Financial Institutions - Essay Example

Introduction With a global collapse of the financial markets, financial s are struggling to keep alive. In my view, despite their failures and perhaps mismanagement, they still play an important role in the lives of ordinary citizens. In this paper, I will try to explore the different roles of financial institutions to individuals and businesses. After which, I shall highlight the importance of financial tools and methods such as forecasting by taking the hypothetical role of manager of the high school division of Abel Athletics. Part 1 - Financial Institutions Financial institutions play a role as stakeholders in Individual Development Accounts or IDAs. An IDA is a savings account “matched with outside contributions that are designed to help lower-income families accumulate money for homeownership, education, job training, and business development.” (Newberger, 2002) Since they act as “stakeholders,” i.e. they have a vested interest in seeing the individual succeed; it is easy to infer that they will refer you to qualified financial planners. For example, I had a friend from Canada who introduced me to the International Marketing Group (IMG). It is a financial brokerage firm of services in insurance, healthcare, pre-need, and investments. Some of its top agents are financial planners from the Registered Financial Planners Institute. In my case, I think financial institutions such as IMG will likely recommend a particular financial product or service. Without financial institutions, an average American might not have known about the existence of a particular product or service, nor could have found the best deal that is applicable for a person’s financial needs. A financial institution has a pool of experts in the fields of investment planning, estate planning, tax planning, and other financial matters at the household level. I do not believe that a busy person who hates numbers and anything about finances will want to have the burden of learning all these. Therefore, a financial institution provides an individual the expertise and perhaps the peace of mind that he will not be burdened with debt once he religiously follows a financial plan. Financial institutions also act as intermediaries for individuals, governments, and businesses, but they treat each customer differently according to the category which one belongs. For individuals, as hinted earlier, they provide financial information where the individual is more likely uninformed. For governments and businesses, they treat them almost the same as institutions but depending on their credit rating. I believe individuals without a finance background have other subjects, interests, or callings. Or perhaps, they are afraid of anything related to money. Nevertheless, financial information is necessary. Therefore, financial institutions bridge that gap of ignorance by providing financial education and information to the public. For the most part, financial institutions deal with businesses as brokers for debts and other sources of money. Of course, this is different for individuals. An ordinary citizen needs financial information in order to live below his means. Businesses need capital and financial information necessary for huge investments. Therefore, financial institutions are an integral part of the economy. Their importance cannot be underestimated. Part 2 – Financial Forecasting Importance of Financial Forecasting According to Prof. Gordon Phillips (n.d.), a Business Instructor, financial forecasting is important because of the following: 1. Financial forecasting is the process of estimating future business performance (sales, costs, earnings) 2. Corporations use forecasting to do financial planning, which includes an assessment of their future financial needs. Forecasting also is important for production planning, human resource planning, etc. 3. Forecasting is also used by outsiders to value companies and their securities. 4. Here we are taking the aggregate perspective of the whole firm, rather than looking at individual projects. On the first point, it is clear that we are able to extrapolate information about the future via financial forecasting. It is important that we project possible future sales, costs, and earnings, so we can be judicious and do only that which is necessary today. If large Corporations do this, I do not see any reason why Abel Athletics should not do financial planning and forecasting. Organizations utilizing the methods of finance will likely have better cash flow and have sufficient funds for ambitious, useful, or sometimes fancy projects. On the third point by Prof. Phillips, I believe financial forecasting is a good tool by which Abel Athletics can be accountable to existing and future investors. It also helps them appreciate the progress of the company through the years, or on the other hand, help instil a higher sense of vision and awe for the company. The final point is related to the third. By having the over-all picture in mind, we are able to see whether a company is performing well or going to perform well or not. Investors or people in the organization have no need to be inundated with the information concerning individual projects when they can be available through pro forma financial statements. Process of Financial Forecasting According to Block and Hirt (2000), there are two methods of financial forecasting: 1) Percent-of-sales method, which is easier to calculate but less precise than pro forma; and 2) Pro forma or Projected Financial Statements. The steps in financial forecasting are as follows: 1. Develop a sales projection. For investors of Abel Athletics to really put money, it is imperative that our company can make a sale. As a consequence, we should be able to determine up to what extend can our products be sold. 2. Make a Production Plan. Then, Abel Athletics must determine how it will meet its sale requirements. It should really make a production plan. 3. Make a Pro Forma Income Statement. After everything has been considered, Abel Athletics must make a projected financial statement. Relation to Budgeting Making pro forma statements, like budgeting, is a form of financial planning. Without it, the company could spend unwisely not knowing that it is full of debt. However, budgeting is the allocation of available money. It deals with the present and the future, although it may not be necessary to form pro forma statements in budgeting, although it is important. But, it is clear that making projected financial statements are important in many cases in making a budget. Corporations and even governments must produce pro forma financial statements so they can be assured that money allocated in projects will be put to good use. In other words, pro forma statements make the budget process easier by having the people involved know in advance whether a particular product or investment will be an asset or a liability. Finally, the faster and better companies can make projected financial statements, the more can they cope with the fast-changing world, and this can be done through the use of financial planning software (Focus on, 2008). References Block, Stanley B., and Hirt, Geoffrey A. (2000). Foundations of Financial Management. [PowerPoint Slides] Retrieved February 24, 2009, from http://www.fhsu.edu/econ/rterry/805Chapter04.ppt. Focus on forecasting. (2008). Accountancy, Retrieved February 24, 2009, from Business Source Complete Database. Newberger, R. (2002). Financial institutions as stakeholders in individual development accounts. Chicago Fed Letter, Retrieved February 23, 2009, from Academic Search Complete Database. Phillips, Gordon. (n.d.) Cashflow Forecasting and Financing Need. [PowerPoint Slides]. Retrieved February 24, 2009, from http://www.rhsmith.umd.edu/faculty/gphillips/courses/Bmgt640/Notes%207%20External %20Funds%20Needed.pdf. Read More