Financial planning involves many things, from analysing your current financial status, making a forecast based on the economy, and figuring out your budget and investments accordingly. Financial planning is the cornerstone of good management. So you must have complete clarity on the objectives and components that make a financial plan successful.
What is Financial Planning?
Before you begin any business, every organisation must focus on extensive financial planning. It will help estimate the finances required for a business and determine the resources to generate these funds. It also helps create a blueprint of the finances needed for all future activities. This is normally planned for 3-5 years and keeps long-term investment in mind with growth and financial decisions.
Primary Objectives of Financial Planning
The objectives of a good financial plan are as follows:
1. Ensuring that enough funds are available
Good financial planning aims to generate funds as needed and make them available when needed. It also includes estimating the different purposes that these funds will be used for. This includes building assets over time and generating working capital for the business.
2. Estimating the sources and time for funds
Financial planning helps you estimate the time required to generate the necessary funds. It also lists the possible sources for these funds.
3. Creating the structure for capital
The capital structure determines the proportion and the kind of capital that is necessary for your business. It includes both short-term and long-term debt-equity ratios.
4. Avoiding unwanted funds
Surplus funds are just as problematic as a shortage of funds. Financial planning ensures that you do not raise any unwanted funds. When you have a shortage of funds, you are unable to meet all your financial obligations. With surplus funds, you cannot earn any returns, but your costs get added up.
Important Components of a Financial Plan
To make your financial plan successful, you must include all the following components:
1. Income statement
It is the most basic component of your financial plan, also called the profit and loss statement. It makes you understand where your business is likely to suffer losses and where you have maximum chances of earning a profit. This income statement is prepared for three months. The income statement includes particulars like gross margin, revenue, and cost of goods sold. It helps your business plan activities and takes necessary action to improve the profit margin.
2. Cash Flow Statement
Your business needs cash to run. A cash flow statement is just as important as your income statement and company portfolio. This statement explains how much cash inflow your business had, how much cash was paid out, and the closing cash balance. It is drawn for each month and plays a crucial role in calculating and filing your taxes.
3. Balance sheet
If you wish to understand where your business stands financially, you need to check the balance sheet. This statement gives you a quick look at all the finances of the company. It includes details like liabilities and assets. It tells you how your business is performing financially at a given time. It mainly lists three things- how much money your business has in the bank, how much income is generated from customers and clients, and how much you must pay towards vendors and other overheads. Even if you plan to approach investors for your business, an updated balance sheet is a necessary document.
4. Sales forecast
Every business must prepare for sales in the future. They make long-term plans to maintain their short-term profit as well as customers. Creating a sales forecast is a must if you are looking for investors and lenders. You can also prepare an expansion forecast to gain more certainty about your business. Each business has a different approach when it comes to making these forecasts. You can also take into account any event or festival that is upcoming and likely to boost sales.
5. Tax management
This is one of the most neglected components of a financial plan. It helps you also plan investments to avoid paying hefty taxes. You can also analyse the effect on your income as your business grows in scale. With effective tax management, you can control the returns you make on your investments and also retain them.
6. Break-even analysis
Most small businesses struggle with pricing. Break-even analysis helps you understand what price you should quote for various products and services. It takes into account your fixed expenses and the revenue generated from all your units. You can assess if your business is making enough money to manage all the expenses. If not, you can prepare a strategy or change your pricing to ensure that you do not put money out of your income and savings towards running your business.
Financial planning helps you make decisions that give you not just short-term benefits but also long-term. It is the most crucial part of running a business successfully. You can eliminate unwanted expenses, make the correct investments, and maintain good financial health when you regularly prepare a financial plan.
In the case of start-ups, many of them require access to funds from investors or other lenders. Without a financial plan, you will not be able to generate these funds. Your financial plan is the first step in building a good business model. Create strategies that help you not just earn enough revenue but also scale up your business quickly.
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Q. What are the benefits of financial planning?
Ans. Financial planning helps you make meaningful business decisions and offers the following benefits:
1. It gives you better direction to make any financial decisions for your company.
2. You get a clear picture of how a particular financial decision that you make will also affect the other areas of your business and finances. For example, when you buy a certain investment product, it can either help you pay off mortgages faster or may even delay retirement significantly.
3. You get a clear idea about the overall effects of your financial decisions. It includes the short-term and long-term effects on personal and business goals.
4. You can make changes quickly to secure your business and revenue.
5. You can see any patterns or issues in your business model that cause financial issues.
6. You understand the scope of your business and the prospects for growth in the future.
7. You can obtain investments and funding very easily when you have an organised financial plan.
8. It helps organise various levels of management in your business.
Q. Are there any limitations to financial planning?
Ans. There are a few limitations to financial planning, such as:
1. The whole plan is based on a mere forecast of conditions in the future.
2. Once you have prepared your detailed financial plan, it becomes very difficult to make changes.
3. The assets associated can be purchased with huge capital. Other costs incurred include the raw material and labour.
4. Usually, the main reason for the difficulty in changing the financial plan for a company is non-cooperation from the management.
Q. What are the liabilities included in the balance sheet?
Ans. The liabilities included in the balance sheet include all accounts that are to be paid, instalments on loans, credit card bills, and other overheads on your business.
Q. What are the assets included in the balance sheet?
Ans. The balance sheet includes primary assets of the business such as receivables from clients and customers, the amount of money you currently have in the bank, inventory, and others.
Q. Why is a sales forecast important?
Ans. A sales forecast predicts the expected sales and revenue that can be generated in a given period. These figures are usually drawn for three months. The sales forecast is one of the most important documents for any lender or investor as it explains the growth of the business in terms of finances.