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Whys is Financial Awareness so important?

 (A)    Objectives of Financial Planning:

Financial planning is done to achieve the following two objectives:

            1. To ensure availability of funds whenever these are required:

The main objective of financial planning is that sufficient fund should be available in the company for different purposes such as for purchase of long term assets, to meet day-to- day expenses, etc. It ensures timely availability of finance. Along with availability financial planning also tries to specify the sources of finance.

          2. To see that firm does not raise resources unnecessarily:

Excess funding is as bad as inadequate or shortage of funds. If there is surplus money, financial planning must invest it in the best possible manner as keeping financial resources idle is a great loss for an organisation.

Financial Planning includes both short term as well as the long term planning. Long term planning focuses on capital expenditure plan whereas short term financial plans are called budgets. Budgets include detailed plan of action for a period of one year or less.

(B)   Importance of Financial Planning:

Sound financial planning is essential for success of any business enterprise. Its need is felt because of the following reasons:

           1. It Facilitates Collection of Optimum Funds:

The financial planning estimates the precise requirement of funds which means to avoid wastage and over-capitalization situation.

          2. It Helps in Fixing the Most Appropriate Capital Structure:

Funds can be arranged from various sources and are used for long term, medium term and short term. Financial planning is necessary for tapping appropriate sources at appropriate time as long term funds are generally contributed by shareholders and debenture holders, medium term by financial institutions and short term by commercial banks.

         3. Helps in Investing Finance in Right Projects:

Financial plan suggests how the funds are to be allocated for various purposes by comparing various investment proposals.

        4. Helps in Operational Activities:

The success or failure of production and distribution function of business depends upon the financial decisions as right decision ensures smooth flow of finance and smooth operation of production and distribution.

          (v)    5. Base for Financial Control:

Financial planning acts as basis for checking the financial activities by comparing the actual revenue with estimated revenue and actual cost with estimated cost.

        (vi)    6. Helps in Proper Utilisation of Finance:

Finance is the life blood of business. So financial planning is an integral part of the corporate planning of business. All business plans depend upon the soundness of financial planning.

       (vii)    7. Helps in Avoiding Business Shocks and Surprises:

By anticipating the financial requirements financial planning helps to avoid shock or surprises which otherwise firms have to face in uncertain situations.

      (viii)    8. Link between Investment and Financing Decisions:

Financial planning helps in deciding debt/equity ratio and by deciding where to invest this fund. It creates a link between both the decisions.

        (ix)    9. Helps in Coordination:

It helps in coordinating various business functions such as production, sales function etc.

          (x)    10. It Links Present with Future:

Financial planning relates present financial requirement with future requirement by anticipating the sales and growth plans of the company.


What is financial planning? Contrary to popular belief, financial planning is not just investing. It is a process. It allows you to manage your finances in such a way that you link it to your goals. Making a standalone investment in a life insurance product means nothing if you do not know the amount of cover you need, or whether the maturity proceeds are adequate, or whether you need a life cover.

The process of financial planning should help you answer three questions. Where you are today, that is, your current personal balance sheet, where do you want to be tomorrow, that is, finances linked to your goals, and what you must do to get there, that is, the asset allocation and investment strategy that will help you achieve your objectives.

Developing a financial plan needs a consideration of various factors. First, your objective or the purpose for which the investments are being made. The time period, too, is critical, since the longer the period of investment, the higher is the ability to absorb risks. Also, one of the most important factors that many of us did not account for earlier is inflation. The level of inflation can deplete your return from investment considerably. Today's expense of Rs 10,000 would be Rs 43,000 in 30 years if the inflation rate stays at 5% per annum.

 Areas of focus- Financial 

The six key areas of personal financial planning, as suggested by the Financial Planning Standards Board, are

  1. Financial position: is concerned with understanding the personal resources available by examining net worth and household cash flow. Net worth is a person's balance sheet, calculated by adding up all assets under that person's control, minus all liabilities of the household, at one point in time. Household cash flow totals up all the expected sources of income within a year, minus all expected expenses within the same year. From this analysis, the financial planner can determine to what degree and in what time the personal goals can be accomplished.
  2. Adequate protection: or Insurance, the analysis of how to protect a household from unforeseen risks. These risks can be divided into liability, property, death, disability, health and long-term care. Some of these risks may be self-insurable, while most will require the purchase of an insurance contract. Determining how much insurance to get, at the most cost effective terms requires knowledge of the market for personal insurance. Business owners, professionals, athletes and entertainers require specialized insurance professionals to adequately protect themselves. Since insurance also enjoys some tax benefits, utilizing insurance investment products may be a critical piece of the overall investment planning.
  3. Tax planning: typically, the income tax is the single largest expense in a household. Managing taxes is not a question whether or not taxes will be paid, butwhen and how much. Government gives many incentives in the form of tax deductions and credits, which can be used to reduce the lifetime tax burden. Most modern governments use a progressive tax. Typically, as one's income grows, a higher marginal rate of tax must be paid. Understanding how to take advantage of the myriad tax breaks when planning one's personal finances can make a significant impact.
  4. Investment and accumulation goals: planning how to accumulate enough money for large purchases and life events is what most people consider to be financial planning. Major reasons to accumulate assets include, purchasing a house or car, starting a business, paying for education expenses, and saving for retirement.

Achieving these goals requires projecting what they will cost, and when one needs to withdraw funds. A major risk to the household in achieving their accumulation goal is the rate of price increases over time, or inflation. Using net present value calculators, the financial planner will suggest a combination of asset earmarking and regular savings to be invested in a variety of investments. In order to overcome the rate of inflation, the investment portfolio has to get a higher rate of return, which typically will subject the portfolio to a number of risks. Managing these portfolio risks is most often accomplished using asset allocation, which seeks to diversify investment risk and opportunity. This asset allocation will prescribe a percentage allocation to be invested in stocks, bonds, cash and alternative investments. The allocation should also take into consideration the personal risk profile of every investor, since risk attitudes vary from person to person.

  1. Retirement planning is the process of understanding how much it costs to live at retirement, and coming up with a plan to distribute assets to meet any income shortfall. Methods for retirement plan include taking advantage of government allowed structures to manage tax liability including: individual (IRA) structures, or employer sponsored retirement plans.
  2. Estate planning involves planning for the disposition of one's assets after death. Typically, there is a tax due to the state or federal government when one dies. Avoiding these taxes means that more of one's assets will be distributed to their heirs. One can leave their assets to family, friends or charitable groups.

Money management :

The process of managing money which includes investment, budgeting, banking and taxes. It is also called investment management.

Money management is a strategic technique employed to make money yield the highest interest-yielding value for any amount spent. Spending money to satisfy cravings (regardless of whether they can justifiably be included in a budget) is a natural human phenomenon. The idea of money management techniques has been developed to reduce the amount that individuals, firms and institutions spend on items which add no significant value to their living standards, long-term portfolios and assets. Warren Buffett, in one of his documentaries, admonished prospective investors to embrace his highly esteemed "frugality" ideology. This involves making every financial transactions worth the expense:

1. Avoid any expense that appeals to vanity or snobbery
2. Always go for the most cost-effective alternative (establishing small quality-variance benchmarks, if any)
3. Favour expenditures on interest bearing items over all others
4. Establish the expected benefits of every desired expenditure using the canon of plus/minus/nil to standard of living value system.

 

Personal budgeting, while not particularly difficult, tends to carry a negative connotation among many consumers. Sticking to a few basic concepts helps to avoid several common pitfalls of budgeting.

Purpose

A budget should have a purpose or defined goal that is achieved within a certain time period. Knowing the source and amount of income and the amounts allocated to expense events are as important as when those cash flow events occur.

Simplicity

The more complicated the budgeting process is, the less likely a person is to keep up with it. The purpose of a personal budget is to identify where income and expenditure is present in the common household; it is not to identify each individual purchase ahead of time. How simplicity is defined with regards to the use of budgeting categories varies from family to family, but many small purchases can generally be lumped into one category (Car, Household items, etc.).

Flexibility

The budgeting process is designed to be flexible; the consumer should have an expectation that a budget will change from month to month, and will require monthly review. Cost overruns in one category of a budget should in the next month be accounted for or prevented. For example, if a family spends $40 more than they planned on food in spite of their best efforts, next month's budget should reflect an approximate $40 increase and corresponding decrease in other parts of the budget.

"Busting the budget" is a common pitfall in personal budgeting; frequently busting the budget can allow consumers to fall into pre-budgeting spending habits. Anticipating budget-busting events (and underspending in other categories), and modifying the budget accordingly, allows consumers a level of flexibility with their incomes and expenses.

Budgeting for irregular income

Special precautions need to be taken for families operating on an irregular income. Households with an irregular income should keep two common major pitfalls in mind when planning their finances: spending more than their average income, and running out of money even when income is on average.

Clearly, a household's need to estimate their average (yearly) income is paramount; spending, which will be relatively constant, needs to be maintained below that amount. A budget being an approximate estimation, room for error should always be allowed so keeping expenses 5% or 10% below the estimated income is a prudent approach. When done correctly, households should end any given year with about 5% of their income left over. Of course, the better the estimates, the better the results will be.

To avoid running out of money because expenses occur before the money actually arrives (known as a cash flow problem in business jargon) a "safety cushion" of excess cash (to cover those months when actual income is below estimations) should be established. There is no easy way to develop a safety cushion, so families frequently have to spend less than they earn until they have accumulated a cushion. This can be a challenging task particularly when starting during a low spot in the earning cycle, although this is how most budgets begin. In general, households that start out with expenses that are 5% or 10% below their average income should slowly develop a cushion of savings that can be accessed when earnings are below average. Whether this rate of building a cushion is fast enough for a given financial situation depends on how variable income is, and whether the budgeting process starts at a high or low point during the earnings cycles.

  • Ref-

    Source of wikipedia.org

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