What Do You Understand By Financial Planning? Describe The Steps To Formulate A Financial Plan
Financial planning is a process by which funds required for each course of action is decided. It must consider expected business scenario and develop appropriate course of action. A financial plan has to consider capital structure, capital expenditure and cash flow.
Steps in financial planning:
1) Establish corporate objectives: Corporate objectives could be grouped into qualitative and quantitative. For example, a company’s mission statement may specify “create economic value added”. But this qualitative statement has to be stated in quantitative terms such as a 25% ROE or a 12% earnings growth rates. Since business enterprises operate in a dynamic environment, there is a need to formulate both short run and long run objectives.
2) Next stage is formulation of strategies for attaining the objectives set. In this condition connection corporate develops operating plans. Operating plans are framed with a time horizon. It could be a five year plan or a ten year plan.
3) Once the plans are formulated, responsibility for achieving sales target, operating targets, and cost management bench marks, profit targets, etc. is fixed a respective executives.
4) Forecast the various financial variables such as sales, assets required, flow of funds, cost to be incurred and then translate the same into financial statements. Such forecasts help the finance manager to monitor the deviations of actual from the forecasts and take effective remedial measure to ensure that targets set are achieved without any time overrun and cost overrun.
5) Develop a detailed plan for funds required for the plan period under various heads of expenditure.
6) From the funds required plan, develop a forecast of funds that can be obtained from internal as well as external sources during the time horizon for which plans are developed. In this connection legal constrains in obtaining funds on the basis of covenants of borrowing should be given due weight age. There is also a need to collaborate the firm’s business risk with risk implications of a particular source of funds.
7) Develop a control mechanism for allocation of funds and their effective use.
At the time of formulating the plans certain assumptions need to be made about the economic environment. But when plans are implemented economic environment may change. To manage such situations, there is a need to incorporate an inbuilt mechanism which would scales up or scale down operations accordingly.
