Financial Planning

Planning is a systematic way of deciding about and doing things in a purposeful manner. When this approach is applied exclusively for financial matter, it is termed as financial planning. In connection with any business enterprise, it refers to the process of estimating a firm’s financial requirements and determining pattern of financing.

It includes determining the objectives, policies, procedures and programmes to deal with financial activities. Thus, financial planning involves:

  1. Estimating the amount of capital to be raised
  2. Determining the pattern of financing i.e., deciding on the form and proportion of capital to be raised
  3. Formulating the financial policies and procedures for procurement, allocation and effective utilisation of funds

Objectives of Financial Planning

The main objectives of financial planning are:

  1. To ascertain the amount of fixed capital as well as the working capital required in a given period.
  2. To determine the amount to be raised through various sources using a judicious debt-equity mix.
  3. To ensure that the required amount is raised on time at the lowest possible cost.
  4. To ensure adequate liquidity so that there are no defaults in payments and all contingencies (any unforeseen expenditure) are met without difficulty.
  5. To ensure optimal use of funds so that the business is neither starved of funds nor has unnecessary surplus funds at any point of time.

Essentials of a Sound Financial Plan

While preparing a financial plan for any business unit, the following aspects should be kept in view so as to ensure the success of such exercise in meeting the organisational objectives:

  1. The plan must be simple: Now-a-days you have a large variety of securities that can be issued to raise capital from the market. But it is considered better to confine to equity shares and simple fixed interest debentures.

  2. It must take a long term view: While estimating the capital needs of a firm and raising the required funds, a long-term view is necessary. It ensures that the plan fully provides for meeting the capital requirement on long term basis and takes care of the changes in capital requirement from year to year.

  3. It must be flexible: While the financial plan is based on long term view, one may not be able to properly visualise the possible developments in future. Not only that, the firm may also change its plans of expansion for various reasons. Hence, it is very necessary that the financial plan is capable of being adjusted and revised without any difficulty and delay so as to meet the requirements of the changed circumstances.

  4. It must ensure optimal use of funds: The plan should provide for raising reasonable amount of funds. As stated earlier, the business should neither be starved of funds nor have surplus funds. It must be strictly need based and every rupee raised should be effectively utilised. There should be no idle funds.

  5. The cost of funds raised should be fully taken into account and kept at the lowest possible level: It must be ensured that the cost of funds raised is reasonable. The plan should provide for a financial mix (combination of debt and equity) that is most economical in terms of cost of capital, otherwise it will adversely affect the return on shareholders’ funds.

  6. Adequate liquidity must be ensured: Liquidity refers to the ability of a firm to make available the necessary amount of cash as and when required. It has to be ensured in order to avoid any embarrassment to the management and the loss of goodwill among the investors. In other words, the investment of funds should be so planned that some of these can be converted into cash to meet all possible eventualities.

Importance of Financial Planning

  1. It helps to estimate accurate requirement of funds.

  2. It facilitates in developing a sound capital structure which gives maximum returns to shareholders.

  3. It helps in proper utilisation of funds.

  4. It tries to avoid the shortage of funds and surplus of funds.

  5. It provides policies and procedures for coordinating different departments of an enterprise.

  6. It acts as a basis to control the financial activities of an organisation.

  7. It helps to face unforeseen financial situations in the business.