Financial Planning and Analysis in Financial Management - Essay Example

Financial planning and analysis in Financial Management By Name: Presented to Instructor’s Name, Course Institution Name, Location Date Due Literature Review Introduction Financial planning and analysis is the determination of how the business firm will manage to achieve its strategic goals and by scrutinizing and analyzing its financial elements and plans. It is the process of identifying the financial weak point and strong holds of the organization by establishing the relationship between the items of profit and loss accounts and the balance sheet. The financial statements are required for choice making procedure; they play a very vital role in setting the structure of managerial decision makings (Gullapalli 2007). Financial planning and d analysis is the foundation on which smart enterprises find their through way to upcoming supremacy, it plays a pivotal task in managing the present challenges and the development of future strategies for the company. The agility of a modern business organization in acting upon the continuous changing economic situations is highly dependent on the efficiency and effectiveness in it implementation of the financial planning and analysis functions (Henrion 2009). Planning and analysis also helps in the assessment of the viability of the business and determine the chances of running the business successfully by making sure that the plan is fulfilled through the process of continuous assessment. There is an increasing emphasis put on the financial planning and analysis by the upcoming organizations, this pressure comes due to the cost pressure put on the finance departments. Managing the financial challenges with very limited resources and the process of finding ground-breaking ways of delivering the objectives of the companies has is the top most priorities of the decision makers. Financial planning and analysis is one of the major functions that help the managers in making major decisions concerning the profitability and other elements that facilitate the financial sanity in the of the firms. In addition, the process of planning and analysis provide vital information that helps the managers to foresee the future performance of the business firm. Hence, the process of financial planning is very important to the success of any business organization (Labaton 2009). The importance of research is to figure out whether the application of financial ratios helps its financial fitness and choice making procedure in any business organization in financial administration. Financial management is the activity that is curried out by managers concerning the planning and controlling of the organizations financial resources. The foundation of financial planning, analysis and choice making is financial information. Financial information is needed for prediction, making comparisons and evaluation of the ability for the company to earn success. It is an important requirement for recognition of economical decisions both for investment and financial (Gullapalli 2007).Managing the financial wealth for a company addresses the complicated issues of financial planning and control. This provides room for achievement measures and sum analysis, the methods of recuperative gain and techniques of financial natural balance and management. Financial administration is very critical in any form of business supervision. There should be clear adherence to correct use of optional sources of capital, in adjustment to recognize a spending grouping to move in the management of its widespread goals (Gullapalli 2007). Elements of financial planning and analysis For any company it financial goals it should have and implement a comprehensive financial plan, a comprehensive and detailed financial plans covers all the basics of finance. This means that all the factors of a financial plan. The basic element of a detailed financial plan and analysis include forecasting, budgeting, reporting and analysis, the other major elements include resource allocation, information technology support and human resources support not forgetting operational support. Each off all these elements is a topic of its own (Labaton 2009). Forecasting is defined as the periodic calculation of the future trend after having a greater consideration of both the internal and external factors, this is done by continuous analysis and extrapolation of the past results and applying known anomalies to the past trends. This element is a very important part of financial analysis, a financial planner or a department dealing planning of financial strategies of a company cannot afford to miss this element. Individual financial plan should also have this element to avoid taking a path that one doesn’t know it future in financial life (Gullapalli 2007). Budgeting is also another important element of financial planning and analysis. It involves the well drawn and detailed financial plan that ascertains the future periodic goals. The budgeting process is done before the beginning of every other financial year and is drawn out by month. Budgeting usually has the details of the financial elements considering the potential of the business. It helps in establishing the goals of the enterprise for the future period. It also gives the details of the various financial plans considering the abilities of the business. Creating a budget sets out a well planned cash flow in the business, by having the ability to monitor the cash flows using the budget then it is very easy to identify any potential crisis that is likely to arise. A budget also sets out the expenditure and income in the business (Labaton 2009). Reporting is also another significant element of financial planning and management; it is the provision of detailed information at a periodic interval on the financial status of the business as required by the stakeholders to help them in making very important decisions for the business organization, the stakeholders of any business organization include management, business partners, creditors, debtors and the investors (Henrion 2009). The information that should be reported includes: the past performance of the business, the strategies that has been put in place, the future plans, the esteemed goals and objective of the business and finally the market shares including others. Analysis as a vital element of financial planning refers to the assessment of the financial aspects of the organization to gauge the level of performance of the company. Analysis usually involves the in depth understanding of the financial ratios of the business; it also needs the comparison between the budget and the forecast of the company. Financial analysis also involves the profitability, deployment of funds, the viability of the business, the marketing environment and the investor’s protection (Henrion 2009). The process of analysis plays a major role in helping the management to understand the problems that affect the business; it also serves as an eye opener to the management to see the opportunities that are available for the business to take up. Resource allocation is the process of decision making on how to make use of the profit earned by the business, the decision on whether to hand out them to shareholders in the form of dividend is in case the dividends are extremely high, the business might also experience a starving situation and hence the business can reinvest the resource in order to produce revues thus making the profits. Financial management is basically about the procurement, control of the finances of the business by making right decisions and the proper allocation of resources of the business (Labaton 2009). Financial control is another element that aims at making sure that the objectives and goals of the business is achieved. The issues dealt with by business control include making sure that the assets of the business are well utilized and are highly secured to avoid discrepancies. It also does the management act in the best way possible to meet the interest of the shareholders also, minding the rules that govern the business deals (Henrion 2009). Insurance is also another vital element of financial planning and analysis it is all about protecting the business from risks that prevail, it is intended to reduce risks and liability in an event of a loss related to the business. Insurance help the company safe a lot in case of tragedies, therefore, it is essential for the companies to include insurance payment of policies to ensure that it does not get to a loss in case of tragedies. Importance of financial planning in financial management Financial management is very important and no one can ignore the implications that can have to a business if ignored by the management. Every individual is supposed to understand the importance of finance to an economy. Financial planning is an ingredient of financial management and therefore to have a successful finance management there should be a very detailed and comprehensive financial planning (Henrion 2009). There are very many reasons why firms need to carry out financial planning and analysis. First, financial planning and analysis in any organization helps the managers to envision and plan both the long term and short term objectives of the organization. (Labaton 2009) They look at the nature of the elements of the financial analysis and make a decision on the most appropriate steps to be taken that that are geared towards developing good performance of the company. Secondly, financial planning and analysis drives the performance of any firm ahead. It gives the direction that the organization ought to be geared towards. The management analysis elements help to compare with the budgeted report at the end of the year hence finding out whether the business achieved its goals or not, if not the management then sets the company in the right track by reanalyzing the financial element well(Henrion 2009) l. Financial planning helps the organization to monitor the income more proficiently in order to separate it into payment of tax. It also gives the companies the ability to monitor their monthly expenditures and saving because every business needs to have appropriate administration of income in order to increase the cash flow. This means that organization has to examine their expenditures and budgets and pay taxes and have some cash left for saving (Labaton 2009). The third reason why it is important to carry out a financial analysis is that it helps in meeting and over-achieving both the internal and external expectation of the company. Both the internal and external expectations are well balanced when planning and analysis are done accurately and the firm automatically realizes these expectations as required (Henrion 2009). The financial planning makes the execution of the strategies put in place in the management goals easier to execute in a logical and successful manner. The financial management of companies should make their decisions on the firm accounts and the financial position by following the local government financial policies. The objectives of the choices should be to create great principles for its stakeholders. The worth of the decisions should be represented by the marketplace price of the company. The companies should use the financial plan and analysis to achieve it profit maximization because the plan has the potential you give back to the company. Financial management should also analyze the financial position of the company every year and take up major decisions on the progress and economical position of the firm (Henrion 2009). Another reason to carry out financial planning is to enable the management to comprehend well the reasons behind the variance between the real achievement and the forecasted expected results. It is very common and normal to find that the expected performance results differ a lot from the real results the variation can either be negative or positive depending on the performance of the company. The variation can have a great meaning to the company or organization, from the variation the company can gauge whether it will have performed efficiently or inefficiently in deploying it expenditure. This gauge will help the management in assessing and evaluating where they failed or succeeded and take action appropriately to avoid the obstacle in the next financial period (Labaton 2009). Financial planning also helps in enabling the strategic analysis of the performance of the company. The company need to know its performance as compared to other companies in order to rate itself with the competing companies, the process is very necessary since in the competitive world the companies need to know their position in order to strategize on how to outcompete their market rivals. The planning of finance also help the company in coming up with a strong capital base through savings, this will form the financial position of the company for the days to come this will lead to escalation of the cash flow. With enough capital, the business can venture into investments and can develop a wide portfolio of investments. This will help the company to earn credit from other financial companies like banks that can lend loans hence increasing the business empire (Labaton 2009). Financial planning also gives proper directions to business financial choices. It gives an understanding to all those who were involved on how to plan and make choices about their business finances and areas affected and make scope for goals to be set and considered. This will make the business more safe when they understand what their financial place is how protected they are (Labaton 2009).Organization prepare financial plans in order to be good stewards meaning that they be accountable to other, organizations plan financially in order for the company to act as a steward to other organization like non-profit organization that pay for the services in order to donate resources to the organizations, this will further help the organization to reinvest their revenues to helping the others and have a great impact. Financial planning therefore will help he organization to fulfill mission and win the public trust (Labaton 2009). Financial ratios analysis and the effect in decision making and financial health In assessing the importance of the diverse financial data for proper investment decisions, experts involve themselves in financial analysis, a method used to determine and evaluate financial ratios. A ratio is an association that shows something about the activities of the company for example the ratio between the company’s current assets and liabilities, or comparing between the account receivable and the and its annual sales(Labaton 2009). The most common source of these ratios is the companies’ financial statements that has figures on the assets, profits, loses, and liabilities of the company. The ratios only become important when contrasted with other financial data. Financial ratios are very important profit making tools in any financial analysis that assist the financial analyst put into practice the plans that heighten the profitability, financial structure, since they are mostly compared with data from the industry, the ratios can give a hand to an personality who comprehend the company’s performance in relation to that of its competitors and are usually used to track performance over time (Henrion 2009). Even though those most ratios report mostly on the performance, they can predict the future too and show indicators of highly potential problematic areas. Ratio analysis is usually used to compare financial figures of the organization over a very long period of time this method is usually called trend analysis. Through the trend analysis you can identify the trends either good or bad. This is used to adjust the business activities appropriately. It also shows how the ratios stuck up alongside other businesses both inside and outside the company (Labaton 2009). With regards to (Lancaster, 2005). From the financial statements cash flow various appropriate financial can be acknowledged and calculated. In the process of analyzing this ratios, one should not begin writing and calculating the ratios, this is due to the fact that there are many financial ratios that should be considered and therefore there is need for one to ascertain which particular ratio he/she needs to calculate, financial ratios usually play two important functions; first, the ratios assist in the control of finance by the management, some ratios have a certain implications, hence, the managers looks at the nature of certain ratios and concludes easily the state of the performance of the organization. This gives them the ability of making a comparison of the ratios to these benchmarks is referred to as financial control (Labaton 2009). The financial ratios also help in financial planning. The financial ratios of the previous year can help a lot in managing the available resources in order to come up the most appropriate budget for the new financial year, the budget that is reached after making a clear analysis of the previous ratios is usually a clear, appropriate and realistic with achievable objectives. The financial ratios show the financial position of the company (Labaton 2009). Actually, financial planning deals with assessing the business surrounding, the identification of business resources an issued of the budget. The calculation of financial ratios enables all these activities to be done effectively and the company in return will improve its performance (Gullapalli 2007). The capital investment decisions are long term corporate finance decisions concerning fixed assets and capital structures (Labaton 2009). The decisions are based on the several unified criteria. The cooperate management seeks to make the most of the value of the firm by investing in projects which produce a positive net current value when prized using an suitable discount rate. These projects must also be financed appropriately. If there are no such opportunities that exist, maximizing shareholders value dictates that the management should return the excess cash to the shareholders. Capital venture decision thus comprises an investment decision, a financing, and a dividend decision. A positive venture can only be in use as the use of ratio analysis. According to Baker and Powell (2005) financial planning is a function of management concerned with the laying down of projections on what should define the organization in terms of projects and investments in the longer ter. The organization’s financial planning team is as well concerned with the issue of fund flow, commonly referred to as cash flow management in the contemporary business setting. Cash flow is concerned with the rate at which money flows into and out of an organization. A financial planning team will in most cases seek to manage cash flows with the primary aim of maintaining and improving the liquidity position of an organization. Liquidity usually refers to the ability of an organization to meet its short term financial obligations, as and when they fall due Toten (2006). Financial planning as well concerns itself with the aspect of financing. The financial planning team of an organization should at all times endeavor to ensure than an organization is not indebted to an extent that its credit worthiness is compromised. Stoval and Maurer (2011) define financial analysis as the process of trying to evaluate the financial strength of a company for comparison purposes. They argue that financial analysis enables the stakeholders of a company to compare the performance of an organization in two ways. One of the most important ways through which the organization’s stakeholders can compare performance is through carrying out cross sectional evaluation. Groppellli and Nikbakht (2006) explicate cross-sectional comparison as the process of comparing the performance of an organization with the performances of other organizations of equal size, and operating in the same industry. The performance of an organization can be compared to another organization or the market averages. Groppellli and Nikbakht (2006) as well explain another form of comparison, which is vertical comparison. Vertical comparison entails the organization trying to evaluate its current performance, against various performances along the continuum of time. This means that current performance can be compared to either past performance or projected results. Such analysis makes use of financial ratios. Moyer and Moyer (2012) describe financial management as the totality of all activities related to the way an organization raises funds for both short term and long term projects, and how such projects are projected to be productive. As such, financial management is concerned with the manner in which an organization will finance its long term projects. Bull (2008) argues that financial planning and analysis has a central role to play in financial management. One of the roles prominently mentioned by Bull (2009) is the actuality that financial analysis forms s the basis of decision making in financial management. Financial management, being the primary decision making function, needs accurate and reliable information on the financial structure and capabilities of an organization. Such information can only be acquired from financial analysts within the organization. Booker (2003) argues that financial ratios have a central role to play in decision making in the sense that they give information relating to activity level in the organization, the profitability rate in the organization, the liquidity position, leverage as well as efficiency within the organization. Khan and Jain (2007) argue that apart from providing the required figures, the financial ratios help financial management departments to establish the liquidity position of an organization. From knowing the liquidity position of an organization, the financial managers will determine whether or not the organization should obtain more debt in the capital structure. Khan and Jain (2007) explain that, despite the fact that financial managers are better decision makers than financial accountants, they rely on accounting information to make decisions. Since such ratios are based on financial information, it is valid to conclude that financial planning is quite helpful in financial management. The most common financial planning tool is the budget. The budget has variously been described as a quantitative plan indicating how the organization intends to raise money and how such money will be spent (Booker 2003). Budgets are used by financial managers to plan how money should be raised for organizational use. Additionally, financial managers will usually rely of the budgets to select which activity looks unnecessary. Such activity is plucked from the list as a way of mitigating expenses. Financial analysis helps the financial planning teams to establish the extent to which an organization is liquid. This is achieved trough expressing the current assets as a fraction of the short term liabilities (Moyer and Moyer 2012). Through such an analysis, the financial manager will be in a position to determine whether or not an organization can meet its obligations. If the financial analyst tells the financial manager that the current ratio is less than one, then the financial manager can come up with alternative methods of financing. Apart from indicating the liquidity of an organization, financial analysis can reveal the leverage level of the organization to the financial manager. A highly levered firm is one that has a big percentage of debt in its capital structure. Chandra (2010) explains that the financial manager of a highly levered firm should not go for more debt as this is likely to compromise the capacity of the organization to handle debts. The leverage ratio is calculated as a comparison of debt to equity (Groppelli and Nikbakht 2006). Financial analysis through the various ratios upholds the health of the organization through preventing it from going into a state of financial distress. Bull (2008) explains financial distress as a state in which an organization cannot be able to bear its obligations. Through the quick ratio analysis, the financial manager can sense danger and design such strategies as enhanced debt collection and cost reduction. Cost reduction is fundamentally important as a way of enhancing relative profitability. cost reduction is a concept that is employed by the financial manager as part of cash flow management efforts. Chandra (2010) explains that cash flow management is a concept associated with income assurance. Being assured of cash is the most important aspect of financial management and planning. Assurance of cash eliminates all uncertainties in the short run and paves way for proper planning. It is pointless and rather illogical to count on funds that a company is not assured of (Brigham and Houston 2009). Fundamentally, assurance is concerned with the availability of some minimum cash. Once the organization is sure to receive some minimum amount of cash, it can come up with a comprehensive plan on how to raise extra cash that can be used in enhancing organizational resilience. Brigham and Houston (2009) explain that a resilient organization is one that is capable of operating as a going concern even when the economic times are characterized by financial adversity. Summarily, the fact that cash flow management can assure an organization of some minimum amount of cash is important as it is in line with the going concern concept of business finance. The going concern concept of a business states that an organization should be able to be operating smoothly into the foreseeable future (Bull 2008). Apparently, many scholars (Brigham and Houston (2009), Bull (2008), Baker and Powell (2005), Chandra (2010) argue that financial analysis or financial ratios are the basis for short term and long term decision making procedures. What this means is that ratio analysis and financial planning provide information that guides the financial manager. The financial manager is responsible for evaluating and consequently approving or turning down many proposed long term projects. This is achieved through analyzing the long term profitability of the projects. Apparently, among the few things to be considered in considering a project worthwhile or otherwise is the performance of similar projects in the past (Brigham and Houston 2009). As a matter of common knowledge, such past information is provided by the financial planning and analysis function. As such, ratio analysis is a significant factor to consider in evaluation f development projects that define the long term position of the organization. One of the most critical roles of the financial manager is to evaluate the performance of various products and departments in an organization (Bull). This is done through careful evaluation of the efficiency of the organization in contributing to the overall profitability of the company. Essentially, the profits that a company realizes can be traced back to the respective departments. Financial analysis provides such information, which the financial management department roles upon in establishing the non viable products. These are those products that need to be scrapped off. The financial manager will not be in a position to make such decisions without careful financial analysis and presentation of the resultant ratios (Booker 2003). Along with this comes the make or buy decisions. In deciding whether to buy or make a certain component, the organization should at all times rely on financial analysis. Profitability ratios form the basis of resource allocation, a primary role of the financial manager. Resource allocation is mostly based on the extents of profitability in such a way that the most profitable departments and lines are allocated the highest number or amount of resources (Stoval and Maurer 2011). The profitability ratios will be able to identify the most profitable as well as the worst performing departments. This will put the finance manager in a better position to determine which department should be allocated a certain amount of resources. Clearly, such crucial financial decisions cannot be made without financial analysis, which is made possible through ratio analysis. Khan and Jain (2007) argue that allocation of resources is a crucial duty of the management and should be treated with utmost care and diligence. This explains the importance of the financial ratios in ensuring the financial health of an organization. Capital budgeting is synonymous with financial management (Toten 2006). Capital budgeting is a function that concerns itself with making decisions relating to the long term investments that the organization endeavors to undertake. In preparing capital budgets, an organization’s management should rely on the smaller budgets such as the cash budgets which are prepared on a semi annually basis. Such budgets reveal to the financial manager the probability that an organization is in a position to sustain longer term projects. If the cash budgets are deficit budgets, for example, meaning that the amount raised is less than the amount required, it means that the organization will not be in a position to pursue heavy longer term projects, as these will compromise the liquidity of the organization by tying up the much needed cash (Baker and Powell 2005). The historical ratios will as well help the financial manger identify the most viable long term projects. This will be achieved through discounting in a bid to incorporate the time value of money. Time value of money refers to the differences in the value of money as time brings about changes in the economy. Financial planning and analysis is a great determinant of the capital structure of an organization (Brigham and Huston 2009). Capital structure is the composition of the capital of a company, which is basically defined by the ratio of equity to debt. The degree to which an organization has debt in its structure is referred to as leverage. Khan and Jain (2007) observe that the equity-debt ratio is the guide that the financial manager relies on in making decisions relating to the extent to which an organization can make the best out of leverage. Apparently, there are many benefits that accrue to using debt in the capital structure. Moyer and Moyer (2012) explain that the most effective way through which the financial manager can make good of such leverage to understand the extent to which the organization is levered. It is important to note that the organization can be levered to an extent that is risky. Business risk is a type of risk that, according to Bull (2008), can be mitigated by a combination of financial planning and financial management efforts. The financial manager will find better ways of mitigating risk, through adhering to the financial policy of the company, and making use of the results of financial analysis. Despite all the usefulness of the financial levels explained by the above scholars and gurus in finance and accounting, many authors (Brigham and Huston (2009), Khan and Jain (2007), Baker and Powell (2005), Stoval and Maurer (2011) agree in near unanimity that the ratios have quite a number of shortcomings. Among the primary shortcomings is the actuality that such ratios are quantitative in nature. They do not reflect the human aspects of financial decisions (Bull 2008). Apparently, such ratios may mislead the financial manager on some matters due to errors in the original entries in the accounting information used. Brigham and Houston (2009) argue that financial ratios are not an efficient way to compare the organization with other organizations and market standards because the counting policies used to generate such figures are different. For instance, Khan and Jain (2007) argue that one company could be using a different depreciation method from another. In that case, they say, the values of the assets are likely to be different. References Baker, D. (2009). "It's Not the Credit Crisis,. The New York Times , 25-56. Casteuble, T. (2007). Using Financial Ratios to Assess Performance. Association Management , 6-10. F., E. (2009). Fundamentals of Financial Management. Cincinnati, Ohio: South-Western College Pub. Gullapalli, D. (2008). "Bailout of Money Funds Seems to Stanch Outflow. The Wall Street Journal , 20-28. Henrion, M. (2007). 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