Financial Planning & Management Week 11 PDF

FINANCIAL PLANNING & MANAGEMENT WEEK 11 1 PREPARED BY DR. JANE N. WERE 12/1/2024  Definition of Financial Planning  Financial planning is a continuous process of directing and allocating financial resources to busine...

FINANCIAL PLANNING & MANAGEMENT WEEK 11 1 PREPARED BY DR. JANE N. WERE 12/1/2024  Definition of Financial Planning  Financial planning is a continuous process of directing and allocating financial resources to business activities to achieve strategic goals and objectives. The output from financial planning takes the form of activity budgets. The most widely used form of budgets is Budgeted Financial Statements. The foundation for budgeted financial statements is detailed budgets. These detailed budgets include sales forecasts, production forecasts and other estimates in support of the financial plan.  Financial planning can be broken into planning for operations and planning for financing. Operating people focus on sales and production while financial planners are interested in how to finance the operations. 2 PREPARED BY DR. JANE N. WERE 12/1/2024  Importance of Financial Planning  Financial planning involves the question of a firm’s long-term growth and profitability, investment and financing decisions. It focuses on aggregate capital expenditure programme and debt equity mix rather than the individual project.  It helps managers to avoid surprises and think ahead about how they should react to unavoidable surprises. It also helps to trace out the possible impact of today’s decisions on tomorrow’s opportunities. Without financial planning, the firm itself becomes a “black box”.  Financial planning further helps establish concrete objectives to motivate managers and provide standards for measuring performance.  The functions of finance can be broken down into three major decisions the firm must make: the investment decision, the financing decision and the dividend decision. Each must be considered in relation to the objective of the firm: an optimal combination of the three decisions will maximize the value of the firm to its shareholders. 3 PREPARED BY DR. JANE N. WERE 12/1/2024  FINANCIAL MANAGEMENT  Financial management is concerned with the acquisition, financing, and management of assets with some overall objective in mind. Thus, the decision function of financial management can be broken down into three major areas: the investment, financing, and asset management decision.  Investment Decision The investment decision is the most important of the firm’s three major decisions when it comes to value creation. It begins with a determination of the total amount of assets needed to be held by the firm.  Financial Decision The second major decision of the firm is the financial decision. Here the financial manager is concerned with the makeup of the right-hand sides of the balance sheet. If you look at the mix of financing the firms across industries, you will see marked differences. Some firms have relatively large amounts of debt, where as others are almost debt free.   PREPARED BY DR. JANE N. WERE 12/1/2024 4  Assets management decision  Functions of Financial Management  Financial management is concerned with the efficient and effective determination of asset structure of firm.  It concerned with determining the most appropriate and economic methods of financing the acquisition of these assets.  It is also concerned with ensuring that appropriate payments are made to lenders and creditors in accordance with the terms of their debts.  It is concerned with ensuring that appropriate rewards are paid to the risk takers in the organization in a manner that is consistent with their individual preferences and with the long term objectives of the organization.  It deals with advising the other managers and owners regarding the most effective utilization of the finances of the organization.  Finally, financial management is concerned with the custodianship of the organization’s finances; managers must preserve procure and disburse the finances and be held accountable for them to the owners and lenders. 5 PREPARED BY DR. JANE N. WERE 12/1/2024  SOURCES OF FINANCE  The function of finance may be defined as the provision of the amount of money required at a specific time and at an acceptable cost. It is not easy to ensure that income will always be available to pay for expenditure at any specific time, as expenditure on expensive equipment or sales of seasonal goods provide peaks that need special provisions.  A company needs cash for everyday (i.e. current) working expenses, e.g. wages, rent and stocks of goods). These can be termed short-term investments as they can be recouped by the profit from the sale of products within a relatively short space of time. When the investment is made in fixed items, e.g. plant or buildings (fixed assets), money is locked away for a long period before any return on the investment is available. Time therefore, can be seen to be a crucial element in financial planning. The period of finance obtained should match the period of maturity of an investment. These are important factors in analysis of the solvency of an organization. 6 PREPARED BY DR. JANE N. WERE 12/1/2024  Factors influencing choice of finance  Physical risks – fire, theft;  Technical risks – inferior technical expertise or equipment;  Economic factors – down in trade;  Political factor – change in government, civil disturbance or taxation change;  Management – inadequate management decision.  Capital must be raised on acceptable terms and firms which have a sound profit record and prospects normally have no problem in raising finance. The problem in obtaining finance for the relatively new small firm is continually being discussed and government measures to assist are partially solving the problem. 7 PREPARED BY DR. JANE N. WERE 12/1/2024  Main internal sources of finance 1.Retained profits: - These give a steady source of finance. The retaining or ‘ploughing back’ of profits is encouraged by taxation legislation allowing undistributed profits to remain free of income tax. If they are paid as dividends, they would suffer tax. 2.Provision for depreciation. Setting aside money for depreciation of assets results in reducing stated profit without actually paying out any cash. Such provisions represent cash retained by an enterprise and above normal undistributed profit. 3.Provision for Taxation. Amounts set aside to pay tax 8 when due PREPARED BY at DR. a JANE N. future WERE date are similar to provision 12/1/2024 for depreciation. 4.Reduction in current assets. If stocks and debtors are reduced, cash funds will be released into business The advantages of Internal Financing  No interest payments have to be met;  No repayment is necessary;  No costs are involved – as would be the case if a financing operation was involved (e.g. in the issue of shares there is the cost of a manager’s time locating sources and arranging terms) 9 PREPARED BY DR. JANE N. WERE 12/1/2024  The main external sources  Financial institutions: Financial intermediaries acquire primary securities (issued by borrowers’ at the same time issue secondary securities (to savers).  Commercial Bank. It operates several types of accounts on behalf of its customers.These are as follows:  Current account  Savings account  Fixed deposit  Non-bank Financial Institutions (NBFI) Hire –purchase Finance Companies: These financial institutions specialize in offering credit facilities to economic agents interested in acquiring durable assets (machinery, household equipment, etc). A hire- purchase financial company can help such a person to acquire the item in return for periodic payments. These payments are worked out in such a way that the company is able to recover its money and in addition earn a reasonable rate of interests. 10 PREPARED BY DR. JANE N. WERE 12/1/2024  Saving & Credit Co-operative Societies (SACCOs) These are financial institutions organized in the form of co-operative societies. Membership to these societies is limited to individuals with a common bond. A common bond exists where the member belong to a common neighbourhood, profession or have a common employer. SACCOs obtain their funds by offering members two types of accounts: member’s share accounts and member’s society.  The Co-operative Bank of Kenya It acts as a banker to all co-operative societies in the country and its resources are rechanneled back to the co-operative movement.  Development Banks. These are capital market institutions. Development banks in Kenya are sector specific and because of this their sources of finance should also be long-term. The sources of finance for development banks in Kenya have in the past been restricted to government and foreign organizations. This capital base is rather narrow and it makes the banks vulnerable to policy changes by the government and forces external to Kenya. 11 PREPARED BY DR. JANE N. WERE 12/1/2024  Building Societies These financial institutions are also referred to as mortgage finance companies. They focus exclusively on the provision of finance for the development or acquisition of residential and communal properties (house). Their lending is necessarily long- term and hence they are capital market institution. Sources of finance for building societies is members’ contributions, deposits by other savers and revenue earned on mortgage  Pension & Provident Funds These are retirement benefit schemes set up for the benefit of employees or their beneficiaries (in the event of premature death). Pension and provident funds in Kenya are either organized by the government or through schemes based on the occupation of the individual. 12 PREPARED BY DR. JANE N. WERE 12/1/2024  National Social Security Fund (NSSF). This is a compulsory national provident fund. All employers and employees who do not belong to another recognized pension fund must join this fund. NSSF has therefore a large membership and enormous funds.  Post Office Savings Banks This is another captive financial institution because, like NSSF, most of its funds must be lent to government at extremely low rates of interest. Most of its funds come from small-scale savers whose savings are not large enough to enable them to open a savings account in a bank or who live far a way from a bank.  Nairobi Stock exchange (NSE). Unlike the above financial institution, (NSE) is not a deposit taking institution. Its principal function is to provide an institutional framework through which the buying and selling of securities can take place. The members of NSE are called stock brokers although in fact they sometimes act as stock dealers and investment bankers. 13 PREPARED BY DR. JANE N. WERE 12/1/2024  EQUITY & DEBT FINANCING  It is the most preferred since it does not involve debt obligations. Equity holders also known as ordinary shareholders of the firm only get their return (dividends) after all secured /unsecured lenders have been paid.  After all changeable expenses have been deducted from revenue what is left if any, is then paid in form of dividends to ordinary shareholders. It is preferred because it has not cost obligation on the firm 14 PREPARED BY DR. JANE N. WERE 12/1/2024  Debt financing  Debt financing is sought after equity financing is inadequate to finance long term capital development of a business firm.  It carries a fixed financing charge on the principal sum (interest rates) payable at pre-determined intervals of a fixed period of time e.g. 3-10 years.  The principal and accrued interest thereon must be paid in the agreed installment whether the firm makes profits or not.  It can either be short term, medium – 3-8 years anything above 15 considered long term and are a cash flow management 15 PREPARED BY DR. obligation JANE N. WERE 12/1/2024   The role of the finance manager is to leverage (equity/debt financing a preferable ratio of 2:1 to ensure the liquidity and solvency of the firm.  The tools used to gauge the financial health of the firm include ratios Solvency / liquidity ratio Activity (utilization of firm’s productivity assets. Profitability Gearing ratios 16 PREPARED BY DR. JANE N. WERE 12/1/2024  Definition of Budgeting  A budget is a detailed plan for the acquisition and use of financial and other resources over a specified time period. It represents a plan for the future expressed in formal quantitative terms.  The act of preparing a budget is called a budgeting. The use of budgets to control a firm’s activities is known as budgetary control. Advantages of Budgeting  Budgets provide a means of communicating management’s plans throughout the organization.  Budgets force managers to think about and plan for the future. In the absence of the necessity to prepare a budget, too many managers would spend all their time dealing with daily emergencies. 17 PREPARED BY DR. JANE N. WERE 12/1/2024   The budgeting process provides a means of allocating resources to those parts of the organization where they can be used most effectively.  The budgeting process can uncover potential bottlenecks before they occur.  Budgets coordinate the activities of the entire organization by integrating the plans of the various parts. Budgeting helps to ensure that everyone in the organization is pulling in the same direction.  Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance. 18 PREPARED BY DR. JANE N. WERE 12/1/2024  Budgetary Control  Budgetary control is derived from the concept and use of budgets. Thus budgetary control is a system that uses budgets as a means for planning and controlling entire aspects of organizational activities or parts thereof.  Control is defined as “Budgetary control is a process of comparing the actual results with the corresponding budget data in order to approve accomplishments or to remedy differences by either adjusting the budget estimates or correcting the cause of the difference.” 19 PREPARED BY DR. JANE N. WERE 12/1/2024  Benefits of Budgetary Control  Budget and budgetary control leads to maximum utilization of resources with a view to ensuring maximum returns because it provides aid to managerial planning and control.  Besides, it also helps in coordination. Thus, budgetary control can play three roles in an organization. These are budgetary control as a tool for planning, control, and an aid to coordination. 20 PREPARED BY DR. JANE N. WERE 12/1/2024  Types of Budgets a) The Sales Budget  A sales budget is a detailed schedule showing the expected sales for the budget period; typically, it is expressed in both KES and units of product or services. An accurate sales budget is the key to the entire budgeting process. All of the other parts of the master budget are dependent on the sales budget in some way, as illustrated in figure below. Thus, if the sales budget is sloppily done, then the rest of budgeting process is largely a waste of time. The sales budget will determine how many units will have to be produced. Thus, the production budget is prepared after the sales budget. The production budget in turn is used to determine the budget for manufacturing costs including the direct materials budget, the direct labor budget and the manufacturing overhead budget. 21 PREPARED BY DR. JANE N. WERE 12/1/2024  The Cash Budget  Once the operating budgets (sales, production and others) have been established, the cash budget and other financial budgets can be prepared. A cash budget is a detailed plan showing how cash resources will be acquired and used over some specified time period. All the operating budgets have an impact on the cash budget. In the case of the sales budget, the impact comes from the planned cash receipts to be received from sales. In the case of other budgets, the impact comes from the planned cash expenditures within the budgets themselves.  The schedule of expected cash collections, which is completed in connection with sales budget, provide data for both the cash budget, budgeted income statement and the budgeted balance sheet. 22 PREPARED BY DR. JANE N. WERE 12/1/2024  The Master Budget Interrelationships Sales Budget Ending Inventory Production Selling & Budget Budget administrative expense budget Direct Material Direct Labor Manufacturing Budget Budget Overhead Budget Cash Budget Budgeted Income Budgeted Statement Balance Sheet 23 PREPARED BY DR. JANE N. WERE 12/1/2024  PROFIT & LOSS STATEMENT Kshs “000,000” Million 2023 2024 Forecast 2025 Sales 2,320 2,320 2,240 Cost of Goods Sold 2,240 2,030 1,960 Gross Profit 70 280 280 Operating Expense 140 208 280 Net Profit Before -70 72 0 24 TaxBY DR. JANE N. WERE PREPARED 12/1/2024  Balance Sheet XYZ LIMITED BALANCE SHEET AS AT 31ST DECEMBER, 2023 Fixed Assets KSh s KShs KShs KShs Free hold Premises 240,000 Plant & Machinery 126,000 Fixture & Fitting 21,250 387,250 Current Assets Stock 60,000 Debtors 60,000 Less provision for bad 2,400 57,6000 debts Interest receivable 30,000 Prepaid 25 Insurance PREPARED BY DR. JANE N. WERE 500 12/1/2024 Cash in Hand 2,400 150,500  Less current liabilities Creditors 43,000 Bills payable 15,000 Accrued rates 400 Bank overdraft 18,600 77,000 73,500 460,750 Financed By Equity Capital 292,000 Net Profit 168,750 460,750 460,750 26 PREPARED BY DR. JANE N. WERE 12/1/2024