Financial Planning and Analysis - Research Proposal Example

Financial planning and analysis Name Course Tutor Date Introduction Financial planning and analysis is the determination of how a business firm will manage to achieve its strategic goals and objectives by scrutinizing its financial elements. It provides the supportive decision to the management to visualize both short term and long-term objectives. It helps in assessing the viability by ensuring fulfillment through the process of continuous assessment. Financial planning and analysis is a function that aids the managers to take important decision concerning the profitability and other elements that facilitates financial health of the firms Saunders, M. Lewis, P. & Thorn-hill, A. (2007). Moreover, this process provides important information that helps the managers to foresee the future performance o the business firm. Therefore, the process of financial planning is quite critical to the success of any given business organization. The purpose of this research is to deduce whether the application of financial ratios help is financial health and decision making pro cess in any business firm. Section I Literature review Elements of financial planning and analysis. The basic elements of financial planning and analysis are forecasting, budgeting reporting and analysis. Other elements include resource allocation, IT support, human resource support and operation support. Each of these elements is just subject on itself. Forecasting element is the periodic prediction of the future trends after considering both the internal and external factors. Forecasting is done by the analysis of the past results and application of the known anomalies to the past trends, this element is an integral part of financial planning and analysis. Budgeting is also another important element of financial planning and analysis. Budgeting involves drawing a detailed financial plan and ascertaining the future period goal (Saunders, M, Lewis, P and Thornhill, A .2007), This process of budgeting is done before the beginning of the financial year and made by month. Budgeting normally details the financial elements considering the potential of the business. Reporting is also another element of financial planning and analysis. Reporting is the provision of information at a periodic interval to the required stakeholders that helps them to make important decision for the organization. The information reported includes the past performance, strategies, future plans, the goals and objectives, market share etc. The stakeholders who may want to use these information reported are business partners, debtors, creditors, investors, auditors etc. All these people depend on this information to make their own decision in relation to the company. Analysis as an element of financial planning that refers to the assessment of the financial aspects of the organization to gauge the level of the organization performance. Analysis usually involves understanding financial ratios, the comparison of the budget and the forecast Collis, J &Hussey, R. (2003). Financial analysis involves assessing profitability, deployment of funds, the viability of the business, the marketing environment and the investors’ protection. The activity of analysis plays a major role since it not only assists in understanding the problems facing the company, but also aid in seeing the opportunities in the business environment. This ensures better performance. Why financial planning and analysis There are various reasons why firms ought to carryout financial planning and analysis. First, financial planning and analysis in any organization helps the managers to envision both the short term and long-term objectives. They look at the nature of the elements and decide the appropriate steps that are geared towards enhancing good performance. Secondly, financial planning and analysis drives the performance of any firm. It gives the direction where the firm ought to be steered to. The management analyses the elements, compare it to the budgeted at the beginning of the year, and rectifies where necessary to ensure that before the year ends, the firm achieves its goal. Thirdly, planning and analysis of finance helps in meeting and overachieving internal and external expectations. Both the internal and external expectations are balanced when the planning and analysis are done accurately and the firm automatically realizes these expectations as required. Another reason for this exercise is enabling the management to understand the reasons behind variances from the forecasted. It is quite common and normal that the expected performance results vary from the really results, the variation can be positive or negative. The variation can mean a lot the firm was either efficient or inefficient in expenditure (Gill, J and Johnson, P 2002). Lastly, the exercise enables strategic analysis of the performance so that the company can compare its performance with other competing firms. Therefore, good analysis gives the firm an opportunity to strategize to counter the competition and gain a competitive advantage to outdo other firms. Financial ratios analysis In regards to Lancaster, G (2005). From the financial statements and cash flow, various relevant financial ratios can be identified and calculated. In analyzing these ratios, one should not just start calculating the ratios and how, this is because there are many financial ratios that and it is needless for one to ascertain all the financial ratios. One should have a good reason why he/she wants to calculate the particular ratio. Financial ratios normally play two important functions. First, the ratios help in financial control by the management. Some ratios have certain implication, therefore, the managers looks at the nature of a certain ratios and easily concludes the state of the organization performance. This enables them to control or direct the available resources to the right channel to attain the set objectives. These ratios are used to compare the actual results basing on various benchmarks of performance. The activity of doing a comparison of the ratios to these benchmarks is called financial control. The second use of financial ratios is it helps in financial planning. The financial ratios of the previous financial year help the planners to plan for the available resources to come up with an appropriate budget that is realistic and achievable objectives (Campsuggans. n. d: 1). The financial ratios project a company’s future financial position, this activity is called financial planning. Actually, financial planning involves, assessing the business environment, identification of the business resources, summarizing the costs of creating a budget and identification of the risks and the issues of the budget. The accurate calculation of financial ratios enables all these activities to be done effectively and the firm in return improves in its performance. Financial ratios are always classified into five categories. We have liquidity ratios, leverage ratios, turnover or activity ratios, profitability ratios and marketing ratios. Al these kinds of ratios are important in evaluation of the financial stability of any company. 1. Debt service coverage ratio = Earnings available for debt service / (interest +installment). Earning for debt service = net profit + non-cash operating expenses + non-operating adjustment + fixed assets + interest on debt fund. Service coverage ratio is a ratio that is much depended on by lenders or creditors to judge the ability of the company to pay off the current interest and installments. 2. Return on capital employed (ROCE) is one of the most important financial ratios. It is the percentage return of money invested in a business by the investor. In summary, ROCE indicates the returns the management has made on resources available. Return on capital employed (ROCE) = (Return / capital employed) x 100. Where Return = net profit +non-trading adjustment +interest on long term debts+ tax provision – interest from non-trading investments. Capital employed = equity share capital + reserve + preference shares capital +debentures - miscellaneous expenses. 3. Quick ratio adjusts the current ratio to eliminate all assets that are already in cash. Any ratio that is less than one implies that there is low liquidity this is a danger sign. Quick ratio = Quick assets / current liabilities. Where quick assets = current assets – the inventory. 4. Stock turnover ratio is a ratio that is used to determine if there is too much inventory buildup. When the stock turn figure increases larger than the average in any industry, it indicates that there is poor stock management. Stock turnover ratio = Cost of sales /Average inventory 5. Gearing ratio is a ratio that shows how much a business firm is funded by borrowing. When the level of borrowing (gearing) is high, it means that there are higher risks to the business. However, gearing can be important if the business has strong predictable cash flows. Gearing ratio = Borrowings /Net Assets or shareholders funds 6. Return on equity = Net profit margin x Asset turnover x Equity multiplier Where the net profit margin is the after tax-profit, a firm generates for each currency revenue. Net profit margin is a safety cushion. When it is low, there is less possibility of less room for error. Net profit margin = net income /Revenue Asset turnover is the measure of how effective a firm converts its assets into sales. Asset turnover = Revenue/Assets. It is related to the net profit margin, the higher the net profit margin, the lower the assets turnover. On the other hand, equity multiplier is a measure of the financial leverage which allows the business owner see the portion of the return on equity as a result of debt. Equity multiplier = Assets /Shareholders’ Equity. Limitations of financial ratios As much as the financial ratios are much important to all the stakeholders in a business world, they carry several limitations if they are not calculated accurately or interpreted accurately. The first limitation is that many industries operate diversified products lines. Therefore, in such cases financial ratios calculated based on aggregate data thus, they cannot be used for intercompany comparisons (Campsuggans. n. d: 1). The second limitation of financial ratios is that financial data sometimes can be badly affected by inflation and other external factors. Thus, the historical costs values are substantially very different from the actual values. To give a good picture to the popularly used financial ratios, the management may make some yearend adjustments that are not real but just to entice the investors and blindfold the creditors. Such window dressing often changes the features of the financial ratios that would be quite different and misleading (Campsuggans. n. d: 1). Another limitation of ratios is that the differences in accounting policies and the accounting period always make the accounting elements of two or more firms to be non-comparable. This is because the accounting ratios used in one firm would be different from those in another firm. Lastly, seasonal factors in most cases affects the financial data hence the data always looks different from the previous years. Seasonal factors such as irregular or low supply, interest rates or disaster effects may alter the financial data. Section II Research strategies Financial planning and analysis research involves various research strategies to because it is a wide subject. In order for the planners to reach on the decision making process they must have carried out various research to enable them get the relevant information that would help them make credible decisions (Bryman &Belly 2007; 32). Choosing an appropriate research strategy enhances accuracy in calculation of ratios and accurate decisions. Some of the strategies used in this research are; first, the one can use the textbooks to look for the relevant information that guide him/her on how to conduct a certain type of research. For example in this research, financial textbooks that have information concerning financial elements and ratios were used to analysis the financial status of the firm. Therefore, using textbooks is one strategy a researcher can use to find relevant information and guiding formulas and principles to make important financial decisions. The second strategy is the use of the online guides that are available for various disciplines and topics. Nowadays numerous online resources are available to any one carrying out a research work (Bryman &Belly 2007;32). These resources have the information that may be required by the researchers and even the guidelines of carrying out the research. Moreover, these online resources are easily reached therefore the researcher can be easily be compared to one another, thus, one can come up with a concrete research work within the shortest time possible. Many companies publish their financial statements and other financial data on the internet. People access this information freely even the researcher can use the information of various companies to come up with conclusions and solutions to answer various financial questions. Another strategy that can be used is the visiting the libraries and asking for the relevant resources that are available in the library that can be useful to the research. A library can have numerous resources both old and new ones that can be used for comparison purposes (Saunders, Lewis &Thornhill 200: 7). Therefore, utilizing the library is a strategy that can be very important to the researcher. Moreover, when in the library, the researcher can also look for reliable database and indexes. A library is a store of the information that is required to carry out a research work. Sampling strategies Like the research strategies, sampling methods are also numerous. The research often has less time or money to access the whole population, so many adopts some sampling methods that seem to be a bit cheaper and consume less time (Saunders, Lewis &Thornhill 200: 7). In this financial analysis paper, several sampling methods were used. First, we had simple random sampling where the whole data was available. For example, the financial statements and cash flow statements showed all the elements in the financial data of the firm. Therefore, any person who would like to carry out the study gets accessed to the whole financial information. Another sampling method used is the stratified sampling where specific sub-groups are made by the researcher. He analyzes these subgroups to find a specific objective. For examples when the financial data is grouped in terms of assets, liabilities one can calculate the liquidity ratio easily. In getting the stock turnover ratio, the researcher would just need to group all the sales and the group all the inventory. When these variables are divided, he will be able to calculate the turnover ratio, which is a ratio that is very much important in knowing the performance of the company. Purposive sampling technique is also another method used in this financial analysis. Purposive sampling method is based on the intention of the researcher. In determining a certain financial ratio, a researcher will only sample his data by taking the elements, which are useful in determining that particular ration (Saunders, Lewis &Thornhill 200: 7). For example, when the researcher wants to find out if a company is in a position to pay off its debtors, he will use purposive sampling because he has a particular purpose. In getting the quick ratio, he will purposefully sample the assets and the current liabilities that are available in the financial data. When the assets are divided by the current liabilities, the resulting ratio would be able to tell either the investor or the creditor whether that firm is in a good financial position to pay off its short term debts. Lastly, we have the diversified sampling techniques where the researcher deliberately seeks variations by using different elements to determine accurately the position of the firm on the various aspects of trading. The managers use this sampling technique when they are brainstorming a certain unfavorable condition that has faced the organization. A diversified sampling method as the name suggest, the managers do not just rely on one sampling technique but try to blend the methods so as to have an accurate conclusion on what might be causing the situation. Data collection methods Data collection method is an integral part in any research study. Inaccurate data collection method can alter the results of the study thereafter causing miscalculation of the goals and objectives. Data collections methods are base around the qualitative and quantitative methods. Quantitative data collection methods majorly rely on the random sampling and the structured data collection instruments that are commonly used. The results of the quantitative data collection methods are often easy to compare, analyze, summarize and even generalize. The most common quantitative data collection methods are experiments or clinical trials, observation and recording the events, obtaining relevant data from the information systems and carrying out surveys. The surveys can be done through interviews, or closed ended questions, face-to-face interview where the researcher asks standard the questions (Collis & Hussey 2003: 14). In financial planning and analysis, the researcher may carry interviews by interviewing the chief executive officers, the financial officers, the marketing directors about various aspects of the performance of the business. For example, when the creditor wants to ascertain whether a particular firm is legible in getting the credit, the creditor will have to carry an interview with the financial officers and the top-level managers to find out important information that would enable him to give out this credit. Qualitative data collection methods like the quantitative methods also play an important role in providing useful information to the researcher. The qualitative methods are employed by the researchers to improve or expand and clarify the quantitative evaluation findings (Collis & Hussey 2003: 14). Qualitative methods are characterized by various attributes. First, these methods tend to use open-ended questions where the researchers try to alter the data collection strategy. He adopts some strategies, drop or refine the techniques used. Secondly, they heavily rely on the interactive interviews where the respondents can be interviewed many times. Thirdly, these methods use triangulation to increase the credibility of their findings. Then lastly, the results of the qualitative methods are not generalizable to any specific population. The most commonly qualitative method used in financial analysis are; in-depth interview, observation methods and document review. Therefore, the main data analysis methods are the quantitative and qualitative methods (Bryman &Belly 2007; 32). Both of these methods should be employed by a serious researcher in order for him to come up with a thorough research that would give him creditable results that would help boost the form’s performance. In most case, the analysis and planning of the business organization should be based on the qualitative research. Business organization tend to compete one another, thus for a firm to compete effectively it has to use the qualitative methods to find the exact variables that it will use to gain an advantage over other firms. In analyzing the research data, the research calculates some statistical variables such as the range, the variance and the standard deviation to find out the difference between the forecasted budget and the actual budget. These variables aid a lot in finding where the problem came and rectifying of the errors done. When the statistical variables are combined with the financial ratios, the researcher or the management is in a position to estimate accurately the financial level and performance of the organization. Bibliography Bryman, A. &Bell, E. (20070. Business Research Methods. 2nd Edi. Oxford; Oxford University press. Campsuggans. (n. d). Chapter3. Financial analysis and planning. Accessed on web 6th Sept 2012. Retrieved from http://220.227.161.86/18411compsuggans_pcc_FM_chapter3.pdf Campsuggans. (n. d). Chapter 2 Financial analysis and planning. Accessed on web 6th Sept 2012. Collis, J &Hussey, R. (2003). Business research. 2nd Edi. Basingstoke: Palgrave Macmillan. Smartpsych.co.uk. (2012). Research methods: Data analysis. Acce4ssed on web. 6th Sept 2012. Retrieved from http://www.smartpsych.co.uk/wp- content/uploads/2012/02/psych_methods1.pdf Saunders, M. Lewis, P. & Thorn-hill, A. (2007). Research Methods for Business students. 4th Edi. New Jersey: Financial Times. Prentice Hall. Gill, J and Johnson, P (2002), Research Methods for Managers (3rd Edition), London: Sage. Lancaster, G (2005), Research Methods in Management, Oxford: Elsevier Butterworth- Heinemann. Saunders, M, Lewis, P and Thornhill, A (2007), Research Methods for Business Students (4th Edition), New Jersey: Financial Times/Prentice Hall. Read More