Business Studies · Ch 9 — Financial Management
Importance
Importance
Financial planning is not a separate, isolated activity — it is a core part of the overall planning of any business enterprise. Its fundamental purpose is to help the company handle uncertainty regarding the availability and timing of funds. By doing this, financial planning ensures the smooth functioning of the organisation.
The importance of financial planning can be understood through the following points:
- It helps in forecasting future scenarios. Financial planning forces the firm to think about what may happen under different business situations. For example, a company might predict a 20% growth in sales. But what if the actual growth is only 10%? Or as high as 30%? Many expense items will differ in each of these three situations. By preparing a blueprint — an alternative financial plan — for each possible outcome, management can decide in advance what must be done in each case. This preparation is of immense help in running the business smoothly.
- It helps in avoiding business shocks and surprises. By preparing for the future, financial planning prevents the firm from being caught off guard by sudden changes. The company is better prepared to face whatever comes.
- It helps in coordinating various business functions. Financial planning provides clear policies and procedures. This clarity helps different departments — for example, sales and production — work together without conflict or confusion.
- It reduces waste, duplication of effort, and gaps in planning. Detailed plans of action, prepared under financial planning, ensure that resources are used efficiently and that no important area is left uncovered.
- It links the present with the future. Financial planning connects today's decisions with tomorrow's goals, ensuring that short-term actions are aligned with long-term objectives. …
Even successful businesses have debt, but how much is too much? Learning how to manage debt is what can put you ahead.
Taking on the right amount of debt can mean the difference between a business struggling to survive and one that can respond nimbly to changing economic or market conditions. A number of circumstances may justify acquiring debt. As a general rule, borrowing makes the most sense when you need to bolster cash flow or finance growth or expansion. But while debt can provide the leverage you need to grow, too much debt can strangle your business. So the question is: How much debt is too much?
The answer, experts say, lies in a careful analysis of your cash flow as well as your industry. A business that doesn't grow dies. You've got to grow, but you've got to grow within the financial constraints of your business. What is the ideal capital structure a business needs in its industry to remain viable? The higher the volatility (in your industry), the less debt you should have. The smaller the volatility, the more debt you can afford.
Although banks and other financial institutions look for a satisfactory debt-to-equity ratio before agreeing to make a loan, don't assume a creditor's willingness to extend funds is evidence that your business is in a strong debt position. Some financial institutions are overzealous lenders, particularly when trying to lure or hold on to promising business customers. "The bank may be looking more at collateral than whether the (business's) earnings are going to come in to justify the debt service." …