Financial planning is a process that helps people and organizations to identify their financial goals and then develop strategies for meeting those goals. It is a process that helps you to understand your current financial situation and plan for the future.
A comprehensive financial plan includes both protection (life insurance) and investment (stocks, bonds). Protection includes what can be done to protect one’s assets from possible risks such as death, disability or loss of employment. Investment refers to the act of investing money in stocks, bonds, real estate or other vehicles with the goal of generating income or capital gains over time.
Financial planning is a very important aspect of life. It helps in ensuring that the person has enough money to take care of their needs and also prepare for their future. Financial planning includes the creation of a budget and monitoring progress against that budget. It also includes saving money for retirement and other future goals as well as providing income in the event of death or disability.
The goal is to achieve financial security by managing risk and uncertainty over time. The process of putting together a plan, based on managing finances, for potential expenses and income in the future is financial planning. In other words, it is a process of analyzing your current financial situation and building a plan based on your financial goals. The overall process of financial planning includes;
- Estimating capital requirements along with determining its competition
- Identification of financial goals and formulation of strategies to achieve those goals
- Framing financial policies related to investment, procurement, and administration of funds of a business
- Evaluating current financial status of the company
Process involved in Financial Planning
Financial planning is not just a practice by businesses. Individuals too can benefit from sound financial planning. The process of financial planning includes of the following steps;
Identification of Financial Status
The first step towards financial planning is assessing your current financial status and determining ways on how you can improve your financial situation. The key areas to focus here include; budgeting, routine income and expenditures, tax obligations, investment and saving reserves, emergency funds, and other financial obligations.
Determination of Financial Goals
It’s important to be clear about your financial goals in order to execute a successful financial plan. Determining your financial goals help you give a clear idea as to what your main priorities are. It helps you classify your needs from your wants. Your financial goals may range from saving up capital for long term investments to paying off debts for sustainability. Along with that, you can also determine whether your financial goals are for the short term or the long term.
Identification of Alternatives for Investment
After the determination of your short, medium, and long term financial goals, the next step is to determine your investment alternatives. You can develop integrated investment strategies based on your requirements. These investment alternatives can be developed based on the timeframe, cash flow, risk tolerance, current insurance coverage, tax strategies and investment goals.
Evaluation of Alternatives
It’s important to have a one-to-one discussion with the key decision makers and evaluate your alternatives before making any conclusive decisions. Each investment alternative provided may possess a certain degree of risk. Hence, it’s very important to assess the impact of risks borne by these alternatives and come to a decision accordingly. To make these decisions, it’s important for the decision maker to remain updated about political, economic, and social trends and events.
Implementation of the Financial Plan
After careful assessment of the alternatives, the next step is to formulate a concrete plan and move into action. The actions may vary based on the strategies formulated for long, medium, or short term goals. It’s important to move into action right away after the decision has been taken as your plan may become ineffective the longer you take to implement it.
Monitoring and Re-evaluation of the Financial Plan
Financial planning is a continuous process and you must be aware of the fact that it requires continuous improvement throughout its life cycle. It’s important to make periodic assessments of the actions taken and alter decisions based on the current scenario. If you are rigid and stick to your initial plan without making any changes, then there are high chances that your plan might fail.
Characteristics of Financial Planning
Financial planning is essential for the success of any organization. It includes guidelines and practices for effective coordination amongst the various company functional areas. This entails properly allocating resources among several departments, which reduces resource waste. A sound financial plan consists of the following characteristics;
A good financial foundation should offer a straightforward financial framework that even a layperson can manage and comprehend. “Simplicity” is a necessary prerequisite that aids the management and promoters in raising the required quantity of capital. Making a straightforward financial plan is also simple.
In order to predict capital requirements as accurately as possible, the scope of operation must be planned with foresight. If a plan is imagined without thought, it will fail to meet the company’s needs for both fixed and working capital. In layman’s terms, the canon of foresight states that in addition to today’s needs, consideration should also be given to tomorrow’s needs.
Financial modifications are frequently necessary. Modification of financial plans should be simple and understandable. Flexibility is necessary so that a financial plan may be implemented as quickly as possible to adapt to future changes and conditions.
Optimum Use of Funds
Capital should not only be sufficient, but should also be used productively. A financial strategy should be able to reduce capital waste, avoid idle capacity, and assure optimum utilization of funds to increase the company’s earning potential. Financial resources should be used in the best possible way. If not done properly, it will become less profitable. The fixed capital and the working capital need to be properly balanced.
Financial planning should ensure the company’s solvency and liquidity. Both short-term and long-term payments must be made on time in order to maintain solvency. The amount of liquidity that must be preserved depends on the company’s size, age, credit standing, nature of operations, rate of turnover, etc.
When developing a financial strategy, planners should include contingencies or emergency circumstances. This could result in saving some extra money for unforeseen circumstances. It would be preferable if these contingencies were foreseen beforehand.
Cost of Raising Capital
When choosing a financial plan, the cost of raising capital is a crucial factor to be considered. The numerous sources should be chosen so that the financial load is as minimal as possible. Interest-bearing securities should be returned as soon as is practical to decrease the load.
A financial plan should modify different securities in a way that does not adversely influence the company’s profitability. It is important to adjust the interest-bearing securities and other liabilities in such a way that it would allow the company to increase its profitability.