Definition of Financial Planning
Financial Planning is the process of estimating the capital required and determining its competition. It is the process of framing financial policies in relation to procurement, investment, and administration of funds of an enterprise.
Objectives of Financial Planning
Financial Planning has got many objectives to look forward to:
This will depend upon factors like cost of current and fixed assets, promotional expenses and long- range planning. Capital requirements have to be looked with both aspects: short- term and long- term requirements.
The capital structure is the composition of capital, i.e., the relative kind and proportion of capital required . This includes decisions of debt- equity ratio- both short-term and long- term.
Ensures that the scarce financial resources are maximally utilized in the best possible manner at least cost in order to get maximum returns on investment.
Importance of Financial Planning
Financial Planning is process of framing objectives, policies, procedures, programs and budgets regarding the financial activities of a concern. This ensures effective and adequate financial and investment policies. The importance can be outlined as:
- Adequate funds have to be ensured.
- Financial Planning helps in ensuring a reasonable balance between outflow and inflow of funds so that stability is maintained.
- Financial Planning ensures that the suppliers of funds are easily investing in companies which exercise financial planning.
- Financial Planning helps in making growth and expansion programs which helps in long-run survival of the company.
- Financial Planning reduces uncertainties with regards to changing market trends which can be faced easily through enough funds.
- Financial Planning helps in reducing the uncertainties which can be a hindrance to growth of the company. This helps in ensuring stability an d profitability in concern.
Investment Decision
One of the most important functions of financial planning is to intelligently allocate capital to long-term assets. This activity is also known as capital budgeting. It is important to allocate capital in those long-term assets so as to get maximum yield in the future. Following are the two aspects of investment decision
- Evaluation of new investment in terms of profitability
- Comparison of cut off rate against new investment and prevailing investment.
Since the future is uncertain therefore there are difficulties in the calculation of expected return. Along with uncertainty comes the risk factor which has to be taken into consideration. This risk factor plays a very significant role in calculating the expected return of the prospective investment. Therefore while considering an investment proposals it is important to take into consideration both the expected return and the risk involved.
Investment decision not only involves allocating capital to long-term assets but also involves decisions of using funds which are obtained by selling those assets which become less profitable and less productive. It wise decisions to decompose depreciated assets which are not adding value and utilize those funds in securing other beneficial assets. An opportunity cost of capital needs to be calculating while dissolving such assets. The correct cut off rate is calculated by using this opportunity cost of the required rate of return (RRR)
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