Financial Plan

Financial Plan• A financial plan is a series of steps or goals used by an

individual or business which are designed to accomplish a final financial goal.

• This often includes a budget which organizes an organization finances and sometimes includes a series of steps or specific goals for spending and saving future income.

• This plan allocates future income to various types of expenses, such as rent or utilities, and also reserves some income for short-term and long-term savings.

Cont’d

• A financial plan sometimes refers to an investment plan, which allocates savings to various assets or projects expected to produce future income.

• It is a comprehensive evaluation of an investor's current and future financial state by using currently known variables to predict future cash flows, asset values and withdrawal plans.

Context of Business

• Financial forecast or Financial plan also refer to a formal and defined series of steps or goals to an annual projection of income and expenses for a company, division or department.

• A financial plan can also be an estimation of cash needs and a decision on how to raise the cash, such as through borrowing or issuing additional shares in a company.

Financial Statements

• A financial statement (or financial report) is a formal record of the financial activities of a business, person, or other entity.

• For a business enterprise, all the relevant financial information, presented in a structured manner and in a form easy to understand, are called the financial statements.

Financial Statements

• In business, a financial plan can refer to the four primary financial statements created within a business plan accompanied by a management discussion and analysis.

• Balance Sheet• Profit & Loss Statement• Owner’s Equity Statement• Cash Flow Statement

Balance Sheet

• Balance Sheet also referred to as Statement of Financial Position, reports on a company's assets, liabilities, and ownership equity at a given point in time.

• The Balance Sheet is based on the following fundamental accounting model:

Assets = Liabilities + Equity

Assets• Assets can be defined as anything of value that is owned

by business. It includes current assets and fixed assets.

• Current Assets are assets that quickly and easily converted into cash. It includes cash, accounts receivable, marketable securities etc.

• Fixed Assets are assets that cannot easily be converted into cash. It includes land, buildings and equipment.

Liabilities

• Liabilities represent the portion of a firm’s assets that are owned to creditors. It is a claim against your assets.

• It includes current (short-term) liabilities and non-current (long-term) liabilities.

• Current liabilities includes accounts payable, interest payable, wages payable etc.

• Non-current liabilities includes bonds payable, debentures etc.

Equity

• Equity referred to as the amount  of the funds contributed by the owners (the stockholders) plus the retained earnings (or losses). It is also referred to as "shareholders' equity".

Profit & Loss Statement

• It is also referred as Statement of Comprehensive Income, revenue statement, statement of financial performance, earnings statement, operating statement or statement of operations and reports on a company's income, expenses, and profits over a period of time.

• It presents the results of a entity’s operations during a period of time. These include sale and the various expenses incurred during the processing state.

Cont’d

• The Profit & Loss Statement is based on the following fundamental accounting model:

Net Income = Revenue- Expenses

Cont’d• Revenue refers to the inflows from the delivery or

manufacture of a product or from the rendering of a service.

• Expenses are outflows incurred to produce revenue.

• It displays the revenues recognized for a specific period, and the cost and expenses charged against these revenues.

• The purpose of this statement is to show managers and investors whether the company made or lost money during the period being reported.

Owner’s Equity Statement• It is also known as Statement of Changes in Equity or statement of

retained earnings and explains the changes of the company's equity throughout the reporting period.

• It explains the changes in retained earnings.

• Retained earnings appear on the balance sheet and most commonly are influenced by the income and dividend.

• The statement of retained earnings therefore uses information from the income statement and provides information to the balance sheet.

Cont’d

• The Owner’s Equity Statement is calculated as follows:

Common stock + Premium on common stock + Preferred stock + Premium on preferred stock + Retained earnings = Stock holders

equity

Cash Flow Statement

• It is also known as funds flow statement, and shows how changes in balance sheet accounts and income affect cash and cash equivalents.

• It summarizes company’s cash flow activities, its sources and uses of cash and indicates whether enough cash is available to carry on routine operations.

Cont’d

• The statement of cash flow is useful in evaluating the company ability to pay its bills.

• The cash flow statement provides the following information:

• Sources of cash• Uses of cash• Change in cash balance

Cont’d• It breaks the sources and uses of cash into the following

categories:

•Operating activities•Investing activities•Financing activities

• The information used to construct the cash flow statement comes from the beginning and ending balance sheet of the period and from the income statement of the period.

Notes to Financial Statements• For large corporations, these statements are often complex

and may include an extensive set of notes to the financial statements and explanation of financial policies and management discussion and analysis.

• The notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail.

• Notes to financial statements are considered an integral part of the financial statements.

Purpose of Financial Statements by Business Entities

• The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.

• Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities, equity, income and expenses are directly related to an organization's financial position.

• Financial statements are intended to be understandable by readers who have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently."

Users of Financial Statements

• Owners and managers require financial statements to make important business decisions that affect its continued operations.

• Prospective investors make use of financial statements to assess the viability of investing in a business.

• Vendors who extend credit to a business require financial statements to assess the creditworthiness of the business.

Cont’d• Financial institutions (banks and other lending companies) use

them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.

• Government entities (tax authorities) need financial statements to ascertain the accuracy of taxes and other duties declared and paid by a company.

• Media and the general public are also interested in financial statements for a variety of reasons.

Break-Even Analysis

• The break-even point is that level of sales in units or rupees at which a firm covers all of its cost.

• It is the level at which total sales revenue just equals the total costs necessary to achieve these sales.

Cont’d

• An analysis to determine the point at which revenue received equals the costs associated with receiving the revenue.

• Break-even analysis calculates what is known as a margin of safety, the amount that revenues exceed the break-even point. This is the amount that revenues can fall while still staying above the break-even point.

Cont’d

Total variable and fixed costs are compared with sales revenue in order to determine the level of sales volume, sales value or production at which the business makes neither a profit nor a loss (the "break-even point").

Formula

Profit = (Sales − Variable expenses) − Fixed expenses

Here profit is 0 as firm covers at this point its all expenses. Firm is neither at loss nor at profit at this point.

Net Present Value Analysis On of the best ways to analyze the financial aspects

of a company is Net Present Value Analysis.

It is the difference between the present value of cash inflows and the cash outflows.

This method employs a discounted cash flows, which takes into account the time value of money and its price to borrower.

Cont’d

Formula:

NPV is used to analyze the profitability of an investment or project.

  NPV compares the value of a dollar today to

the value of that same dollar in the future, taking inflation and returns into account.

Cont’d If the NPV of a prospective project is positive, it should be

accepted.

However, if NPV is negative, the project should probably be rejected because cash flows will also be negative.

According to the theory of net present value (NPV), participating in a positive NPV project will increase firm or shareholder wealth.

Ratio Analysis A tool used by individuals to conduct a quantitative

analysis of information in a company's financial statements.

Ratio analysis provides the analyst an easy and efficient method form investigating a firm’s financial position by comparing the firm’s ratio across time or with ratios of similar firms in the industry or with industry averages.

Cont’d

Financial ratio analysis involves calculating certain standardized relationship between figures appearing in the financial statements and then using those relationships called ratios to analyze the business' financial position and financial performance.

Cont’d

Ratios are divided into different categories They are:

Liquidity Ratios Solvency Ratios Profitability Ratios Activity Ratios Market Ratios

Liquidity Ratios

Liquidity Ratios

Liquidity is the ability of a business to pay its current liabilities using its current assets.

Current ratio, Quick ratio, Cash ratio are key measures of liquidity.

Solvency Ratios

Solvency Ratios

Solvency is a measure business ability to pay off its long-term obligations such as bank loans, bonds payable, etc.

Key solvency ratios are debt to equity ratio, debt to capital ratio, debt to assets ratio, times interest earned ratio, fixed charge coverage ratio, etc.

Profitability Ratios

Profitability Ratios

Profitability is the ability of a business to earn profit for its owners.

Profitability ratios are relationships that explain the financial performance of a business.

Key profitability ratios include net profit margin, gross profit margin, operating profit margin, return on assets, return on capital, return on equity, etc.

Activity ratios

Activity ratios

Activity ratios explain the level of efficiency of a business.

Key activity ratios include inventory turnover, days sales in inventory, accounts receivable turnover, days sales in receivables, etc.

Market Ratio

Market Ratio

• This ratio is related to the market value of an enterprise.

• These ratios will be calculated to attract new investors.

• Key market ratios include price earning ratio, dividend yield, market price to book value etc.

Conclusion

• A financial plan is a written set of goals, strategies and timelines for accomplishing these goals.

• The entrepreneur use this plan for forecasting of his new venture.

• This plan helps the entrepreneur in research to predict about venture’s net worth, spending plan, build emergency funds, obtain adequate information etc.