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Understanding Financial Planning: Fixed and Working Capital Requirements, Thesis of Financial Accounting

An overview of financial planning, focusing on the essential concepts of fixed and working capital requirements. Learn about the nature of financial planning, the importance of capital structure, and the determinants of fixed and working capital. Understand how to assess the capital requirement for a business and the factors influencing it.

What you will learn

  • What is financial planning and why is it important?
  • What factors determine the working capital requirement?
  • How is the capital requirement for a business assessed?
  • How does the nature of business influence the fixed capital requirement?
  • What is the difference between fixed and working capital?

Typology: Thesis

2018/2019

Uploaded on 11/27/2019

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A
SEMINAR REPORT
ON
FINANCIAL PLANNING
SUBMITTED TO
GURU NANAK DEV UNIVERSITY, AMRITSAR.
In partial fulfill for the degree MASTER OF COMMERCE.
3RD SEMESTER (2ND YEAR)
(SESSION 2019-2020)
SUBMITTED TO: SUBMITTED BY
MRS. SHILPI GUPTA VARKHA KUMARI
M.COM (2ND YEAR)
ROLL NO 8401
POST GRADUATE DEPARTMENT OF COMMERCE AND
BUSSINESS MANAGEMENT
HINDU COLLEGE, AMRITSAR
DECLARATTION
I hereby certify that the work embodied in the seminar report
“FINANCIAL PLANNING” submitted to GURU NANAK DEV
UNIVERSITY, AMRITSAR in the partial fulfillment for the degree of
M.COM 3rd semester is my original work and has not been
submitted for any degree or diploma at this or any other university.
VARKHA KUMARI
M.COM (3RD SEM)
23/09/19 7:56 PM
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A
SEMINAR REPORT
ON
FINANCIAL PLANNING
SUBMITTED TO
GURU NANAK DEV UNIVERSITY, AMRITSAR.

In partial fulfill for the degree MASTER OF COMMERCE. 3 RD^ SEMESTER (2ND^ YEAR) (SESSION 2019-2020)

SUBMITTED TO: SUBMITTED BY
MRS. SHILPI GUPTA VARKHA KUMARI
M.COM (2ND^ YEAR)
ROLL NO 8401
POST GRADUATE DEPARTMENT OF COMMERCE AND
BUSSINESS MANAGEMENT
HINDU COLLEGE, AMRITSAR

DECLARATTION

I hereby certify that the work embodied in the seminar report

“FINANCIAL PLANNING” submitted to GURU NANAK DEV

UNIVERSITY, AMRITSAR in the partial fulfillment for the degree of

M.COM 3 rd^ semester is my original work and has not been

submitted for any degree or diploma at this or any other university.

VARKHA KUMARI
M.COM (3RD^ SEM)
23/09/19 7:56 PM
ROLL NO.

ACKNOWLEDGEMENT

I would like to express my special thanks to gratitude to my

teachers “MRS.SHILPI GUPTA”, who gave me golden opportunity

to do this wonderful project of “FINANCIAL PLANNING”.

Who also helped me in completing my project? I came to

know about so many things. I am really thankful to

them. Secondly I would also like to thank my

parents and friends who helped me a lot in finalizing this project

within limited time frame.

INTRODUCTION OF FINANCIAL PLANNNING

You know that every business unit whether it is an industrial establishment, a trading concern or a construction company needs funds for carrying on its activities successfully. It requires funds to acquire fixed assets like machines, equipment’s, furniture’s etc. and to purchase raw materials or finished goods, to pay its creditors, to meet its day-to-day expenses, and so on. In fact, availability of adequate finance is one of the most important factors for success in any business. However, the requirement of finance, now days, is so large that no individual is in a position to provide the whole amount from his personal sources. So the businessman has to depend on other sources and use various ways to raise the necessary amount of funds. In the previous lessons you learnt about the sources and methods of raising funds. You know that the process of raising funds require considerable amount of time and cost. This has its own costs. Hence, every businessman has to be very careful not only in assessing the firm’s requirement of finance but also in deciding on the forms in which funds are raised and utilized. In this lesson, you will learn about the process of estimating the firm’s financial requirement and deciding on the pattern of finance.

DEFINITION OF FINANCIAL PLANNING

Financial Planning is the process of estimating the capital required and determining it’s competition. It is the process of framing financial policies in relation to procurement, investment and administration of funds of an enterprise.

What is financial planning?

Financial planning is the process of setting, planning, achieving and reviewing your life goals through the proper management of your finances. A holistic financial plan not only involves investing money and building your wealth; but also your credit and tax obligations, everyday spending, planning for a family, setting up your home, saving for your children’s education fund, and saving for retirement – as well as protecting yourself and your family with suitable insurance policies and arranging your estate. All these facets of your financial plan are interconnected. Financial planning is an important life skill to help you plan for your future and take better control of your financial goals by helping you to set realistic plans, evaluate alternatives and take effective measures. Sounds difficult? It does not have to be! With the steps outlined in this simple guide, you can start putting together a basic financial plan all by yourself.

Common misconceptions about financial planning.

One only needs to start financial planning when approaching retirement.

Financial planning is a life-long process.2 02 8 The earlier you start, the sooner you can enjoy the benefits – and the more time you have to grow your savings.

  1. Financial planning is just another name for investing.

Financial planning is more than just investment. Rather, it is about the big picture: bringing together all aspects of personal finance to achieve your financial goals.

  1. Once you finish your financial plan,2 02 8 you do not have to think about it again.

Identify the determinants of capital structure; and 2 02 8 Explain the meaning and factors in determining dividend. 2 02 8

ESSENTIALS OF A SOUND FINANCIAL PLAN

While preparing a financial plan for any business unit, the following aspects should be kept in view so as to ensure the success of such exercise in meeting the organizational objectives. (a) The plan must be simple. Now a day you have a large variety of securities that can be issued to raise capital from the market. But it is considered better to confine to equity shares and simple fixed (b) It must take a long-term view. While estimating the capital needs of a firm and raising the required funds, a long-term view is necessary. It ensures that the plan fully provides for meeting the capital requirement on long-term basis and takes care of the changes in capital requirement from year to year. 2 02 8 (c) It must be flexible. While the financial plan is based on long term view, one may not be able to properly visualize the possible developments in future. Not 2 02 8 only that, the firm may also change its plans of expansion for various reasons. Hence, it is very necessary that the financial plan is capable of being adjusted and revised without any difficulty and delay so as to meet the requirements of the changed circumstances. (d) It must ensure optimal use of funds. The plan should provide for raising reasonable amount of funds. As stated earlier, the business should neither be starved of funds nor have surplus funds. It must be strictly need based and every rupee raised should be effectively utilised. There should be no idle funds. (e) The cost off fundraised should be fully taken into account and kept at the lowest possible level. It must be ensured that the cost of funds raised is reasonable. The plan should provide for a financial mix (combination of debt and equity) that is most economical in terms of cost of capital, otherwise it would adversely affect the return on shareholders’ funds. 2 02 8 (f) Adequate liquidity must be ensured. Liquidity refers to the ability of a firm to make available the necessary amount of cash as and when required. It has to be ensured in order to avoid any embarrassment to the management and the loss of goodwill among the investors. In other words, the investment of funds should be so planned that some of these can be converted into cash to meet all possible eventualities. 2 02 8

DIFFERENT TYPES OF FINANCIAL PLAN

TYPES OF CAPITAL REQUIREMENT FOR FINANCIAL PLAN

The capital requirement of any business unit can be broadly divided into two categories: (a) fixed capital requirement, and (b) working capital requirement. In order to ascertain the amounts of such requirements for any business, one must understand the exact nature of fixed and working capitals and also the various factors that influence their requirement.

FIXED CAPITAL

Fixed capital represents the requirement of capital for meeting the permanent or long-term financial needs of the business. It is primarily used for acquiring the fixed assets like land and buildings, plant and machinery, office equipment, furniture and fixtures etc. Fixed capital is required not only while establishing a new enterprise but also for meeting expansion requirement in the existing enterprises. Preparing a list of fixed assets needed by the business unit and ascertaining their prices from the market can assess the amount of such requirement. It may be noted that investment in fixed assets is a long-term commitment and the amount so invested cannot be withdrawn quickly. Hence, the funds for such requirement are always provided from owners’ fund or raised by issuing shares and debentures and taking long-term loans from financial institutions.

FACTORS DETERMING FIXED CAPITAL REQUIREMENT

In order to assess the fixed capital requirement for any business enterprise, one must be fully conversant with the factors that influence such requirement. These factors are summarised as follows: (a) Nature of business: The amount of fixed capital requirement is determined primarily by the nature of business the firm is engaged in. Such requirement, for example, is very large in case of industrial establishments, shipping companies, public utilities, etc. which involve heavy investment in plant and machinery. The trading concerns (wholesalers and retailers) do not require much investment in the fixed assets. 2 02 8

Long-term financial plan (Time period more than 5 years)

Short-term financial plan (Time –period 1year max)

Medium term financial plan (Time period 1to 5 year)

Adequate working capital is very necessary for maintenance of liquidity and running the business smoothly and efficiently. However, the amount of working capital required varies from business to business and from period to period. The various factors that influence such requirement are as follows: a) Nature of business: The working capital requirement of the manufacturing companies is usually high as they require huge stock-in-trade (inventories) and the amount of their debtors is also expected to be large because of the credit sales involved. As against this, the public utilities like electricity and telephone companies and the concerns like hotels, restaurants, etc. can manage with small amount of working capital as most of their transactions are undertaken on cash basis and their inventory needs are low. (b) Size of business: The size or volume of business plays a major role in determining the amount of working capital requirement of every firm. Obviously, larger the volume of business, larger would be the amount of working capital need. This is because, as their inventory requirement will be large and so also the amount of their debtors. (c) Length of production cycle: Length of production cycle refers to the time period involved in converting raw material into finished goods. Longer the length of such period, larger will be the requirement of working capital and vice versa. The length of production cycle, however, depends upon the type of product being manufactured and the nature of technology used. For example, in case of products like cars and cotton textiles, the production cycle is much longer than in case of items like stationery, detergents, etc. Therefore working capital requirement is large for car companies and textile mills. Similarly, the firms using updated technology may have shorter production cycles and hence their requirement of working capital may not be large. (d) Inventory turnover rate: Inventory turnover rate refers to the speed at, or the time period within which finished stock is converted into sales. There is a high degree of correlation between the amount of working capital required and the inventory turnover rate. A firm having high inventory turnover rate needs less working capital as against a firm, which has low inventory turnover rate. It is so because the firm with high rate can manage with less investment in stock. Take the case of a retailer dealing in fast moving items like groceries and cosmetics with a high turnover rate. Its investment in stock is bound to be much less than a retailer who is dealing in slow moving items like readymade garments or electronics goods. (e) Credit policy: The firms, which provide liberal credit facility to their customers, need more working capital as compared to those firms which observe strict credit terms and are efficient in realisation of their debts. It is so because when customers enjoy longer period of credit, a larger amount of firm’s funds get tied up with debtors. This results in higher requirement of working capital. However, if such a firm also enjoys liberal credit facility from its suppliers, it can manage with lower amount of working capital. But, this may not be true in all cases. (f) Seasonal Fluctuations: The firms that are engaged in manufacturing products like ceiling fans or woolen garments, the demand of which is limited to a specific period of the year, require higher amount of working capital not only during the peak period but also during off season. This is so because they may be left with a good amount of unsold goods, which is kept in stock for sale during the next season.

CAPITIALISATION DETERMINING THE AMOUNT OF CAPITAL

The term capitalisation has various connotations. In common parlance, it refers to the amount at which a company is valued based on its capital employed. Some of the experts on finance used this concept in a narrower sense and defined it as the par value of a company’s shares and debentures, while some of them interpreted it as the par value of its total long-term funds which includes owners fund, borrowed funds, reserves and surplus earnings. In the context of financial planning however, it refers to the process of determining the amount of capital required by a company. Using the following two theories arrives at the capital estimation. (a) Cost theory; and2 02 8 (b) Earning theory.2 02 8

Let us have a brief about these two theories. a) Cost Theory: According to the cost theory of capitalisation, the amount of capital required by the company is calculated by adding up the cost of its fixed assets, the amount of its working capital and the cost of establishing the busi- ness. This approach is simple and used widely in case of new companies. (b) Earning Theory: According to earning theory, the capital requirement of a company is calculated on the basis of the capitalised value of its earning. For example, if the average annual earning of a company is Rs. 5 lakh and the normal rate of return on the capital employed in case of companies in the same industry is 10%, then the amount of capitalisation is Rs. 50 lakh. For a new company the amount of capitalisation is calculated on the basis of its estimated earning. For example, if a new company expects to earn an average annual income of Rs. 3 lakh and the normal rate of return of the industry is 5%, then the amount of capitalisation or the quantum of fund it would require to run the business is Rs. 60 lakh. This approach of capitalisation is considered more rational and relevant because it helps in evaluating as to how far the actual capital employed is justified by the earning of the company. If the actual rate of return is same as the normal rate of return then it is said to be proper capitalised. But in real sense, a company may be either over capitalised or under capitalised that means the actual rate of return may be less or more than the normal rate of return. Let us know in detail about the concept of over- capitalisation and un- der-capitalisation in the next section.

Capitalisation

Proper Capitalisation

Over-Capitalisation

Under-Capitalisation

Rs.10 may be converted into five shares of Rs. 2 each). Although under-capitlisation is considered a lesser evil than over-capitalisation (as the situation can be remedied more quickly) it is better to ensure a fair or proper capitalisation.

2 0 2 8

Misunderstanding KEYKKEY

KEY STEPS TO DRAW UP A BASIC FINANCIAL PLAN (PROCESS)

Assess your financial situation

A good first step when developing your financial plan is to assess your financial situation. With a clear understanding of your current financial situation, you can decide where you should start from, and what you need to achieve your financial goal Knowing your net worth is important to assessing your financial situation. Start by making a list of all your assets as well as your liabilities. Net worth is broadly calculated as your assets minus your liabilities. Assets are what you own, including savings, property, investments; and liabilities are what you owe, such as mortgage loans, tax bills and outstanding debts.

Create a budget

Track the ins and outs of your money to understand your money habits and take control of your spending and savings. Prioritise your needs and wants and look for any unnecessary expenses you can cut to save money. Also refrain from overspending especially impulse buying by credit card. Before you decide to borrow money, make sure you can afford new debt repayments on top of your current expenses or commitments.

Set your financial goals

Based on a sound understanding of your financial situation, you may be able to identify your short-, medium- and long-term financial goals. This will help you review your budget, determine your investment time frame and work out a strategy for deciding on the appropriate investments. With measurable and clearly defined goals, it will be easier to monitor the progress.

When setting your financial goals, you have to consider:

It is important to know what you are planning for. Make a list of all your needs and goals. Remember, managing your day-to-day expenses should come first. The key thing is to set realistic goals and priorities. For example, if you have borrowed money at a high interest rate (e.g. credit card advances or other personal loans), make paying off that debt your first priority before taking on other goals. You

also need to map out the cost of each goal and how much time you have to save or invest before you need to pay for it (eg investment time horizon). When setting your financial goals, it is important to be realistic. As you regularly review and refine your financial plan and assess your risk tolerance level, you may find it worthwhile to adjust your goals accordingly.

Saving – the earlier the better!

The earlier you start saving, the sooner you will allow yourself to benefit from the effect of compounding, a powerful mechanism that puts time to work on your savings. When you save or invest in something that pays interest, you earn interest on your principal (the original investment amount). If you continue to save and earn interest, you will receive interest on the principal plus the interest you earned last time, ie earning interest on your interest. This is called compound interest, and it can significantly boost your savings over time.

Know your risk tolerance

An important part of your financial planning is to evaluate your tolerance for risks. Risk is the potential threat that may impact the expected outcome of your investments. Investments that deliver potentially higher returns are usually accompanied by higher risks. Are you willing to accept potential losses in exchange for greater potential gains?

Risk tolerance can be classified into five categories. Which one best describes you?

Conservative Not willing to take up risk and see loss in investment and may rather forgo potential gains.

Moderately cautious May be willing to accept a limited amount of risks to improve their long-term investment returns, but still try to avoid large short-term fluctuations.

Balanced Weighting the risks and returns, balanced investors recognise that taking on a measured amount of risks will improve the probability of achieving their long- term financial goals.

Moderately aggressive By taking on greater investment risks, moderately aggressive investors expect to see their investment portfolio outperform the market; and do not2 02 8 mind accepting a bit more risk or loss than the market bears.

Aggressive Ready to take on higher levels of risks in order to substantially outperforms the markets. Managing risks You cannot totally avoid risks. But you can control your exposure to risks to an acceptable level. Make sure you understand exactly what you are investing in and recognise the potential risks. Take the trouble to learn about the products you wish to invest in. Read prospectuses, offer documents, annual reports and announcements carefully. Pay

What we have learnt from financial planning

Misund Adequate and proper financing is quite important for success in any business. While the overall managerial activity of handling finance is called ‘Financial management’, the process of estimating the financial requirement, determining the pattern of financing and formulating financial policies and procedures is termed as ‘Financial planning’. To achieve the objectives of financial planning effectively, it must be ensured that the financial plan is simple, takes a long- term view, has the necessary flexibility to meet changing financial needs of the organization, provides for reasonable amount at the lowest possible cost, and takes care of the liquidity requirement of the company. The firm’s capital requirement can be broadly divided into fixed capital and working capital requirements. Fixed capital represents the requirement of capital for permanent or long-term financial needs of the business. Such requirement depends upon the nature of business, size of business, product involved, type of production process adopted, method of acquiring the fixed assets such as cash basis, installment payment method or lease basis. Fixed capital is funded through long-term sources of finance. 2bi

a REFERENCE

Misunderstanding

www.investecwin.co.uk /finanancialplanning

www.thechinfamily.hk

Book Financial planning By Sharma Publication.

20

Author Prof D.R Sharma. Misunderstanding 4 Misunderstanding