Unit 4

Financial
Planning and
Budgeting
Learning Outcomes
 Discuss the basic concepts of the financial planning process.

 Differentiate the budget used in financial planning.

 Discuss the approaches and objectives of financial planning.

 Overview
 One of the most common cited reasons for firms encountering financial distress or
failure is the lack of effective short-range and long-range financial planning.
 Financial planning focuses on what the firm intends to do in the near future. It is a
system that guides the top management to direct the actions of the different units of
the organization in accomplishing its objectives.
 Financial planning covers the processes of setting the primary objective, identifying
the alternative courses of action, and choosing the best alternative to achieve the
objective. It also involves systematically thinking about the possible barriers a firm
has to confront. Although there is no exact answer to what the firm is looking for,
preparing for the best logical and fundamentally stable plan will help it cope with the
risk it will face in the future
Overview
 Financial planning is not the sole responsibility of the top management or the finance
manager. Developing the plan involves the whole organization.
 The overall objective of the firm is set by the top management and is carried down to
the lowest level of the organization. With the information properly handed down, the
different units can develop their own plans that would lead to achieving the overall
goals of the organization.
 The main function of the finance department in this process is to integrate the
different plans and develop a forecast. The forecast that leads to the preparation of the
budget also becomes the motivating and controlling factor of the managers of the
different departments of the organization. It serves as a guide in determining if the
departments are on a par with what they have set out to do before the budget is
implemented.
DIMENSIONS OF
FINANCIAL
PLANNING
Dimensions of Financial Planning
For planning purposes, it is always better to think that the future
has to be categorized as short-range and long-range. These
dimensions of plans differ not only in the period covered but also
in purpose, orientation, financial strength, and degree of detail.
Short-Range Plan
A short-range plan usually covers the next twelve months. It focuses on the goals needed to
be achieved in the coming year. Companies tend to look at the volatility of the market, the
stability of their operations, and the rate of change in technology in the coming year that
would affect their product lines and production processes. A short-range plan provides a great
deal of details and direct guidelines from time to time to the different heads of the
organization.

A short-range plan requires forecasting all activities of the firm affecting its balance sheet,
income statement and cash flow. The sales, raw materials requisition, raw materials purchase,
desired balance of inventories for the beginning and ending of the period, salaries and wages,
and other operating expenses are some of the details that should be in the plan.

At the start of the accounting period, a short-range plan serves as a guide on what to achieve.
At the end of the year, it serves as a control or measuring device. It helps the firm analyze any
difference in the action plan and actual performance so that future performance is improved.
Long-Range Plan
This is a plan that has a timeframe of two to five, or more, years and does not require a great
amount of detail. The contents of the financial statements have to be identified as part of long-
term financial management, although the financial statements are to be presented in terms of
years and not months.

The long-range plan, as compared with the short-range plan, is more difficult and more prone to
errors because of the time frame involved. Covering more than a year, environmental changes,
people’s needs, top management composition, and even political stability affect the long-range
planning.

However, it is still imperative for the firm, despite the errors it could have, to have a long-range
plan to serve as a guide for the long-term goals. It helps to see how far a firm has gone in terms
of what has been planned in the past. Nevertheless, a long-range plan is also subject to changes
and is usually revised every year to incorporate perceptions about the future.
APPROACHES TO
FINANCIAL PLANNING
1. Zero-based Approach
Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must
be justified for each new period. The process of zero-based budgeting starts from a
"zero base," and every function within an organization is analyzed for its needs
and costs. Budgets are then built around what is needed for the upcoming period,
regardless of whether each budget is higher or lower than the previous one.
2. Incremental-based Approach
Incremental budgeting is a type of a budgeting process that is based on the idea
that a new budget can best be developed by making only some marginal changes
to the current budget. In other words, with incremental budgeting, the current
budget is used as a base to which incremental assumptions are added or
subtracted from the base amounts to determine new budget amounts. Among all
budgeting methods, incremental budgeting is commonly considered as the most
conservative approach.
OBJECTIVES OF
FINANCIAL
PLANNING
Financial planning serves certain purposes.
1. Planning. Financial planning helps the firm determine its objectives and
courses of action. With the clear set of objectives, the firm looks forward to
placing itself as one of the major players in the industry.

2. Coordination. Financial planning creates a harmonious relationship among the

different units of the organization. Though departments are created with different
functions with a clear set of objectives, departments learn to coordinate,
communicate, and work with each other.

3. Control. A financial plan becomes an important tool in enhancing and

measuring the performance of the company. With the diligent preparation of
summarized reports containing comparisons with the planned objectives,
differences are analyzed for improvements. It is also used as a basis to evaluate
individual performance.