Why is financial planning important in business?

Written by stephen byron cooper Google
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Why is financial planning important in business?
Financial planning decides the dividend payment and so affects the share price. (Comstock/Comstock/Getty Images)

All businesses need to plan ahead. Any kind of production or service provision engenders lead times. An order takes time to fulfil, even if it can be met from stock. Therefore, the provision of resources to complete delivery and make the sale requires projections of requirements and thus the availability of money to supply those resources becomes a key consideration. Financial planning enables business to use working capital to its greatest effect.

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Payment of dividend

Companies are either owned by their founders, a small number of people, or a large group of shareholders. The purpose of operating a company is to provide profits to the shareholders. A company may pay out all of its earnings in a year to shareholders, but then have no money to continue operating into the next financial year. A certain percentage of profits is usually retained to provide working capital. A company needs a regular supply of cash in order to buy supplies to process into saleable products. It is important, therefore, for the company’s directors and accountants to project how much of the profits need to be retained in the company before settling on a portion to pay out to shareholders as dividend.

Financing

The company’s management may decide to meet most of its cash requirements through loans. In this case, the company can minimise its outlay on interest payments by delaying the loan for as long as possible. This strategy requires precise financial planning to avoid halting the company’s operations due to cash shortages. Companies require very accurate forecasts if they want to minimise the cash they have tied up in bank deposits.

Payment terms

Although it is always good to get new customers and win big orders, some new business can actually destroy a company if its financial planning lacks clarity. A company needs to buy supplies to meet orders and it needs cash to pay for them. If the company doesn’t get very good payment terms from suppliers, but offer long payment terms to a big customer, it can run out of cash by buying supplies to fulfil an order and having to wait too long before that investment matures into income. Sometimes it is better for companies to turn down big orders in order to remain viable. Financial planning highlights these risks.

Financial stability

Businesses have ongoing obligations. They have to pay the costs of their premises and they have to pay their workforce. These two forms of expense are recurring and the business needs to ensure that it has enough cash on hand to meet these regular monthly expenses. If it does plan to meet these costs, it could find itself put out of business by its electricity being cut off or its workforce going on strike in protest over delayed pay.

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