Financial Planning Process

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Financial Planning: Tools and Concepts

Financial Planning: Tools and Concepts

1. Financial Planning Process

  • Overview: The financial planning process starts with long-term (strategic) financial plans, which guide the development of short-term (operating) financial plans and budgets.
  • Long-term Financial Plan:
    • Duration: Affects the firm for 5-10 years.
    • Supported by short-term plans that specify financial actions for shorter periods.

2. Planning

  • Relation to Management Functions: Planning is closely related to controlling. Both functions are essential for organizational success.
  • Management Planning:
    • Involves setting organizational goals and identifying ways to achieve them.
    • Can be broken down into long-term plans (reflected in the business strategy) and short-term plans.
    • Resources needed include manpower, production capacity, and financial resources.

3. Steps in Planning

  1. Set Goals/Objectives: Identify long-term and short-term objectives, as reflected in the company’s vision and mission statements.
    • Example:
      • Vision: To excel in providing great tasting food that meets local preferences better than anyone; to become one of the three largest and most profitable restaurant companies in the world by 2020.
      • Mission: To serve great tasting food, bringing the joy of eating to everyone.
  2. Identify Resources: Resources include production capacity, human resources, and financial resources.
  3. Identify Goal-related Tasks: Determine how to achieve the objectives (e.g., hiring more sales agents to support a sales increase).
  4. Establish Responsibility Centers: Identify which department will be accountable for each task.
  5. Establish an Evaluation System: Implement a mechanism to monitor progress through budgets and projected financial statements. Compare actual results to plans and investigate deviations.
  6. Determine Contingency Plans: Consider unforeseen events in planning, as budgets and projections are based on assumptions.

4. Profit Planning

  • Definition: Profit planning projects the firm’s operational results and overall financial position based on historical information and future assumptions.

Criteria for Effective Planning

  • SPECIFIC: Target a specific area for improvement.
  • MEASURABLE: Quantify progress or suggest indicators.
  • ASSIGNABLE: Specify who will execute the plan.
  • REALISTIC: State achievable results given available resources.
  • TIME-RELATED: Specify when results can be achieved.
Reference: Doran, G. T. (1981). "There's a S.M.A.R.T. way to write management's goals and objectives." Management Review (AMA FORUM) 70 (11): 35-36.

Importance of Quantified Plans

  • A quantified plan is represented through budgets and projected financial statements, which are essential for monitoring actual performance. Meeting plans is positive, but not meeting them can be acceptable if justifiable reasons exist.

5. Budgets

  • Definition: A budget is a quantitative plan emphasizing resource use and allocation over a specified time.

Types of Budgets

  • Master Budget: Overall plan of an organization, aggregating all lower-level budgets.
  • Flexible Budget: Adjusts based on varying activity levels, typically prepared at the end of a period for comparison with actual results.

The Sales Budget

  • Importance: Critical for forecasting since most expenses correlate with sales.
  • Formula: Forecasted unit sales x Price per unit = Total gross sales.


Factors in Sales Forecasting

External Factors

  • Macroeconomic Variables: GDP growth rate, inflation, interest rates, foreign exchange rates, and income tax rates.
  • Industry Developments: Competitive landscape, consumer trends, and economic crises.

Internal Factors

  • Production Capacity: Limitations based on available resources and workforce.
  • Manpower Requirements: Assessing if current staffing meets expected demand.

6. Purchases Budget

  • Definition: A budget outlining the estimated number of units the firm needs to purchase for a specific time period.
  • Formula:

    Purchases Budget = Expected Sales in units + Desired Ending Inventory - Beginning Inventories

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