in handy, especially when businesses are set up and there is a constant requirement of cash flow. No aspect of running a business (or life, for that matter) takes as much precedence as planning your finances does. Let’s understand the objectives and importance of this virtue for the success of any business or organization.
Financial Planning – Definition
Financial planning in businesses is the process of estimating or approximating the capital required to run the business while determining its competition. The process involves framing important financial policies related to procurement of the finances, investing the procured finances and administering them in the enterprise. Simply put, financial planning means determining in advance what to spend on and how much to spend on in accordance to the funds available at your disposal.
The creation of the plan for finances, in any business is necessary as it helps the entrepreneurs and investors see the bigger picture and determine short and long-term goals, which is a significantly crucial step in charting out the financial future of a business. A plan for allocating finances also aides businesses in making financial decisions and helps them stay on track with their goals.
Financial planning at an organization level – what it includes
Financial planning at an organization level includes the following
• Determining the amount of money required by the organization to ensure operations are carried out smoothly
• Determining the source of funds or the patterns of securities that must be issued
Determining appropriate policies to utilize and administer the funds accurately
The first step in financial planning is to determine the total capital required. Finance managers conduct a sales forecast. If there appears to be bright future prospects coupled with an increase in sales, then the firm must increase its capacity for production for which more funds may be required in the long term. Higher levels of productions coupled with a boost in sales require higher fixed and working capital.
After estimating the fund requirement, the next step is to determine how finances can be raised. Finances can be generated internally by the organization or capital can also be raised from external sources like equity shares, loans, preference shares, debentures etc. But the scope of financial planning is broader and does not end with raising finances. The entire exercise includes long term decisions for investments. Finance managers must analyse several investment plans and select the one which best suits the business. Short term financial planning or budgeting is extremely crucial.
Objectives of financial planning
There are two main objectives of financial planning
Ensuring availability of funds when required: Sufficient funds should be accessible in the company for various purposes like purchasing long term assets and meeting day-to-day expenses. Ensuring timely availability of finances is highly critical as is specifying the source of the finances.
Ensuring that resources are not raised unnecessarily: Just like shortage of funds can be damaging, so can excess funding be bad for the business. If a business has surplus money, the finance manager must invest it in the most appropriate manner as leaving the financial resources idle could be of great loss to the business. Both short and long term planning should be included. While the latter focuses on capital expenditure plan, the former helps in budgeting which includes detailed plans of action for a single financial year or less.
Significance of financial planning
Financial planning contributes majorly to the success of any business enterprise. The need for it is felt owing to the following reasons.
Financial planning helps fix the most suitable capital structure: Finances can be raised from different sources and can be budgeted according to short, medium and long term. Planning finances is important for tapping the appropriate sources at appropriate periods of time. Short term funds are generally raised from commercial banks, while long term funds are contributed by debenture holders and shareholders.
It aids operations: The success or failure of the process of production and distribution is linked with financial planning. Right decisions of planning the finance can ensure smooth flow of the funds and a smooth operation of production as well as distribution patterns.
It aids in investing finances in suitable projects: Financial planning can suggest how the funds should be allocated for different purposes. This is done by comparing different investment proposals.
It is the base of financial control: Planning the finances serves as the basis for checking an organization’s financial activities by comparing the actual and estimated revenues with the actual and estimated costs.
Planning finances enables optimal fund collection: Planning finances allows enterprises to estimate the exact amount of funds required due to which wastage and over-capitalization situations can be avoided.
It is the link between investments and financial decision:Financial planning helps determine the debt/equity ratio and assists in making the right decisions for investing the funds. It thus creates a link between these two crucial decisions.
It helps evade business shocks or surprises: By anticipating the required finances, financial planning helps businesses evade any surprises or shocks which may come their way. It prepares the firms in facing uncertain situations.
It assists co-ordination:Financial planning assists the co-ordination of various functions of the business like production, operations, sales, re-investments etc.