Free Guide – How to Improve Understanding of Financial Planning
The application of planning to various aspects of finance function is called financial planning. Business finance involves the formulation of a financial plan that states the quantum of finance required, the pattern of financing and the policies. This is only to pursue for the administration of the financial plan. A business enterprise requires short-term and long-term capital. The short-term capital or the working capital is the capital required to meet the day-to-day obligations or the operating expenses. The total capital required by a concern is called capitalization. The long-term capital is required to acquire the fixed assets. Generally, on a conservative ground, a portion of the working capital is also met out of long-term capital.
The capital required can be collected from the different sources. A substantial share is raised from internally generated funds. The remaining part is raised from outside sources such as issue of shares and debentures and loans. This pattern is known as capital structure. It is designed to obtain the required amount needed at the lowest possible cost. Once the required amount is raised, then the funds are allocated in the best possible way to obtain the maximum benefits.
Implementing proper control systems can ensure the efficient use of the funds. All-important matters are reported to the top management to take proper actions at the right time. The financial reports are analyzed to evaluate the performance of the firm. According to Cohen and Robin, business finance aims at determining the financial resources required meeting the company’s operating program. Business finance also forecasts the extent to which these requirements are met by internal generation of funds and the extent that they will be met from external resources. Business finance helps in establishing and maintaining a system of financial control governing the allocation and use of funds.
Business finance is broadly concerned with the acquisition and use of funds by a business firm. Its scope may be defined in terms of the following questions: What should be the composition of the firm’s assets? How large should the firm be and how fast should it grow? What should be the mix of the firm’s financing? How should the firm analyze, plan and control its financial affairs? Business finance rests on the premise that the objective of the firm should be to maximize the value of firm to its equity shareholders. What is the justification for this objective? It appears to provide a rational guide for business decision-making and promote efficient allocation of resources in the economic system. Savings are allocated primarily on the basis of expected return and risk and the market value of a firm’s equity stock reflects the risk-return trade-off of investors in the market place.
When a firm maximizes the market value of its equity stock, it ensures that its decisions are consistent with the risk-return preferences of investors. This suggests that it allocates resources optimally. If a firm does not pursue the goal of shareholder wealth maximization, it implies that its actions result in sub-optimal allocation of resources. This in turn leads to lower rate of economic growth and inadequate capital formation.
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