Financial planning means deciding in advance how much to spend, on what to spend according to the funds at your disposal.
In the words of Gerestenbug financial planning includes:
(i) Determination of amount of finance needed by an enterprise to carry out its operations smoothly.
(ii) Determination of sources of funds, i.e., the pattern of securities to be issued.
(iii) Determination of suitable policies for proper utilisation and administration of funds.
(a) The financial planning begins with determination of total capital requirement. For this the finance managers do the sales forecast and if the future prospects appear to be bright and expect increase in sale, then firm needs to increase its production capacity which means more requirement of long term funds. Higher level of production and increase in sales will require higher fixed as well as working capital.
(b) After estimating the requirement of funds the next step of financial planning is deciding how to raise this finance. Finance may be internally generated by the business or capital may have to be raised from external sources such as equity shares, preference shares, debentures, loans, etc.
(c) Financial planning is broader in scope as it does not end by raising estimated finance. It includes long term investment decision. In financial planning finance manager analyses various investments plans and selects the most appropriate. Finance managers make short term financial plan called budgets.
Objectives of Financial Planning:
Financial planning is done to achieve the following two objectives:
1. To ensure availability of funds whenever these are required:
The main objective of financial planning is that sufficient fund should be available in the company for different purposes such as for purchase of long term assets, to meet day-to- day expenses, etc. It ensures timely availability of finance. Along with availability financial planning also tries to specify the sources of finance.
2. To see that firm does not raise resources unnecessarily:
Excess funding is as bad as inadequate or shortage of funds. If there is surplus money, financial planning must invest it in the best possible manner as keeping financial resources idle is a great loss for an organisation.
Financial Planning includes both short term as well as the long term planning. Long term planning focuses on capital expenditure plan whereas short term financial plans are called budgets. Budgets include detailed plan of action for a period of one year or less.
Importance of Financial Planning:
Sound financial planning is essential for success of any business enterprise. Its need is felt because of the following reasons:
1. It Facilitates Collection of Optimum Funds:
The financial planning estimates the precise requirement of funds which means to avoid wastage and over-capitalization situation.
2. It Helps in Fixing the Most Appropriate Capital Structure:
Funds can be arranged from various sources and are used for long term, medium term and short term. Financial planning is necessary for tapping appropriate sources at appropriate time as long term funds are generally contributed by shareholders and debenture holders, medium term by financial institutions and short term by commercial banks.
3. Helps in Investing Finance in Right Projects:
Financial plan suggests how the funds are to be allocated for various purposes by comparing various investment proposals.
4. Helps in Operational Activities:
The success or failure of production and distribution function of business depends upon the financial decisions as right decision ensures smooth flow of finance and smooth operation of production and distribution.
5. Base for Financial Control:
Financial planning acts as basis for checking the financial activities by comparing the actual revenue with estimated revenue and actual cost with estimated cost.