EMT 301

LECTURE 7

FINANCIAL PLANNING AND MANAGEMENT

 FINANCIAL PLANNING
Planning involves setting a target (goal) to be achieved and setting

in motion modalities for achieving the set target. Any business that

fails to plan is planning to fail.

Financial planning therefore means deciding in advance the

financial activities to be done so as to achieve the basic objective

of the firm / business. The basic objective of a firm is to get

maximum profits out of minimum efforts.

 FEATURES OF GOOD FINANCIAL PLANNING
1. identification of viable projects and the
amount required to finance such projects;
2. identification of surplus/deficit periods and
amount of cash involved in any of the two
situations;
3. uses of surplus funds in order to avoid cash
being made idle; how to raise fund to take
care of deficit fund and the likely cost of
raising such funds.
 FUNCTIONS OF FINANCIAL PLANNING
1. Determination of Financial Objectives: - the main function of Financial Planning is to

determine the long – term and the short – term financial objectives of the firm.

2. Formulation of Financial Policies: - this is to formulate certain policies to be followed by the

financial authorities with regard to the administration of capital to achieve the long term and

the short term financial goals of the firm. Such policies may be related to capital requirement

estimates, credit policies, investment policies, dividend and assets management policies.

3. Development of Financial Procedures: this is to develop the procedure for performing the

financial activities. This is necessary for the sub – division of financial activities into smaller

activities, duties and responsibilities be delegated to the subordinate officers.

 IMPORTANCE OF FINANCIAL PLANNING
1.Adequate funds have to be ensured

2.It helps in ensuring a reasonable balance between

outflow and inflow of funds so that stability is maintained.

3.Financial planning helps in making growth and expansion

programmes which helps in long run survival of the firm

4.It helps in reducing the uncertainties which can hinder

the growth of the firm. This helps in ensuring stability and
profitability of the firm.
 FINANCIAL PLAN
Financial Plan is a comprehensive evaluation of a
firm current and future financial state by using
currently known variables to predict future cash
flows and asset values.

A financial plan is referred to as an Investment

plan.
 CHARACTERISTICS OF A FINANCIAL PLAN
1. Simplicity: - the financial plan of a firm should be as
simple as possible, the plan should be easily
understandable to all and free from ambiguity
2. Foresight: - aside from the momentary needs of capital
the future requirements must be ensured so as to design
a sound capital structure.
3. Flexibility: - the capital structure of a firm must be
flexible to meet the needs of the firm at any given time
and under any circumstance.
4. Liquidity: - liquidity means that a reasonable amount of
current assets must be kept in the form of liquid cash so
that firm operations may be carried on smoothly without
any shock due to shortage of funds.
 Financial plans are based on future projections via forecasts which are;

1. Environment forecasts: - these are to enable the firm assess

and monitor likely economic situations that may influence
the future prospects of the business. Some of the economic
factors include; rate of inflation, foreign exchange rate and
borrowing rate.
2. Market/ Industry forecasts: - a firm belongs and operates
within a market or industry therefore forecasts are prepared
to cover the likely rate of growth or decline in the industry.
3. Segmental forecasts: - it is not unusual to make forecasts
for sales and profits when forecasts are prepared but
necessary to segment for future projection.
 FINANCIAL MANAGEMENT
Financial Management is concerned with the
procurement and effective utilisation of funds
for the efficient functioning of a business.

Financial management is the operational activity

of a business that is responsible for obtaining
and effectively utilising the funds necessary for
efficient operations.
 FUNCTIONS OF FINANCIAL MANAGEMENT
• Financial Forecasting: - the first function of financial management is to forecast the financial
needs of the firm. This is usually done by the chief executive officer or the financial manager,
in estimating the financial requirements budgets of all the departments are taken into
account.
• Establishing Asset – Management Policies: - in order to estimate and arrange for cash
requirements of a firm, it is very necessary to decide how much to be invested in fixed assets.
Establishing a sound asset – management policy is a pre – requisite to an effective financial
management.
• Allocation of Funds: - the financial manager oversees the allocation of funds among
alternative uses.
• Regulation of Cash Flows: - this is the adequate supply of cash made available for the smooth
running of the firm. Cash inflow and cash outflow must be continuous and uninterrupted.
• Financial Control: - the financial manager is under an obligation to check the financial
performance of the funds invested in the firm. An unbiased assessment of financial
performance is of great importance to the firm in improving the standards and techniques of
operations.
• Proper record keeping and reporting
OBJECTIVES OF FINANCIAL MANAGEMENT
The basic objectives of financial management are; profit maximisation and
wealth maximisation
• Profit maximisation: - Business has been considered as an economic
institution as such, it has developed a common and unique
measurement of efficiency which is profit, that is, maximisation of profit
is the main objective of a business. Investors purchase shares with the
hope of getting maximum profits from the company as dividends. This is
possible only when the company’s goal is maximisation of profits.

• Wealth maximisation: - maximisation of wealth or value is represented

by the market price of the equity shares of the firm over the long run
which is certainly a reflection of company’s investment and financing
decisions. The long run means a considerable long period in order to
work out a normalised market price.
 IMPORTANCE OF FINANCIAL
•
MANAGEMENT
Measurement of Performance: - the performance of the firm can be
measured by its financial results. The financial data for the evaluation of
the performance of a business are computed by the finance managers
and the application of financial management tools on this data will reveal
the performance of the business.
• Co – ordination of Functional Activities: - financial management provides
complete co – ordination between various functional departments such
as marketing, production and personnel to achieve the organisational
goals. If financial management is defective the efficiency of all other
departments can in no way be maintained.
• Successful business promotions: - one of the most important reasons for
failure of business is a defective financial plan. If the plan adopted fails to
provide sufficient capital to meet the fixed and fluctuating capital
requirements of the business the business cannot carry on successfully.
Hence, sound financial plan is indispensable for the success of a business.
 THREE CORE DECISION AREAS IN
FINANCIAL MANAGEMENT

There are three core decision areas in financial

management; these are:

1. Investment decision

2. Financing decision

3. Dividend decision
 INVESTMENT DECISION

This involves the identification of viable projects;

it deals with the appraisal of projects using

various techniques to determine those that are

viable.
 FINANCING DECISION

This involves the identification of the

appropriate source (s) of finance that would be

used to finance the projects.

 DIVIDEND DECISION

This is the appropriate amount to be paid as

dividend and the profit that would be ploughed

back to finance expansion in the company.

 FINANCIAL STATEMENT
The term financial statement refers two statements-
The Income Statement and the Balance Sheet. Income statement
is also termed as Profit and Loss account while
Balance sheet is a statement of financial position of a business at
a specified moment of time. It represents all assets owned by the
business at a particular time.
The important distinction between an Income statement and a
Balance sheet is that the Income statement is for a period while
Balance sheet is on a particular date. Income statement is
therefore a flow report as contrasted with the Balance sheet
which is a status report.
Table 1: Profit and Loss Statement
ITEM/YEAR 1 2 3 4 5
Sales Revenue
Less: Production cost
Profit before tax
Less: Tax @ 30%
NET PROFIT
Less: Dividend @ 40%
RETAINED PROFIT
CUMULATIVE PROFIT
 A SAMPLE OF BALANCE SHEET
YEAR 0 1 2 3 4 5

TOTAL ASSET
Fixed Asset
Current Asset
Cash Balance ITEM/YEAR 1 2 3 4 5
TOTAL LIABILITIES Sales Revenue
Current liabilities Less: Production cost
Loan Profit before tax
Equity Less: Tax @ 30%
Retained profit NET PROFIT
Less: Dividend @ 40%
RETAINED PROFIT
CUMULATIVE PROFIT
 RATIO ANALYSIS

Ratios can be classified into the following

categories:
1. Profitability ratios
2. Financial or solvency ratios
 PROFITABILITY RATIOS

Profitability is an indication of the efficiency with

which the operations of the business are carried
out, poor operational performance may indicate
poor sales and hence poor profits.
The following are the profitability ratios: -
 RETURN ON INVESTMENT (ROI)
It indicates the percentage of return on the total
capital employed in the business.
Operating profit x 100
Capital employed

• Operating profit means profit before interest

and tax
 GROSS PROFIT RATIO
This ratio expresses relationship between gross
profit and net sales
Gross profit x 100
Net sales

This ratio indicates the degree to which the selling

price of goods per unit may decline without
resulting in losses from operation to the firm.
 NET PROFIT RATIO
This indicates the relationship between net
profit after tax and net sales.

Net profit after tax x 100

Net sales
 FIXED CHARGES COVER
Also known as Debt Service Ratio. It indicates
whether the business would earn sufficient
profits to pay periodically the interest charges.

Income before interest and tax

Interest charges
 Financial Ratios

Financial ratios indicate the financial position of

the company. A company is deemed to be

financially sound if it is in a position to carry on its

business smoothly and meet all its obligations

both long term as well as short term.

Fixed Assets Ratio: - the ratio should not be more
than 1. The ideal ratio under this is 0.67, if it is less
than 1 it shows that a part of working capital has
been financed through long term funds.
Fixed Assets
Long term funds
Liquidity Ratio: - this is also known as quick ratio.
This is ascertained by comparing the liquid assets (i.e.
assets that are immediately convertible into cash
without much loss) to current liabilities.
Liquid Assets
Current liabilities
Debt – Equity Ratio: - the debt – equity ratio is
determined to ascertain the soundness of the
long term financial policies of a business.
Total long term debt
Total long term funds
OR
External Equities
Internal Equities
END OF LECTURE 7