FINANCIAL PLANNING
9.0 Introduction
In this lecture we will discuss short-term financial planning which aim at projecting
future profits and future cash needs. The key outputs of the financial planning process are
the cash budget, pro-forma income statement, pro-forma balance sheet, and a number of
operating budgets.
Objectives
At the end of this lecture you should be able to:
1. Explain the financial planning process.
2. Prepare cash budgets
3. Prepare pro-forma income statements
4. Prepare pro-forma balance sheets
11.1 OPERATING FINANCIAL PLANS
The financial planning process begins with long term plans, which are based on the
firm’s long term strategic goals. Short financial plans (operating plans) implement as
much as possible the long term strategies. The focus in this lesson is on the operating
(short term) budgets.
A key task of financial management is to look ahead – to plan. An operating plan of
action is a statement of what is to be done in some future period, how it is to be done,
and the likely impact of the actions. Planning confers the following rewards to an
organization:
Insurance against risk. Careful planning helps a firm identify likely future contingency
and prepare for them. Plans are not only helpful as a guide to action but may be required
by external parties when they have to deal with the firm (i.e. lenders)
Decision making. Planning, essentially, is making decisions in advance about what is
to be done in future. Financial planning helps a firm make decisions in advance on how
to deal with the uncertainties regarding the amounts, timing and nature of future
financing requirements
Communication. Plans are useful in the communication with important outside parties,
including investors and other suppliers of funds. By coming to the bargaining table with
a comprehensive plan, a firm’s management sends a confidence invoking signal and
gains a psychological advantage in the bargaining process.
Co-ordination. A planning system improves co-ordination in an organization. The
basic elements of the financial plan are the cash budget and the projected income
statement and the balance sheet. The building blocks for these three are myriad detailed
1
, operating budgets (including personnel budget, production budget, purchasing budget)
representing time-phased schedule of the expenditures, people, material and activities
required to accomplish the objectives set forth in the overall financial plan. Without co-
ordination such meshing could be a daunting task.
Control. Management control systems are based on comparisons of actual data versus
plans. By comparing actual versus plan data at frequent intervals, deviations can be
detected as events unfold, and timely corrective action can be taken. Production
schedules can be modified, advertising budgets increased, collection efforts intensified or
expenses cut. In sum, cash budgets and pro-forma financial statements are indispensable
in achieving good control.
9.2 FINANCIAL PLANNING PROCESS
The process of generating short-term financial forecasts is depicted in Figure 11.1 below.
A systems approach is necessary for development of the budgets. They input is the sales
forecast, from productions are prepared then the cash budget and the pro-forma income
statement and finally the pro-forma balance sheet. The steps are summarized as:
1. Establish a sales projection.
The key input to preparation of cash budgets is the firm’s revenue (sales)
forecast. It is on the basis of this forecast that the manager predicts cash
receipts, cash outlays, fixed asset requirements and the amount of outside
financing that will be necessary. The sales forecast could be eternally based
(i.e. on the national GDP) internally based or a combination of the two.
2. Determine a production schedule and the associated use of raw materials,
labour, overheads and operating expenses. The number of units produced will
depend on the beginning inventory, the sales projections, and the desired level
of ending inventory
3. Prepare the pro-forma income statement and the cash budget.
4. Finally, develop the pro-forma balance sheet.
9.3 PREPARING FINANCIAL FORECASTS
2
9.0 Introduction
In this lecture we will discuss short-term financial planning which aim at projecting
future profits and future cash needs. The key outputs of the financial planning process are
the cash budget, pro-forma income statement, pro-forma balance sheet, and a number of
operating budgets.
Objectives
At the end of this lecture you should be able to:
1. Explain the financial planning process.
2. Prepare cash budgets
3. Prepare pro-forma income statements
4. Prepare pro-forma balance sheets
11.1 OPERATING FINANCIAL PLANS
The financial planning process begins with long term plans, which are based on the
firm’s long term strategic goals. Short financial plans (operating plans) implement as
much as possible the long term strategies. The focus in this lesson is on the operating
(short term) budgets.
A key task of financial management is to look ahead – to plan. An operating plan of
action is a statement of what is to be done in some future period, how it is to be done,
and the likely impact of the actions. Planning confers the following rewards to an
organization:
Insurance against risk. Careful planning helps a firm identify likely future contingency
and prepare for them. Plans are not only helpful as a guide to action but may be required
by external parties when they have to deal with the firm (i.e. lenders)
Decision making. Planning, essentially, is making decisions in advance about what is
to be done in future. Financial planning helps a firm make decisions in advance on how
to deal with the uncertainties regarding the amounts, timing and nature of future
financing requirements
Communication. Plans are useful in the communication with important outside parties,
including investors and other suppliers of funds. By coming to the bargaining table with
a comprehensive plan, a firm’s management sends a confidence invoking signal and
gains a psychological advantage in the bargaining process.
Co-ordination. A planning system improves co-ordination in an organization. The
basic elements of the financial plan are the cash budget and the projected income
statement and the balance sheet. The building blocks for these three are myriad detailed
1
, operating budgets (including personnel budget, production budget, purchasing budget)
representing time-phased schedule of the expenditures, people, material and activities
required to accomplish the objectives set forth in the overall financial plan. Without co-
ordination such meshing could be a daunting task.
Control. Management control systems are based on comparisons of actual data versus
plans. By comparing actual versus plan data at frequent intervals, deviations can be
detected as events unfold, and timely corrective action can be taken. Production
schedules can be modified, advertising budgets increased, collection efforts intensified or
expenses cut. In sum, cash budgets and pro-forma financial statements are indispensable
in achieving good control.
9.2 FINANCIAL PLANNING PROCESS
The process of generating short-term financial forecasts is depicted in Figure 11.1 below.
A systems approach is necessary for development of the budgets. They input is the sales
forecast, from productions are prepared then the cash budget and the pro-forma income
statement and finally the pro-forma balance sheet. The steps are summarized as:
1. Establish a sales projection.
The key input to preparation of cash budgets is the firm’s revenue (sales)
forecast. It is on the basis of this forecast that the manager predicts cash
receipts, cash outlays, fixed asset requirements and the amount of outside
financing that will be necessary. The sales forecast could be eternally based
(i.e. on the national GDP) internally based or a combination of the two.
2. Determine a production schedule and the associated use of raw materials,
labour, overheads and operating expenses. The number of units produced will
depend on the beginning inventory, the sales projections, and the desired level
of ending inventory
3. Prepare the pro-forma income statement and the cash budget.
4. Finally, develop the pro-forma balance sheet.
9.3 PREPARING FINANCIAL FORECASTS
2
