LESSON 3: FINANCIAL PLANNING AND CONTROL PROCESS

Strategic Plan
❖ is a method of achieving the goal of maximizing shareholders’ wealth. This strategic plan
requires both long and short term financial planning that brings together forecasts of
the company’s sales with financing and investment decision making. Budgets, such as
the cash budget and production budget, are to manage the information used in this
planning.

Financial Planning
❖ is the process of estimating the capital required and establishing expectations for
income, expenses, personal needs, future growth, and more. Specifically, it is the
process of framing financial policies in relation to procurement, investment, and
administration of funds of an entity. This ensures effective and adequate utilization of
financial resources.

Financial Control or Monitoring

❖ This is the phase in which financial plans are implemented and monitored the
organization’s progress in meeting its goals. In this process, the actual results for a
period are compared to the budgeted results for that period. The difference between the
actual and expected results is called a variance and there are two (2) types of variance;
1. Negative or Unfavorable Variance - is variance that occurs when revenue falls
short of the budgeted amount or expenses are higher than predicted, which could
result in net income below what is originally expected.
2. Positive or Favorable Variance - is a variance revenue that comes in higher
than budgeted, or expenses are lower than predicted, which could result in
greater income that originally forecasted.
Therefore, this allows the managers to oversee areas to deal with the feedback and
adjustment process required to ensure adherence of plans and modification of plans
because of unforeseen circumstances.
❖ Master budget can be broken down into divisional levels which allows each level of the
organization to be evaluated. The organization as a whole may be meeting its goals
while individual divisions and departments are failing.

Long-term Planning
❖ This plan usually involves a five- to 10-year plan of actions required to achieve the
company’s goals. Such action plans could be discontinuing certain operations over time,
arranging for equity or debt financing, and allocating resources gradually to new
branches of business. Hence, these are major reorganizations which can be
accomplished only over a period of time and involve the use of capital budgeting.
Capital Budgeting
❖ It is the process of allocating resources to an entity’s proposed long-term projects.
Because buildings, equipment, and hiring and training staff are all extremely expensive,
such allocations must be made in accordance with strategy.

Short-term Objective
❖ These are the variations in the long-term plan that result from capital budgeting, the
operating results of past periods, and expected future results caused by the current
economic, social, industrial, and technological environment. These variations are fed into
each year’s master budget.

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Budget
❖ Is an operational plan and a control tool for an entity that identifies the resources and
commitments needed to satisfy the entity’s goals over a period.

Budgeting
❖ It is the undertaking steps involved in preparing a budget. Along with clear
communication of organizational goals, the ideal budget also contains budgetary
controls. There are four main reasons a company creates a budget: planning,
communication, monitoring, and evaluation.

Budgetary control
❖ It is a management process to help ensure that a budget is achieved by instituting a
systematic budget approval process, by coordinating the efforts of all involved parties
and operations, and by analyzing variances from the plan and providing appropriate
feedback to responsible parties. The goals identified in the budget must be perceived by
employees as realistic if those employees are to be motivated to achieve the goals.

Budget cycle
❖ This usually involves the following steps:
1. A budget is created that addresses the entity as a whole as well as its subunits,
and all managers agree to fulfill their part of the budget.
2. The budget is used to test current performance against expectations.
3. Variations from the plan are examined, and corrective actions are taken when
possible.
4. Feedback is collected, and the plan is revisited and revised if needed.

Cash Budgeting
❖ It is an estimation of the cash flows of a business over a specific period of time that is
used to assess whether the entity has sufficient cash to continue its operations. This
budgeting process involves putting together the financing and investment strategy in
terms that allow those responsible for the financing of the company to determine what
 investments can be made and how these investments should be financed. In other
words, budgeting pulls together decisions regarding capital budgeting, capital structure,
and working capital.

Four (4) Budgeting Steps

1. Budget Proposal - This step involves preparation of the initial budget presented in a
formal document that contains a budget plan with the financial details of a company. It
mostly discusses the information about the company, estimations, and rationales. The
initial budget is prepared with consideration of both internal and external factors.
Internal factors include changes in price, availability, and manufacturing processes; new
products or services, changes in related or intertwined responsibility centers; and staff
changes. External factors include changes in the economy and the labor market, the
price and availability of goods and services.

2. Budget Negotiation - When the budget proposal is submitted to the committee on

budget, the proposal is to be reviewed, to see if there is consistency with the
organization’s strategic goals, falls within an acceptable range, reviewers also make
sure that the budget is feasible and if fits within its goals then it will then be negotiated
and will go to the next level.

3. Budget Review and Approval - Budgets are to be reviewed again by another set of
reviewers which is the budget committee, where they are responsible to see if there is a
consistency in considering the budget guidelines, short and long term goals, and
strategic plans. Once it is approved by the committee, it is then submitted to the board of
directors for final approval.

4. Budget Revision - The firmness of a budget varies from the different organization.
Some budgets must be followed absolutely; others can be revised only under specific
situations while others are subject to a constant or non-stop revision until it meets the
satisfaction of the reviewer.

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BREAK-EVEN POINT (BEP)
 Break-even point is the point of zero profit (no profit, no loss).
 Total Revenue (TR) = Total Cost (TC)
 However, companies do not wish merely to ―break even‖ on operations.
 The BEP is determined to serve as a point of reference.

CLASSIFICATION OF COSTS AS TO BEHAVIOR

1. Variable cost – costs that vary directly in total as the activity changes but remains
constant per unit.
2. Fixed cost – costs that remain constant in total regardless of changes in activity but
varies inversely per unit.
 PER UNIT COST TOTAL COST
Increases as production increases
VARIABLE Constant
(Direct Relationship)
Decreases as production increases
FIXED Constant
(Inverse Relationship)

METHODS OF COMPUTING BREAK-EVEN POINT

I. Graphical Approach
 This method involves plotting data regarding fixed cost, total cost and revenue to
predict profit/loss at certain level of activity.
 Total Revenues and Total Costs are presented in a graph where Y axis is in
Pesos and X axis is in units.
 The point where the TR and TC will intersect is the Break-even Point.

II. Contribution Margin Method or Formula Approach

 This approach premises the concept that the contribution margin at BEP is equal
to the Total Fixed Cost.

Total Fixed Cost

A. 𝐁𝐄𝐏 (𝐔𝐧𝐢𝐭𝐬) = Contribution Margin per Unit

 Contribution Margin per Unit = Selling Price per Unit − Variable Cost per Unit

B. 𝐁𝐄𝐏 (𝐏𝐞𝐬𝐨𝐬) = BEP in Units × Selling Price per Unit

Alternative Formula:
Total Fixed Cost
BEP (Pesos) =
Contribution Margin Ratio
Contribution Margin per Unit
 Contribution Margin Ratio = Sales Price per Unit
Example:
BSA Company plans to sell 50,000 units in the upcoming year 2025. Based on initial estimate,
the selling price of each unit is ₱50.00 and the variable cost necessary is ₱20.00. The fixed cost
of the company is ₱300,000.
Required:
a. Compute for the contribution margin per unit and break-even point in units
b. Compute for the contribution margin ratio and break-even point in pesos

FINANCIAL LEVERAGE
Leverage in general refers to an investment strategy of using borrowed funds to improve overall
company profitability. Effective leveraging is attained if the return is greater than the financing
cost. This is also known as financial leverage.

Most companies are financed through either debt or equity.

 Equity financing comes from shareholders, the owners of the company. These
shareholders share in the earnings of the company in an amount proportional to their
investment.
 Debt financing comes from lending institutions, and, while the borrowing company must
pay regular interest payments to its lender, it does not need to share earnings with the
lender. For this reason, a company can use debt rather than additional equity to finance
its operations and magnify the profits with respect to the current equity investment. At
the same time, losses are also magnified through this financial leverage. This is the
fundamental risk/return consideration in the makeup of a company’s financing.