Financial Planning: Steps, Elements, Advantages, Limitations

Financial planning is an important part of financial management. It is the process of determining the objectives; policies, procedures, programmes, and budgets to deal with the financial activities of an enterprise. Financial planning reflects the needs of the business and is integrated with the overall business planning. Proper financial planning is necessary to enable the business enterprise to have the right amount of capital to continue its operations efficiently. So, what we discussing is – Financial Planning: Steps, Elements, Advantages, Limitations.

The Concept of Financial Planning explains their key points into Steps, Elements, Advantages, and Limitations.

Financial planning involves taking certain important decisions so that funds are continuously available to the company and are used efficiently. In this article we Discuss; Financial Planning: Steps of Financial Planning, Elements of Financial Planning, Advantages and Disadvantages of Financial Planning, Limitations of Financial Planning, and Process of Financial Planning.

Steps in Financial Planning:

Financial planning involves the following steps:

These are:

• Set-up Financial Objectives.
• Financial Policies.
• Procedures, and.
• Flexibility.

Now, explain each one;

Set-up Financial Objectives:

The financial objectives of a company should be clearly determined. Both short-term and long-term objectives should be carefully prepared. The main purpose of financial planning should be to utilize financial resources in the best possible manner. There should be an optimum utilization of funds. The concern should take advantage of the prevailing economic situation.

Financial Policies:

The financial policies of a concern deal with procurement, administration, and distribution of business funds in the best possible way. There should be clear-cut plans of raising required funds and their possible uses. The current and future needs for funds should be considered while formulating financial policies.

Procedures:

The procedures are formed to ensure consistency of actions. The procedures follow the formulation of policies. If a policy is to raise short-term funds from banks, then a procedure should be laid to approach the lenders and the persons authorized to initiate such actions.

Flexibility:

The financial planning should ensure proper flexibility in objective, policies, and procedures so as to adjust according to changing economic situations. The changing economic environment may offer new opportunities. The business should be able to make use of such situations for the benefit of the concern. A rigid financial planning will not let the business use new opportunities.

Elements of Financial Planning:

Financial planning involves the following steps or elements:

These are:

• Objectives.
• Capital Requirements.
• Kinds of Securities to be issued, and.
• Policies.

Now, explain each one;

Objectives:

For effective financial planning, it is essential to clearly lay down the financial objectives sought to be achieved. The financial objectives should be based on the overall objectives of the company. The objectives of financial management may be set up in the areas, namely, investment, financing, and dividend.

Capital Requirements:

Capital is required for various needs of the business. The separate assessment is to be made of the requirements of fixed and working capital. Fixed capital is needed for acquiring fixed assets such as land and building, plant and machinery, furniture, etc. It is blocked for a long time. Working capital is required for holding current assets like stock, bills receivable, etc. and cash for meeting day-to-day expenses in running the business.

Kinds of Securities to be issued:

A company can issue equity shares, preference shares, and debentures to raise long-term funds. The types and proportion of securities to be issued should be properly determined.

Policies:

Financial planning leads to the formulation of policies relating to borrowing and lending, cash control and other financial activities. Such policies will help in taking vital decisions for the administration of capital and achieving coordination in financial activities.

Advantages and Disadvantages of Financial Planning:

These are the advantages of financial planning; It will set out clearly the money that you need to put together to start the business and then to run it for a period. It will help you to obtain funding if you need it. It will help prevent you from going into a business that will not be successful. Highlight periods where your business may need extra financial help. Inspire confidence in lenders and banks that you may have to approach for finance. It will help you to spot problems early so you can make plans for the necessary solution. For example, it will highlight whether you are holding too much stock or whether your collection is less than it should be or that you will be short of cash at a particular time.

These are the disadvantages of financial planning; It can be a costly process because you will need the assistance of your accountant or financial adviser. It can take a lot of time, A financial plan merely forecasts and accounting.

Limitations of Financial Planning:

Some of the limitations of financial planning are discussed as follows:

These are:

• Forecasting.
• Changes.
• A Problem of Coordination, and.
• Rapid Changes.

Now, explain each one;

Forecasting:

Financial plans are prepared by taking into account the expected situations in the future. Since the future is always uncertain and things may not happen as these are expected, so the utility of financial planning is limited. The reliability of financial planning is uncertain and very much doubted.

Changes:

Once a financial plan is prepared then it becomes difficult to change it. A changed situation may demand a change in financial plan but managerial personnel may not like it. Even otherwise, assets might have been purchased and raw material and labor costs might have been incurred. It becomes very difficult to change a financial plan under such situations.

A Problem of Coordination:

The financial function is the most important of all the functions. Other functions influence a decision about the financial plan. While estimating financial needs, production policy, personnel requirements, marketing possibilities are all taken into account.

Unless there is a proper-co­ordination among all the functions, the preparation of a financial plan becomes difficult. Often there is a lack of coordination among different functions. Even indecision among personnel disturbs the process of financial planning.

Rapid Changes:

The growing mechanization of the industry is bringing rapid changes in the industrial process. The methods of production, marketing devices, consumer preferences create new demands every time. The incorporation of new changes requires a change in financial plan every time.

Once investments are made in fixed assets then these decisions cannot be reversed. It becomes very difficult to adjust a financial plan for incorporating fast-changing situations. Unless a financial plan helps the adoption of new techniques, its utility becomes limited.

Understand the Process of Financial Planning:

Following decisions are included in financial planning or process of financial planning is as under:

Objectives:

In the first stage, financial objectives of the organization are determined. Financial objectives of an organization may be of two kinds:

• Short-term: It includes the maintenance of adequate liquidity in the organization,
• Long-term: It includes the procurement of adequate finance from different sources so as to increase the efficiency of the organization.

Policies:

In the second stage of financial planning, financial policies are determined so that financial objectives could be achieved. It includes capitalization policy, capital structure policy; fixed assets management policy, dividend policy, working capital management policy, credit policy, etc.

For instance, in respect of capital structure, the policy of the company may be to depend on equity share capital in the initial years; regarding distribution of dividend, the policy may be to keep the rate of dividend low in the initial years, regarding credit sale the policy of the organization may be to sell goods on credit to creditworthy customers alone.

Procedures:

In the third stage of financial planning, financial procedures are determined. Procedures are clearer than policies. In case of a procedure, it is laid down in what order a job will be performed. For instance, the decision regarding depending on equity capital in the initial years of the company is a policy but the different steps taken to procure equity capital fall under the category of financial procedure.

Similarly, credit sale is a policy but prescribing the sequence of action to be taken in case of non-realisation of payment on time, is a financial procedure.