Canons Basic Principles of Financial Planning
First let us revise the meaning of words Canons and Financial Planning.
- Canons are the basic (fundamental) principles (rules or standards) laid down by an authoritative entity (either by an authoritative individual or institution, etc.) on something (may be either a concept or theory or procedure or practice, etc.) with an intention to refine, improve, standardize and optimise its mode of operation.
- Financial Planning tells us how to prepare a financial or capital plan.
The canons or principles of a financial plan are briefly discussed as follows:
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- Long-term corporate objectives : The financial plan must consider the long-term objectives of the company. The amount of capital received, the sources of funds and the application (use) of funds must be decided only after considering the objectives of the company.
- Simple : A financial plan must not be complex. It must be simple to understand and easy to use. The capital structure must be simple. It must include a limited number of securities. If not, the investors will not invest their money in the company.
- Realistic : A financial plan must be realistic and practical. It must show the exact financial requirements of the company. If not, there will be surplus or shortage of capital. The company must be able to collect (acquire) the finance without any difficulty. The finance which is collected must be fully utilised.
- Flexible : A financial plan must be flexible. It must not be rigid. The company must be able to change the financial plan according to the circumstances. The company may have surplus finance or shortage of finance. It must be able to return the surplus finance to the investors. Similarly, in case of shortage, it must be able to collect more finance from the investors.
- Economical : A financial plan must be economical. The cost of collecting finance must be low. The rate of interest and dividend must be low. There must be a proper balance between owned and borrowed finance. In the beginning, the company must use more owned finance i.e. equity shares. However, later, it must use borrowed finance, i.e. loans, debentures, etc.
- Liquidity : A financial plan must have liquidity. That is, the company must have sufficient cash to meet its day-to-day requirements. The company must have a proper cash reserve. The cash reserve must not be too high nor too low. If it is high then the company will have surplus cash. If it is too low then the company will have a shortage of cash. Surplus cash and shortage of cash are both harmful to the company.
- Provisions for contingencies : Contingencies are events, which may or may not happen in the future. They are unforeseen or unexpected expenses. A financial plan must make provisions for contingencies. However, unnecessary provisions must not be made. Proper judgement is required for making provisions for contingencies.
- Appealing to investors : A financial plan must be appealing to the investors. There are many types of investors. Some investors give importance to security while others give importance to profitability. The financial plan must be attractive to all types of investors.
- Effective and optimum use of funds : A financial plan must make the effective and optimum use of the financial resources, i.e. funds. The finance collected by the company must not be wasted. They must be properly used to meet the fixed capital and working capital needs of the company. Proper use of finance results in high profits.
- Balance of owned and borrowed capital : There must be a balance between owned finance and borrowed finance. If not, the company will face many problems.
- Safety to investors : A financial plan must offer safety to the investors' money. If not, the investors will not invest their money in the company.
- Timings of collecting finance : A financial plan must give importance to the timing of collecting finance. During a boom period, the company must collect finance from equity shares. During a depression, it must use borrowed finance.
- Controlled by few shareholders : A financial plan must see that the company is controlled by few shareholders.
- Long-term vision : A financial plan must be prepared with proper vision and foresight. It must be prepared for a long term. The long-term financial needs must be considered while preparing the finance plan. In future, the company will grow. When it grows, it will require finance. All this must be considered while preparing the financial plan.
- Balanced capitalisation : A financial plan must have balanced capitalization. It must avoid over-capitalization and under-capitalization.