FINANCIAL PLANNING PROCESS

Financial Planning is applied in both public finance and business finance. All entities whether a
business for profit or a non-profit organization – undertake financial planning as an inherent activity for
their existence and survival.

Financial planning, however, does not exist and operate as an independent activity in the
organization. It is the offshoot of interrelated planning activities happening in various sections and levels
of the organization. It is one of the important elements comprising the general plan of the business
organization.

The financial plan must be firmly anchored on the thrust of the business. Hence, financial planners
do not simply isolate or coop themselves up In a room and make all the necessary financial projections
sometimes out of nowhere. Rather, financial planners maintain strong coordination with the corporate
level regarding the general plan and with the different functional areas on the specific plans and express
these plans n monetary values.

BUSINESS VISION AND MISSION

All strategic plans of the different functional areas, departments, divisions, and units should be
anchored on the vision and mission of the business. Plans that have been prepared and implemented –
including a financial plan – but are not grounded on the vision and mission of the company may become
the root cause of future misunderstandings and troubles. The financial plan must be congruent with the
corporate vision and mission.

The vision conveys the ultimate goal of the organization. It outlines the final map of what the
business will be and where the business is going. The vision is the guiding star for all the plans, policies
and strategies of the business. Hence, all business activities to be undertaken at present or in the future
should be based on the vision.

Since the corporate vision is long-term in character, the business, through the finance office in
coordination with the different departments, prepares and adopts a long-term financial plan. Though
there is no specific amount of time prescribed, “long-term” commonly denotes five years or more. Three
years is even considered by other business entities as long-term.

Therefore, the basic principle in the preparation of a financial plan is to align it with the vision of
the business.

For example, the vision statement of a rural bank is as follows:

“To be a premier rural bank in Mindanao”

The mission of the business, on the other hand, sets the current business activities and outlines
what the business is for. It defines as well the nature of the business. More importantly, it lists relevant
undertakings and carries out or implements various projects for the realization of the vision.

Aduana, N.L., (2018). Business Finance in the Philippine Setting for

Senior High School. C&E Publishing, Inc.
 The monetary implications of the mission statement, particularly the strategies and various
operating activities, should be expressed in the short-term and medium-term financial plans of the
business. Both financial plans serve as precursor to the long-term financial plan.

With the vision statement of the rural bank mentioned earlier, its mission statement can be
phrased as follows:

“A rural bank providing complete and low-cost agricultural banking services to farmers across
Mindanao”

The goal states where all the activities and operations of the business are directed. It is the refined
version of the company’s vision. If the vision presents the desired end-state of the business in its broadest
term, the goal sets in a more specific medium the general end of the business.

For example, the bank may adopt the following goals in order to become a premier rural bank in
Mindanao:

“To expand the rural banking activities in various parts of Mindanao”

“To increase the quality of loan portfolio extended to farm borrowers”

The objective, on the other hand, is specific and short-term. Usually, business entities express
their objectives in quantifiable terms to highlight the specific aspects or details. The objectives present in
very clear terms the actions that must be taken by the business in order to meet its goals. The objective
is the refined version of the mission statement.

For example the rural bank may have the following objectives:

“To open two branches every year”

“To increase loan portfolio of 23% every year”

FINANCIAL PLANNING PROCESS

Business organizations conduct financial planning as underscored by the concern of goal-setting

in monetary terms. Financial planning answers this question: where will the business be in terms of
financial performance five or ten years from today?

The following steps are adopted in preparing a financial plan.

1. The business makes explicit assumptions of the future levels of the following items:
a. Sales
b. Cost
c. Operating expenses
d. Capital expenditures
e. Borrowings and interest
2. Projected financial statements (e.g., statement of comprehensive income, statement of financial
position, and statement of cash flows) are prepared.

Aduana, N.L., (2018). Business Finance in the Philippine Setting for

Senior High School. C&E Publishing, Inc.
 3. The projected financial statements are commonly analysed and interpreted using the financial
mix ratios.
4. The general financial plan is evaluated and reviewed by the top-level management for
improvement taking into account present trends and developments in the external environment.

Forecast settings on sales, cost,

step 1
expenses, and capital expenditure

Preparation of the projected

step 2
financial statements

Analysis and evaluation of the

step 3
projected financial statements

Review and evaluation of the

step 4
projected financial plan
Figure 1. Financial Planning Process

THE FORECAST

The first step in financial planning is forecast setting or the making of assumptions and
projections. In making a forecast or projection, the following are done:
1. The sale projection is estimated and prepared.
2. The production schedule, together with the estimated cost of production, is computed and
prepared.
3. The marketing and administrative expenses are estimated.
4. Additional funds requirements are determined.
5. The projected financial statements are prepared.

The Sales Forecast

The preparation of the sales forecast is the initial step in making the projection. In other words.
One must always start with the sales forecast when making a financial projection.

Thus, the business has to make projected sales for the next two to five years. In the preparations
of the projected sales, the sales performance of the last five preceding years is considered to determine
if the sales trend is increasing, decreasing, or maintaining a steady level.

Generally, it is the marketing department that is primarily responsible for preparing the sales
forecast. Different forecasting tools are used to predict future sales. Among these forecasting techniques
are the following:

a. Simple moving average

b. Weighted moving average

Aduana, N.L., (2018). Business Finance in the Philippine Setting for

Senior High School. C&E Publishing, Inc.
 c. Arithmetic geometric curve
d. Arithmetic geometric curve
e. High-low point method
f. Method of least square

For example, JENNY Trading presents the following sales figures in terms of units:

2014 22,800
2015 24,500
2016 28,750
2017 32,900
2018 36,350

Assuming that the business applies the arithmetic geometric curve to determine the projected
sales in year 2019, the percentage of increase every year and the average change percentage are
determined as follows:
Percentage of Increase
2014 ---
2015 (24,500 - 22,800)/ 22,800 07.46%
2016 (28,750 - 24,500)/ 24,500 17.35%
2017 (32,900 - 28,750)/ 28,750 14.43%
2018 (36,350 - 32,900)/ 32,900 10.49%
Total 49.73%
Divided by 4
Average change percentage 12.43%

Based on the average change percentage of 12.43%, the projected sales of JENNY Trading for 2019
will be 40,868 units (36,350 X 112.43%).

Once the projection based on past years’ sales performance of the business has been made the
estimated sales forecast is adjusted. The factors that highly influence the result of the projection include
other marketing information such as:

a. Environmental analysis
b. Consumer buying behaviour
c. Competitor’s possible marketing move
d. Government programs and priorities
e. Possible new entrants and threats of suppliers and buyers
f. Marketing mix strategies( price, promotion, product, place)

The Production Schedule

Before preparing the production schedule, the projected sales figure must be finalized. The
production schedule is highly dependent on the sales forecast. Every time a change is made on the sales
forecast, the production schedule is likewise changed.

The production schedule simply shows the cost of making or producing a product. Ti reflects the
following information:

Aduana, N.L., (2018). Business Finance in the Philippine Setting for

Senior High School. C&E Publishing, Inc.
 a. Number of units and the cost of raw materials
b. Direct labor cost
c. Manufacturing overhead cost
d. Desired inventory level

For example, the expected sale in terms of units of JENNT Trading is 2019 is 40,868. Assume further
that there are three types of raw materials required to produce one unit of finished product indicated as
follows:

Material AA 2 units
Material BB 3 units
Material CC 5 units

To manufacture 40,868 finished products, the total requirements are as follows:

Material AA (2 units X 40,868) 81,736 units

Material BB (3 units X 40,868) 122,604 units
Material CC (5 units X 40,868) 204,340 units

To determine the total cost of materials required to manufacture the product, the number of
materials requirement is multiplied by the prevailing price of the raw materials. For example, if Material
AA is priced at Php. 1.50 per unit, then the total cost to purchase Material AA will be Php. 122,604 (81,736
units X Php. 1.50).

Another important element in the production schedule is labor cost. It refers to the amount paid to
workers directly involved in making the product.

For example, JENNY Trading needs 25 workers to make the 40,868 finished products. Based on past
year’s performance, three hours is required to finished one product. Since 40,868 units are expected to
be produced, the total number of direct labor hours will be 122,604 (40,868 X 3 hours). In case the labor
rate per hour is Php 8.00, then the projected labor cost for the 40,868 units will be Php 980,832 (122,604
hours X Php 8.00).

The manufacturing overhead costs refer to costs incurred in producing a product that cannot be
classified as direct materials and direct labor costs. These costs include, among others, the salary paid to
the supervisor, light and water, depreciation of machinery, fuel and gas related to production, and indirect
materials.

Additional Funds Needed by the Business

There is a normal tendency that when the sales volumes increase, the production output also
increases. The moment the production increases in order to meet the expected increase in sales, the plant
capacity likewise increases. The expected increase in the plant capacity requires a corresponding increase
in assets.
A direct relationship between the sales volume and the requirements for assets can be observed.
Hence, an increase in sales will result in an increase in assets. However, there are assets that have no
direct relationship with the sales volume in which case the increase in sales will not result in the increase
in assets. Similarly, there are liabilities that have no direct relationship with sales.

Aduana, N.L., (2018). Business Finance in the Philippine Setting for

Senior High School. C&E Publishing, Inc.
 In accounting, the basis equation is assets are equal to liabilities and capital. Once the assets
increase, the other side of the equation composed of liabilities and capital likewise increase.
Thus, when the assets increase in view of the rise in expected sales, either liabilities or capital, or
both will increase.
An in-depth evaluation of the relationship between assets and the combination of liabilities and
capital indicates that the expected amount to increase in assets is financed by the following.
a. Liabilities (mainly current liabilities)
b. Capital (sourced from net income and not distributed to owners)

Once the expected increase in current liabilities and expected net profit retained in the business are
not sufficient to cover the expected increase in assets, the difference represents the amount of additional
funds needed.

To illustrate the concept, consider the case of JENNY Trading. In year 2019, Jenny is expected to sell
40,868 units. This projected sales figure is higher by 4,518 units (40,868 – 36,350) compared to the 2018
sales figure.

Upon the production of additional 4,518 units, the assets of JENNY Trading in the form of inventory
or finished goods increase. Once the 4,518 units are sold, the amount of increase in inventory has been
converted either into cash or receivable. Clearly, the increase in sales results in increase in assets either
in the form of receivable or cash.

Now, look at what happens to the other side of the accounting equation when the sales increase.
Check first what happens to the liability section.

The increase of sales by 4,518 units requires additional raw materials and direct labor. In other words,
the business incurs additional liabilities on account of purchases of raw materials and salaries of the
workers. This type of liabilities arises, therefore, because of increase in assets. In finance, this type of
liability is called spontaneous liability. Spontaneous liability refers to accounts payable and accruals
incurred by the business because of increase in assets other than property, plant, and equipment.

It appears that the amount of increase on the asset is reduced by the increase in current liability. The
increase in assets is partly financed by the current liability.

Once the 4,518 additional units produced are finally sold, the business realized a profit. The profit
realized by the business increases the equity of the owners. However, part of the profits realized from the
operating activities is returned to the owners in the form of dividends while some are added to the
business. The amount of profit retained in the business finances the increase in assets. It serves as a source
of funding the business.

The amount of income returned to the owners is called dividends. The ratio of dividends to the
earnings of the business is called dividend payout ratio. The ration of earnings invested back to the
business is called retention ratio. For example, the business has earnings of 5,000 pesos. Out of the total
earnings, 2,000 pesos is returned to the owners or shareholders. The amount of 2,000 pesos is called
dividends and the dividend payout ratio is 40% (2,000/5,000). The balance of 3,000 pesos goes back to
the business. The retention ratio is 60% (3,000/5,000).

Ideally, the amount of increase in assets is equal to the amount of increase in liability and capital so
that the fundamentals accounting equation is net violated. However, when the expected or required

Aduana, N.L., (2018). Business Finance in the Philippine Setting for

Senior High School. C&E Publishing, Inc.
increase in assets is more than the increase in spontaneous liability and increase in profit retained by the
business, additional funds from other sources are needed.

The formula to compute for additional funds when sales are expected to grow is as follows:

Additional = Projected increase - Spontaneous increase - Increase in retained

funds in sales in current liabilities earnings
needed

Projected = Change in sales X Current Assets (present)

increase in Sales (present)
sales

Spontaneous = Change in sales X Current Liabilities (present)

increase in Sales (present)
current
liabilities

Increase in = Earnings after tax X Dividend payment

retained
earnings

YVONE Manufacturing Company presents the following information related to 2018 results of
operation:
Sales 7,000,000
Current assets 4,200,000
Non-current assets 2,800,000
Current liabilities 980,000
Non-current liabilities 770,000
Ordinary shares 4,200,000
Retained earnings 1,050,000

The cost of sales is 60% of sales and the operation expenses is 25% of sales. The interest expense
amounts to Php245,000. The applicable tax rate is 30%. The company expects to maintain this relationship
in the 2019 operation and plans to pay 60% of the income as dividends to shareholders.

Because of higher demand of the product and increased share in the market, the business expects a
10 % increase in sales in 2019. Non-current assets in 2019 are not expected to increase including non-
current liabilities spontaneous to the increase in sales.

Aduana, N.L., (2018). Business Finance in the Philippine Setting for

Senior High School. C&E Publishing, Inc.
 Required:

1. Determine whether additional funds are needed because of the expected increase in sales
2. Prepare the projected statement of financial position.

Answer 1: the amount of additional funds if required is computed by determining first the projected
increase in sales such as the following:

Projected increase in sales = (10% X 7,000,000) X 4,200,000

7,000,000
= 700,000 X 60%

= 420,000

When the projected increase in sales is computed, the next step is to compute the spontaneous
increase in current liabilities. The spontaneous increase in current liabilities is computed as follows:

Spontaneous increase in = (10% X 7,000,000) X 980,000

current liabilities 7,000,000
= 700,000 X 14%

= 98,000

The next procedure is to determine the expected earnings after tax by preparing a projected
statement of comprehensive income:
Sales (7,000,000 x 1.10) 7,700,000
Less Cost of Sales (7,700,000 x 60%) 4,620,000
Gross Profit 3,080,000
Less: Operating expenses (7,700,000 x 25%) 1,925,000
Income before interest and taxes 1,155,000
Less: interest expense 245,000
Income before taxes 910,000
Less: income tax (910,000 x 30%) 273,000
Net income after tax 637,000

The amount of dividend to be distributed to the shareholders is Php 382,200 computed as follows:
Dividends = (637,000 x 60% )
= 382,200

Based on the above computations, the amount of additional funds needed is computed as follows:

Additional = Projected increase - Spontaneous increase - Increase in retained

funds in sales in current liabilities earnings
needed = 420,000 - 98,000 - 254,800
= 67,200

Aduana, N.L., (2018). Business Finance in the Philippine Setting for

Senior High School. C&E Publishing, Inc.
Answer 2: The projected statement of financial position appears as follows:

Assets
Current Assets (4,200,000 x 1.10) 4,620,000
Non- current Assets 2,800,000
Total Assets 7,420,000
Liabilities
Current Liabilities (980,000 x 1.10) 1,078,000
Non-current liabilities 770,000 1,848,000
Shareholders’ Equity
Ordinary share 4,200,000
Retained earnings (1,050,000 + 254,800) 1,304,800 5,504,800
Total 7,352,800
Additional funds needed 67,200
Total 7,420,000

Without the additional funding requirements of 67,200, the accounting equation that assets are
equal to the liabilities and capital will not be satisfied.

Aduana, N.L., (2018). Business Finance in the Philippine Setting for

Senior High School. C&E Publishing, Inc.