FINANCIAL PLANNING TOOLS AND CONCEPTS

Planning is an important aspect of the firm’s operations because it provides road maps
for guiding, coordinating, and controlling the firm’s actions to achieve its objectives.
(Gitman and Zuller, 2012)

Different types of Planning

- Financial planning refers to the process of determining the best uses of the
financial resources of an organization to attain its predetermined objectives, and
the procurement of the required funds at the least cost.

- Corporate Planning is defined as a formal and systematic managerial process,

organized by responsibility, time and information, to ensure that operational
planning, project planning, and strategic planning are carried out regularly to
enable top management to direct and control the future of the enterprise.

- Strategic Planning is the process of making decisions which will tend to optimize
the organization’s future position despite changes in future environment.

- Project planning or capital expenditure planning refers to working out the

execution of an action outside the scope of current operations such as acquisition
of another company, a new plant, a new market, or adoption of a new system.

- Operational Planning refers to a forward planning of existing operations

The Financial Planning Process

In planning the best uses of a firm’s resources, the different step followed are based on
the following questions?

Where are we now?

This requires analysis of the current financial statements of a company. This is done
to detect areas of strengths and weaknesses as indicated by the measures of liquidity or
short-term solvency, profitability, and stability.

How did we get there?

This requires an interpretation of historical data which may reveal the causes of
current financial stability or difficulty such as sufficiency or insufficiency of fund inflows
from operations, inability to plough back earnings by declaring the greater portion annual
net income as dividends, and unprofitable operations of some sub-units.
Where do we want to go?
The different alternatives are evaluated, and the best choice is made considering
the projected outcomes.

Budgeting is the process where an entity translates their operations in quantitative terms,
usually monetary, to represent it as its planned operations, activities, and production for
a specific time period consideration.

Objectives of Budgeting
1. A budget should be able to provide a realistic estimate of income and expenses.
2. A budget should provide a coordinated plan of action for the entity.
3. A budget should serve as a control mechanism that can be used in performance
evaluation by being able to check results and suggest future corrective actions.
4. A budget should provide guidance to management.
5. A budget should help in decision-making.
6. A budget should be able to improve communication, coordination, and
harmonious operations within the entity.

Budgeting helps in
- planning - control
- performance evaluation - motivation
- coordination - promoting positive behavior

Benefits of Budgeting
• It compels managers to think ahead.
• It provides an opportunity to reevaluate existing activities and evaluate new ones.
• It aids managers in communicating objectives and coordinating actions across the
organization.
• It provides benchmarks to evaluate subsequent performance.

Master Budget is regarded as a comprehensive financial planning tool that highlights

operating budgets, budgeted financial statements, and a financial plan.

Operating Budget is a budget plan dedicated to the operations of the entity such
as sales, production, and operating expenses.
 Sales Budget  Overhead Budget
 Production Budget  Cost of Sales Budget
 Purchases Budget  Operating Expenses Budget
 Direct Labor Budget
 Financial Budget is a budget plan dedicated to the entity’s cash budget, budgeted
financial statements, and capital acquisitions.
 Cash Budget  Budgeted Financial
 Capital Acquisitions Statements
Budget

Budgeting Process

Comprehensive Problem: Master Budget

Sales Budget
• C. Alvarez Merchandising is preparing budgets for the quarter ending June 30.
• Budgeted sales for the next five months are:
Month Budget Sales (in units)
April 20,000
May 50,000
June 30,000
July 25,000
August 15,000
• The selling price is P10.00 per unit.

Schedule of Expected Cash Collections

• All sales are on account.
• C. Alvarez’ collection pattern is: 70% collected on the month of sale, 25% collected
on the month following sale, 5% uncollected
• The March 31 accounts receivable balance of P30,000.00 will be collected in full.
Purchase Budget
• The management of C. Alvarez Merchandising wants ending inventory to be equal
to 20% of the following budgeted sales.
• On March 31, the ending inventory is P40,000.00
• The cost of sales margin is 60%

Schedule of Cash Disbursement on Purchases

• One-half of the month’s purchases is paid on the month of purchase; the other half
is paid on the following month.
• The March 31 accounts payable balance is P12,000.00

Selling and Administrative Expense Budget

• At C. Alvarez, the selling and administrative expense budget is divided into variable
and fixed components.
• The variable selling and administrative expenses are P0.50 per unit sold.
• Fixed selling and administrative expenses are P70,000.00 per month.
• The fixed selling and administrative expenses include P10,000.00 in costs –
primarily depreciation – that are not cash outflows of the current month.

Cash Budget
Assume the following information for C. Alvarez:
• Annual interest rate for all borrowing is 16%.
• Maintains a minimum cash balance of P30,000.
• Borrows on the first day of the month and repays loans on the last day of the
quarter.
• Pays a cash dividend of P49,000.00 in April.
• Purchases P143,700.00 of equipment in May and P48,300.00 in June (both
purchases paid in cash).
• Has an April 1 cash balance of P40,000.00

Budget Statement of Financial Position

C. Alvarez reported the following account balances prior to preparing its budgeted
financial statements.
• Supplies – P43,150.00
• Land – P50,000.00
• Share Capital – P200,000.00
• Retained Earnings – P146,150.00 (April 1)
• Equipment – P175,000.00

Management of Cash, Inventory and Receivables

Cash Management involves the maintenance of cash and marketable securities
investment level, which will enable the company to meet its cash requirements and at the
same time optimize the income on idle funds.

Reasons for Holding Cash

Although cash has generally considered a non-earning asset, business firms must hold
cash for the following reasons:

1. Transaction Motive - cash needed to facilitate the normal transactions of the

business, that is, to carry out its purchases and sales activities.

2. Precautionary Motive - Cash may held beyond its normal operating requirement
level in order to provide for a buffer against contingencies such as unexpected
slow-down in accounts receivable collection, strike or increase in cash needs
beyond management’s original projections.

3. Speculative Motive- cash held ready for profit making or investment opportunities
that may come up such as a block of raw materials inventory offered at discounted
prices or a merger proposal.

4. Contractual Motive-A company may be required by a bank to maintain a certain

compensating balance in its demand deposit account as a condition of a loan
extended to it.

Inventory Management – the objective in managing inventory is to convert it as quickly

as possible to cash without losing sales due to stock outs.

• Raw Materials – these are purchased materials not yet put into production.
• Work in process – these are goods and labor put into production but not finished.
• Finished goods – these are goods put into production and finished. These are ready
to be sold.

Accounts Receivable Management – represents the assets of the entity that expected
to be collected and thus converted to cash. It involves maintenance of receivables of
optimal level, the degree of credit sales to be made, and the debtor’s collectiob.