Question

What is the importance of financial planning ?

Hint:

Think of financial planning as creating a 'financial roadmap' for the business. Without this map, the business is likely to get lost, run out of fuel (cash), or miss its destination (goals).

Answer 1

Financial planning is the process of estimating the capital required and determining its composition. It is the process of framing financial policies in relation to procurement, investment and administration of funds of an enterprise. Its importance is crucial for the success of any business and can be highlighted by the following points:

Ensures Availability of Funds: The primary importance of financial planning is to ensure that adequate funds are available at the right time. It helps the business to foresee its fund requirements for both long-term and short-term needs, preventing situations of cash shortages.

Optimal Capital Structure: Financial planning helps in deciding the optimal mix of debt and equity capital. A proper balance ensures lower cost of capital, maintains financial stability, and avoids over-capitalization or under-capitalization.

Facilitates Investment Decisions: It provides a framework for making sound investment decisions. By analyzing the available funds and future prospects, management can decide where to invest in fixed assets and working capital to maximize the return for shareholders.

Helps in Operational Activities: Smooth business operations depend on a steady flow of funds. Financial planning ensures liquidity for purchasing raw materials, paying wages, and meeting other day-to-day expenses, thus preventing operational disruptions.

Basis for Financial Control: Financial planning sets the standards against which actual financial performance can be measured and evaluated. It acts as a basis for financial control, helping management to identify deviations and take timely corrective actions.

Helps in Avoiding Business Shocks and Surprises: By anticipating future financial requirements and potential challenges, financial planning helps the business prepare for unforeseen circumstances, thus enhancing its stability and solvency.

Links Present with Future: It helps in linking the present financial decisions with the future needs of the business, facilitating long-term growth and expansion in a coordinated manner.