Financial Planning – Definition, Objectives, and Importance
Definition of Financial Planning
“Financial planning is a statement estimating the amount of capital and determining its composition”.
If you are serious about attaining financial independence you most likely do what many financial gurus say e.g. you save your money, have a budget, live below your means, look for ways to increase your income and so on. These ideas are not just for individuals but are also a must-do for any organization if it’s to remain afloat and manage its money well. Financial planning for an organization is the process of determining how they will fund their activities to ensure they meet their strategic goals and objectives.
In the financial plan, activities are matched with the resources, equipment, and materials needed for it to be achieved and a time frame is also listed. Financial planning confirms to a business that what it has set out to achieve is possible to form a financial point of view. It sets out in advance, according to your cash reserves and future expected earnings, how much to spend and what to spend it on.
How to Do Financial Planning
1. Determine The Total Capital Requirements For a Business
Financial planning is usually done by the business financial manager. The financial manager first looks at the business environment they operate in, this will tell him/her how the sales performance of the business will look like in the coming months or years. If the sales are to take an upward trajectory he needs to plan for that. The business will need to increase its production to meet increasing sales so funds for this need to be sourced and allocated.
2. Work Out How to Raise and Allocate the Money Required
After getting to know how much money is required by the business the next step is getting the funds. The business can either use its own reserves, revenue for the growth or source for funding externally. External sources could include the sale of company shares, bank loans, debentures, etc. Once the funds are available suitable policies for proper utilization and administration of the money must be followed.
3. Financial Planning Doesn’t Stop After Raising Funds For The Business
A financial manager also has to look at various investment opportunities and determine if they make business sense to go into. Create a financial plan is both short and long-term. In the short term you come up with budgets which detail how the money will be spent over a period of one year or less, long-term you focus on a capital expenditure plan.
Objectives of a Financial Plan
They are two key objectives financial planning seeks to address:
1. Ensure a Business Has Funds to Smoothly Run Its Operations
Whether it is the purchase of a long-term asset, day to day expenses a financial plan shows how a business will meet these requirements. It outlines how the money will be earned and used to ensure funds are always available when needed.
2. Avoid Unnecessary Raising of Resources
Financial planning lets you know how much money you need to inject into the business for it to grow. If you don’t know what you require you might spend a lot of time and money raising resources you don’t need, which is not good. With a financial plan, you have a clear picture of what capital is enough so you don’t raise excess. However, should you have a surplus financial planning dictates that that money be spent on a profitable venture instead of lying idle?
Importance of Financial Planning
- For Optimum Fund Raising
As I have already mentioned as a business you don’t want to have fewer funds this will hamper your operations negatively. So, to avoid under or overcapitalization does financial planning, it will tell you how much capital you need.
- Determine Capital Structure
Organizations raise short, medium, and long-term funds from various sources. When doing a financial plan, you will determine how to raise the money for the various stages. Generally, long-term funds are contributed by shareholders, debenture holders, for the medium-term business look to financial institutions while for short-term commercial banks.
- Helps in Financing the Right Projects
Because financial planning looks at the company spending you can choose the best investments which guarantee the best return on investment. You will be able to choose this given that as you come up with the financial plan you will be comparing the various investments proposed.
- Give Investor Confidence
If somebody is to invest in your business they definitely what to know that you understand what you are doing. Ensuring that your business does financial planning will make it easier for you to attract investors. If they ask for the numbers you can give them that and not guessing things when they ask the tough question.
- Helps You Survive Turbulent Times
Remember I told you the first step to financial planning is studying your business environment. Because you had already anticipated and determined your financial requirements the business will be able to manage shocks better than if it didn’t have a financial plan. One thing financial planning does is ensure you have cash reserves which you can use in bad times.
- Links Present and Future
Financial planning outlines what is required now so as to achieve growth in the future i.e. this is the sales numbers we need to be able to achieve this level of growth in 2years.
- Helps in Operational Activities
Succeeding or failing in the production or distribution process largely depends on financing decisions. If proper financial plans are not made, for example, you have not put good plans to pay for trucks maintenance and serving of machinery, the smooth working in this department will be disrupted which only means one thing losses for your business.
As you can see financial planning is an integral part of any business. It is not just individuals who need financial planning even multi-nations do. If you are not already doing it starts today for the better financial management of your business.