What is Financial Planning ? | Types, Principle, Steps, Advantages and Disadvantages (2024)

What is Financial Planning ?

Financial planning is concerned with making optimal decision and anticipating the result of such decisions. It also carries out control function which compares the actual performance with the planned one.

Financial planning is one of the most important steps taken by a company. This step is taken right after the corporation's Inception and setting of vision and objectives of the business. A financial plan detail of various activities to be carried out by the company and resources available for achievement of this set objective within stipulated time. Financial planning is concerned with the determination of strategy objective of the business and the means to achieve them.

Definition of Financial Planning

According to William King :

"Planning is the process of Thinking through and making explicit the strategy, actions and relationships necessary to accomplish and overall objective ".

According to J. H. Bonneville :

"The financial plan of a corporation has two-fold aspects, it prefers not only to the capital structure of the corporation but also to the financial policies which the corporation has adopted or intends to adopt".

According to Walker and Baughn -

"Financial planning pertains to the function of finance and includes the determination of the firms financial objectives, financial policies and financial procedure".

Following are the main takes undertaken by financial planning activity :

Principles of Financial Planning

A sound financial plan must follow this principle in order to be effective :

1) Simple -

A financial plan should be simple so that it can be understood and act as guiding tool to all the concerned parties. However, it should not sacrifice its efficiency for the sake of simplicity.

2) Estimates and Forecasts -

Financial plans use estimate and forecast for designing their strategies. In order to be effective, the plans must have solid basis for projecting these figures as the ultimate efficiency of the plan depends on the accuracy of its estimated numbers.

3) Flexible -

A good financial plan is flexible, In order to keep it relevant, it is important to review of financial plan in consequence of change in circ*mstances. Financial plan should be dynamic and responsive to changing business environment. This flexibility helps to expand and modify the business requirements.

4) Liquidity -

A good financial plan is designed in such a way to ensure that a person has sufficient funds at the time of requirements. Various factors which determine liquidity needs are size for the concern, business cycle and credit standing.

5) Utility -

The main purpose of a financial plan is to make best use of available resources. A good financial plan balance seasonal fluctuations. The financial of this season fluctuation is done through internet, intermediate and external sources. It also strike a balance between fixed and working capital to ensure their optimum utilization.

6) Comprehensive -

A financial plan is required to cover all the bases. It should be able to anticipate potential issues and make provision for them. The plan should arrange for the provisions of fund through internal resources or by rising additional funds.

Steps in Financial Planning

Following steps are required to be taken for the purpose of financial planning

1) Setting up financial objectives -

For effective financial planning, it is imperative to set a financial objectives. This helps in determining the policies and procedures required for the achievement of these objectives. A business should determine both short-term as well as long term plans. Short term plan should be conductive towards the achievement of long-term plans. Objective should be clearly defined for their proper understanding and execution. These plans should also ensure the optimum utilization of funds in a cost-effective manner. Proper financial planning also ensure liquidity for the business which is only possible through proper implementation and of Working Capital Management.

2) Designing Financial Policies -

The second step in the process of financial planning is the formulation of financial policies. The overall purpose of this policy is to determine the sources of funds, procurement, use and control of such funds. Management plays an important role in the designing of financial policies. These policies design the capital structure, determined various types of funding and also look into the methods of distribution of profit financial policies also manage capital including working capital.

3) Formulation of financial procedure -

Financial procedure lay down financial policies in more detailed manner. This procedure enumerate various rules and sub - rules for the implementation of policies. With the help of this procedure employees and workers know their exact work profile. These procedure are required for proper execution of set plans and policies. In order to ensure the achievement of set objectives, proper control measures should also be put in place. Control system compares actual performance with this set standards and finds deviation. The sooner these deviations are found, the easier it is to carry out corrective measures.

4) Developing Financial Plans -

This step involves determination of capital required. For this purpose, proper stock of various assets, including fixed assets and current assets is taken. Other expenses, such as preliminary expenses, are also determined to estimate the funds required. Once fund requirement is qualified, the next step is to determine various sources from which such funds to be procured. This process is known as 'capital structure planning'.

5) Review of financial plan -

Financial planning is a continuous process as financial plans and procedures require periodical review. This process helps in keeping the plan relevant to the changes circ*mstances.

Types of Financial Planning

Financial planning service a very important role for any business. It acts as a blueprint for the business as it determines business objectives and the way to achieve those objectives. This is done by formulating long term as well as short-term financial plans. Formulation of short-term financial plans is important for the overall achievement of long-term financial plans, which is turn are important for the achievement of business objectives.

1) Long-term (Strategic) Financial Plans -

This plan are also known as Strategic financial plan. This plan generally cover the time period of 2 to 10 years. These plans require constant revisions in consequence of changing circ*mstances. Long-term financial plan are generally prepared in conjunction with other long-term plans such as marketing plan and production plans. Together, this plan lead to to the achievement of overall business objectives. Various area covered by these plan our product development activities, evaluation of funds required, procurement for funds, creation of marketing plans and retirement of debts. Such long term plans are generally divided into big sized plans of annual duration.

2) Short-Term (Operating) Financial Plans-

These plans are also known as operating plans. These plans are required to ensure that long-term plans remains on track. Short term plans are developed for the period of 1 to 2 years. Operating plans require sales forecasts and other financial data as input. The main output from short-term financial plans come in the form of various budgets and proforma financial statement.

Short-term financial planning follows serval steps first of all, a sale forecast is made. Based on such forecast, a Production plan is developed. This plan helps to enumerate resources required. These resources are raw material, labour, Capital, Asset and other operation expenses. These estimates are used for designing proforma financial statement and cash budget.

Advantages of Financial Planning

Financial planning is important due to following reasons :

1) Increasing business -

Financial planning helps in increasing the scale of the business as it provide for proper funding as well as operating plans.

2) Easy operations -

A good financial plan is also helps to easy operations. A business is able to work smoothly as all the plans and procedures are hashed out in proper details. Proper control system also allows for early detection of deviations.

3) Proper utilizationof capital -

A good financial plan also allow for proper use of capital including tangible and intangible assets. A proper financial plan ensure that the business is able to access latest technology and machinery as required.

4) Optimum scaling of operations -

Financial planning helps in proper development of the business. It helps in achieving financial as well as operational efficiency. It is also important for recognizing various current and potential issues.

5) Better fund management -

Financial planning helps in proper management of business funds. It also ensure that the firm is able to meet its financial obligations as and when required. It builds the Goodwill of the firm and prevent from over trading situations.

Disadvantages of Financial Planning

Financial planning has certain shortcomings as well, which are as follows :

1) Required Forecast -

A main shortcoming of financial plan is that is required forecasting which is based on assumptions, which are prone to long term or short-term financial plan uncertainty. If assumptions are not solid in Planning based on them is likely to be faulty as well.

2) Management Attitude -

Financial plan require constant update in case of change in circ*mstances. However, a rigid management may ignore such review requirements. Such rigidity may be due to psychological reason. Other reasons are high capital expenditure and fixed costs which may hamper the process of review.

3) Co-ordination HarmonizationIssues -

The successful execution of financial plan requires proper co-ordination harmony between various department. The plan may fail due to lack of co-ordination harmony among the department and units.