Financial Planning Process

The financial planning process can be seen as comprising two main elements: long-term (strategic) planning process which usually reflects a period between two to ten years and the short-term (operating) planning process which usually reflects between one to two years in length. Both of these processes help to determine what a company will need to address in their financial planning during the allotted time period (Gitman, 2009).

Key inputs for the short-term (operating) financial plans include a sales forecast, operational data, and financial data. The key outputs reflected by the short term planning processes include operating budgets, the cash budget, and the pro forma financial planning statement. The sales forecast, which is the first step in the process, takes into account lead or preparation times with estimates reflecting the cost of the raw materials needed. Production plans can help the company create estimates of the labor requirements, factory overhead, and related operational expenses (Gitman, 2009).

In order to define what the company's inflow and outflow of cash is a cash budget or cash forecast needs to be created. Depending on the nature of the business the number of cash forecasts and intervals may need to be adjusted to suit the needs of different companies. Some companies may require seasonal cash budgets while others with a steadier stream of income can focus on monthly or bi-monthly statements for the management to peruse.

The sales forecast is another necessary document in the processes which is created to reflect the estimated sales of the company over a specific period of time which is typically prepared by the marketing department. The sales forecast is broken down into two main areas: internal and external forecasts. The external forecast reflects external factors which may affect the company's ability to make money such as the gross domestic product (GDP), consumer confidence, and the health of the economy, personal disposable income, and many more. The internal forecast reflects sales estimates by the salespeople which can then be translated into how much of which product will be needed for the duration of the time period. The internal forecast will also reflect the sales team's ability to forecast and their track record of sales. Companies will typically use a combination of internal and external factors in the reports to create a finalized sales forecast.

The cash budget can be broken down into several sections which will help the forecasters to build a statement which accurately reflects the state of the company and what the company can expect over a defined period of time. The cash budget is typically broken down into cash receipts, cash disbursements, net cash flow, beginning cash, ending cash, minimum cash balance, required total financing, and excess cash balance.

With the use of these statements in the forecasting process the company can determine fairly accurately what they can expect over a given time period and how much needs to be budgeted given what the forecast may include. Some years and intervals may need more or less money invested in the company than at over times (Gitman, 2009). Using this process, for example, a company can determine what they expect to make on "Black Friday" and how it figures into their overall financial plans for end of year analysis. Will the company need to plan for greater losses or gains? Will the company need to focus its marketing department in areas which will offset some of the projected external forecasts? These and other questions are answered in part by an educated financial forecast.

Pro forma statements are a finalized form of these processes. The pro forma statement is generally viewed by shareholders, creditors, and the company's management when gauging the overall health of the company and its overall financial position. The two inputs which are needed for a definitive pro forma statement are financial statements for the preceding year and a sales forecast for the upcoming one.

The pro forma statement is characteristically seen with the percent-of-sales methodology. The forecasts sales and then expresses these sales figures as percentages of projected sales. Assuming that all the percentages are variables (minus fixed costs) past cost and percent ratios tend to overstate profits as sales decrease and understate them as sales increase. Therefore, when expressing these values it is best to break it down into fixed and variable components (Gitman, 2009).

As the preparer creates the pro forma statement they can use a judgmental approach to its preparation which then estimates the values on the balance sheet and then uses the company's available financing as a "plug" or balancing figure. It then can be read in a positive or negative manner (Grambo, n.d.). If it's a positive value for the external financing the company will not produce enough internally to support its growth in assets. If the opposite is true with a negative, then the company will produce enough internally to meet its goals and have extra to pay off debt, repurchase stock, or increase dividends. Financial managers and lenders use the pro forma statements to analyze a company's inflow and outflow of cash, liquidity, activity, debt, profitability, and overall market value.

References

Gitman, L. (2009). Principles of Managerial Finance. Boston, MA: Pearson-Prentice Hall.

Grambo, R. (n.d.). Financial Forecasting and Pro-Forma Statements. University of Scranton.

Retrieved on November 27, 2009 from http://academic.uofs.edu/faculty/gramborw/tufinfor.html