Financial Planning - Definition,

Objectives and Importance

Definition of Financial Planning
Financial Planning is the process of estimating the capital required and determining it’s 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:

a. Determining capital requirements- 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.
b. Determining capital structure- The capital structure is the composition of capital, i.e., the
relative kind and proportion of capital required in the business. This includes decisions of
debt- equity ratio- both short-term and long- term.
c. Framing financial policies with regards to cash control, lending, borrowings, etc.
d. A finance manager 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, programmes and budgets
regarding the financial activities of a concern. This ensures effective and adequate financial and
investment policies. The importance can be outlined as-

1. Adequate funds have to be ensured.

2. Financial Planning helps in ensuring a reasonable balance between outflow and inflow of
funds so that stability is maintained.
3. Financial Planning ensures that the suppliers of funds are easily investing in companies which
exercise financial planning.
4. Financial Planning helps in making growth and expansion programmes which helps in long-
run survival of the company.
5. Financial Planning reduces uncertainties with regards to changing market trends which can
be faced easily through enough funds.
6. 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.

Finance Functions
The following explanation will help in understanding each finance function in detail

Investment Decision
One of the most important finance functions 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 future. Following are the two aspects of investment decision

a. Evaluation of new investment in terms of profitability

b. Comparison of cut off rate against new investment and prevailing investment.
Since the future is uncertain therefore there are difficulties in 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 investment proposal it is important to take into consideration both 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)

Financial Decision
Financial decision is yet another important function which a financial manger must perform. It is
important to make wise decisions about when, where and how should a business acquire funds.
Funds can be acquired through many ways and channels. Broadly speaking a correct ratio of an
equity and debt has to be maintained. This mix of equity capital and debt is known as a firm’s capital
structure.

A firm tends to benefit most when the market value of a company’s share maximizes this not only is a
sign of growth for the firm but also maximizes shareholders wealth. On the other hand the use of debt
affects the risk and return of a shareholder. It is more risky though it may increase the return on equity
funds.

A sound financial structure is said to be one which aims at maximizing shareholders return with
minimum risk. In such a scenario the market value of the firm will maximize and hence an optimum
capital structure would be achieved. Other than equity and debt there are several other tools which
are used in deciding a firm capital structure.

Dividend Decision
Earning profit or a positive return is a common aim of all the businesses. But the key function a
financial manger performs in case of profitability is to decide whether to distribute all the profits to the
shareholder or retain all the profits or distribute part of the profits to the shareholder and retain the
other half in the business.

It’s the financial manager’s responsibility to decide a optimum dividend policy which maximizes the
market value of the firm. Hence an optimum dividend payout ratio is calculated. It is a common
practice to pay regular dividends in case of profitability Another way is to issue bonus shares to
existing shareholders.

Liquidity Decision
It is very important to maintain a liquidity position of a firm to avoid insolvency. Firm’s profitability,
liquidity and risk all are associated with the investment in current assets. In order to maintain a
tradeoff between profitability and liquidity it is important to invest sufficient funds in current assets. But
since current assets do not earn anything for business therefore a proper calculation must be done
before investing in current assets.

Current assets should properly be valued and disposed of from time to time once they become non
profitable. Currents assets must be used in times of liquidity problems and times of insolvency.
The Role of the Finance Function in
Organizational Processes
The Finance Function and the Project Office
Contemporary organizations need to practice cost control if they are to survive the recessionary times.
Given the fact that many top tier companies are currently mired in low growth and less activity
situations, it is imperative that they control their costs as much as possible. This can happen only
when the finance function in these companies is diligent and has a hawk eye towards the costs being
incurred. Apart from this, companies also have to introduce efficiencies in the way their processes
operate and this is another role for the finance function in modern day organizations.

There must be synergies between the various processes and this is where the finance function can
play a critical role. Lest one thinks that the finance function, which is essentially a support function,
has to do this all by themselves, it is useful to note that, many contemporary organizations have
dedicated project office teams for each division, which perform this function.

In other words, whereas the finance function oversees the organizational processes at a macro level,
the project office teams indulge in the same at the micro level. This is the reason why finance and
project budgeting and cost control have assumed significance because after all, companies exist to
make profits and finance is the lifeblood that determines whether organizations are profitable or
failures.

The Pension Fund Management and Tax Activities of the Finance

Function
The next role of the finance function is in payroll, claims processing, and acting as the repository of
pension schemes and gratuity. If the US follow the 401(k) rule and the finance function manages the
defined benefit and defined contribution schemes, in India it is the EPF or the Employee Provident
Funds that are managed by the finance function. Of course, only large organizations have dedicated
EPF trusts to take care of these aspects and the norm in most other organizations is to act as
facilitators for the EPF scheme with the local or regional PF (Provident Fund) commissioner.

The third aspect of the role of the finance function is to manage the taxes and their collection at
source from the employees. Whereas in the US, TDS or Tax Deduction at Source works differently
from other countries, in India and much of the Western world, it is mandatory for organizations to
deduct tax at source from the employees commensurate with their pay and benefits.

The finance function also has to coordinate with the tax authorities and hand out the annual tax
statements that form the basis of the employee’s tax returns. Often, this is a sensitive and critical
process since the tax rules mandate very strict principles for generating the tax statements.

Payroll, Claims Processing, and Automation

We have discussed the pension fund management and the tax deduction. The other role of the
finance function is to process payroll and associated benefits in time and in tune with the regulatory
requirements.

Claims made by the employees with respect to medical, and transport allowances have to be
processed by the finance function. Often, many organizations automate this routine activity wherein
the use of ERP (Enterprise Resource Planning) software and financial workflow automation software
make the job and the task of claims processing easier. Having said that, it must be remembered that
the finance function has to do its due diligence on the claims being submitted to ensure that bogus
claims and suspicious activities are found out and stopped. This is the reason why many
organizations have experienced chartered accountants and financial professionals in charge of the
finance function so that these aspects can be managed professionally and in a trustworthy manner.
The key aspect here is that the finance function must be headed by persons of high integrity and trust
that the management reposes in them must not be misused. In conclusion, the finance function
though a non-core process in many organizations has come to occupy a place of prominence
because of these aspects.