Financial Planning and Budgeting in Finance

Financial planning and budgeting in finance refers to the process of allocating financial resources to meet an organization’s strategic objectives. It involves forecasting future financial needs, evaluating the impact of business strategies on financial performance, and determining the timing, amount, and sources of capital.

A strategy is the direction a company takes to meet its objective, whereas a strategic plan is how a company intends to go in that direction. For management, a strategic investment plan includes policies to seek out possible investments.

A strategic plan also includes resource allocation. If a company intends to expand, where does it get the capital to do so? If a company requires more capital, the timing, amount, and type of capital (whether equity or debt) comprise elements of a company’s financial strategic plan. These things must be planned to implement the strategy.

Financial planning allocates a company’s resources to achieve its investment objectives.

Financial planning is important for several reasons:

1. First, financial planning helps managers assess the impact of a particular strategy on their company’s financial position, its cash flows, its reported earnings, and its need for external financing.
2. Second, by formulating financial plans, management is in a better position to react to any changes in market conditions, such as slower than expected sales, or unexpected problems, such as a reduction in the supply of raw materials. By constructing a financial plan, management becomes more familiar with the sensitivity of the company’s cash flows and its financing needs to changes in sales or some other factor.
3. Third, creating a financial plan helps management understand the tradeoffs inherent in its investment and financing plans. For example, by developing a financial plan, management is better able to understand the trade-off that exists between having sufficient inventory to satisfy customer demands and the need to finance the investment in inventory.

Financial planning consists of the company’s investment and financing plans. Once we know the company’s investment plan, management needs to figure out when funds are needed and where they will come from. This is accomplished by developing a budget, which is basically the company’s investment and financing plans expressed in monetary terms.

A budget can represent details such as what to do with cash in excess of needs on a daily basis, or it can reflect broad statements of a company’s business strategy over the next decade.

Budgeting for the short term (less than a year) is usually referred to as operational budgeting; budgeting for the long term (typically three to five years ahead) is referred to as long-run planning or long-term planning. But since long-term planning depends on what is done in the short term, the operational budgeting and long-term planning are closely related.