Benefits of Financial Planning
Before you proceed, first do revise the meaning of term financial planning (FP). It is derived from two influential words, viz., Finance and Planning, which are briefly explained as follows:
- Finance is the management of money and other valuables, which can be easily converted into cash. It also deals with profits that adequately compensate for the cost and risks borne by the business and its allied activities.
- Planning is a blueprint of objectives, tasks, actions, scheduling, etc. that determines the future course of implementation strategy to achieve the desired results.
The importance or benefits of financial planning is depicted below.
Image credits © Prof. Mudit Katyani.
Financial planning is beneficial in terms of following points:
- Forecast of cash flows.
- Raising finances.
- Managing the flow of internal funds.
- Facilitate cost control.
- Facilitate pricing of product.
- Forecasting profits.
- Measuring required returns.
- Managing assets.
- Managing funds.
- Managing Cost.
- Miscellaneous importance.
Now let's discuss this importance of financial planning.
1. Forecast of cash flows
Financial planning is necessary for the day to day operations of the business which results in discharging the obligations as and when they arise. This involves forecasting of cash inflows and cash outflows from the ordinary (regular transactions) and unexpected (irregular transactions such as bulk orders, discounts, etc.) business opportunities.
2. Raising finances
Financial planning is important to plan for raising (mobilizing) finance from different sources so that the requisite amounts of finance are made available to compensate the requirement of business processes. These requirements may be in the nature of short-term (temporary overdraft, etc.), medium-term (acquisition of assets, etc.) and long-term (term loans, etc.).
3. Managing internal funds
Financial planning is essential to keep a track of the realized surplus available in the treasury. This is required to make certain that they are properly utilized to meet the requirements of the business which will results in maintaining the liquidity position with a minimum amount of external borrowings.
4. Facilitate cost control
Financial planning is beneficial to recognize the cost of production (material, labor, factory overhead, etc.), cost of administration (salary, legal expenses, office overhead, etc.) and cost of sales (advertisement, marketing and other promotional expenses). Cost control is analyzed by comparing the actual cost with standard (pre-determined) cost.
5. Facilitate pricing of product
Financial planning is necessary for pricing of a product since pricing is the mode of determining, “How much a business will swap (in exchange) for its products?“ Price is the only revenue generating tool of the business.
Pricing has a direct relationship with demand and supply of a product. The desires of the user can be transformed into demand only if the consumer has the willingness and financial-capability to buy the product.
Thus, pricing is very important for the success of the product.
6. Forecasting profits
Financial planning is a model demonstrating comprehensive and forecasted analysis of profitability for the particular business in a specific market condition, with a pre-determined projected financial-plan. A forecasted profitability plan is required to estimate the course of action. A profit is the residual result of the agreed business operations.
7. Measuring required returns
Financial planning is required to evaluate the required returns from the project. This may results in acceptance or rejection of a business proposal. It depends on whether the expected return from the proposed business is equal to or more than the required returns.
8. Managing assets
Financial planning is required to manage the assets (owned and leased) of the business. Such assets shall be properly maintained to avoid any break-down (failure). It shall assist to determine the total investment in assets to carry out business operations properly and promptly.
9. Managing funds
Financial planning is required to manage the funds of the investors and to conduct the activities of the business in the interest of the organization. Funds are the liquid assets of the company. Therefore, Funds should be managed (evaluated) with dual virtual (imaginary) vision, i.e. w.r.t. liquidity and profitability.
10. Managing cost
Financial planning is also required to manage the cost of operations of the business. If the costs of operations are not measured carefully, then it may result in paying excessive money with a subsequent decline in profits.
11. Miscellaneous importance
Financial planning may have a strategy to convert idle equipment into cash. It may also have a strategy to reduce the cost (for e.g. by not giving increments to employees, by not upgrading technology, etc.). It has a plan to hold the foreign remittance and wait for a favorable exchange rate for remitting of the same.