This article provides a practical explanation of Financial Planning. After reading, you will have a basic understanding of this powerful financial management tool.
What is Financial Planning?
Financial Planning is a vital part of financial management, and the first task of management itself. Financial Planning is done in every phase of an organisation, in fact, as early as the start-up phase. It involves creating a plan that sets out how much capital and how many resources the company requires. Generally speaking, a forecast is created for the next three to seven years. Larger corporations often employ Financial Planning & Analysis teams, which are responsible for supporting financial partners and achieving optimum financial performance by implementing the right strategies. Financial performance is measured by identifying KPIs with regards to profitability, cash flows, return on capital, and various other statistics and ratios.
Financial Planning also refers to the process of achieving goals, both personal and organisational. The Financial Plan is often drawn up immediately after the company’s vision and mission have been established. These describe what objectives must be achieved and with what resources.
Financial Planning is essential for any organisation. It ensures that the business model can be verified and developed by visualising how organisational objectives are also financially feasible.
Availability and Allocation of Resources
Allocating resources (such as budget) for business purposes is an important aspect of business and non-business financial plans. These can be found in the budget plan, which is usually created once every year. In the budget plan, every department is allocated a certain budget. This amount imposes limitations on development opportunities. If there is less budget available than in previous years, certain jobs may be lost.
A budget is defined as a pattern of expenditure and income over the period of a financial year or project. In general, it is a prediction of potential costs that will be incurred based on figures from previous years. There are various ways of setting up a budget, such as the Beyond Budgeting Model or Zero Based Budgeting. Realistic Financial Planning is key to the implementation and success of a project or process. Moreover, transparent and professional budgeting will also attract investors and other interested parties.
Strategic Management and Financial Planning
Success largely depends on planning, both strategic planning and Financial Planning. These two approaches to planning focus on disparate areas, and therefore differ significantly. Nevertheless, strategic planning has some similarities and links to Financial Planning.
Financial Planning is about managing and allocating resources in such a way that the organisational objectives can be achieved. Strategic Planning, on the other hand, is about shaping the strategy and determining the course that the organisation will take. In other words, both planning methods are about objectives, collection and analysis of data, and adherence to the established plan.
No matter how well a strategic plan is put together, if there are not enough resources, it will be impossible to implement. The budget therefore also largely determines what the available options are. If the budget is not sufficient for option A, but compatible with option B and C, then the final decision will depend on other variables, such as the need for implementation.
In the best case scenario, strategic planning and Financial Planning are always closely intertwined in an organisation. Both are connected in a cyclical way. A change in the budget may also mean a change in the strategy. If the strategy needs adjusting, sufficient money must first be made available.
Necessity of Financial Planning
Although Financial Planning does not receive equal attention within every organisation, it is an important indicator of success—especially for startups. A number of concrete elements show how crucial Financial Planning is:
Optimal Amount of Capital
All organisations want to prevent a lack of resources and having to suspend business operations. In fact, having to shut down a company or project simply because there is not enough money, requires even more money. Financial Planning ensures that exactly enough money is made available to achieve the objectives.
Types of Capital
Companies have different types of capital, from different capital providers. For instance, some loans are for the short term, whereas other funds are for the medium and long term. Long-term funds are often made available by shareholders. Alternatively, commercial banks are often approached for short-term funds.
Trust in Investors
Complete transparency and professionalism when it comes to financial statements helps investors become familiar with the intricacies of an organisation. An organisation involved in Financial Planning will more easily attract investors than companies that are not.
Link between Present and Future
Financial Planning is about how much money needs to be available in order to guarantee future growth. For example, sales targets can be set to achieve the intended growth.
Important tools and documents that are of interest to investors include the financial statements and annual accounts of an organisation. These contain the balance sheet, income statement, and cash flow statements. The annual accounts are checked by specially appointed institutions and accountants. Annual accounts reflect the financial consequences of business transactions and events. In fact, they are an excellent source of insight into inspirations. In other words, they are an important part of Financial Planning. There are a number of statements that are common throughout any organisation.
An organisation’s balance sheet provides an overview of everything the company owns. It shows how much money a company possesses and how it is used. Assets on the balance sheet are all resources a company owns. These are possessions, such as computers, buildings, and cash money. Liabilities refer to a company’s obligations, such as outstanding loans. The equity on the balance sheet is the amount that belongs to shareholders. This is also referred as the shareholders’ funds.
Profit and Loss Account
A company’s profit and loss account shows the total of all profits and losses that a company has made in the past year. In other words, it is a financial tool that is used to determine whether an organisation has made a profit or loss during a certain period. It is also used to determine the amount that a company must pay in income tax.
Cash Flow Statement
The cash flow statement is one of the annual accounts issued by an organisation and describes the cash flows from and to the organisation’s account. Although this annual account is generally considered less important than the profit and loss account, it is often used to distinguish trends in the performance of a company that cannot be directly deduced from other statements. This makes the annual account suitable for Financial Planning.
The cash flow statement is mainly about three types of activities: business activities, investment activities, and financial activities. business activities include: product sales, lawsuits, commissions, royalties, invoices, and salaries. Investment activities include the purchase of assets. Financial activities include the issue of shares and purchase of own shares. Dividend payments also fall under financial activities.
Now it’s your turn
What do you think? Are you familiar with the explanation of Financial Planning? How is Financial Planning implemented in your own work environment? What do you believe are the crucial elements or benefits of Financial Planning? Do you have any tips or additional comments?
Share your experience and knowledge in the comments box below.
- Boyd, B. K. (1991). Strategic planning and financial performance: a meta‐analytic review. Journal of management studies, 28(4), 353-374.
- Rhyne, L. C. (1986). The relationship of strategic planning to financial performance. Strategic management journal, 7(5), 423-436.
- Welsch, G. A., Hilton, R. W., & Gordon, P. N. (1988). Budgeting: profit planning and control. London: Prentice-Hall.
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