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02.jūlijs, 2015

How to approach financial planning in a company?

The need of financial planning is essential in any business, especially when preparing business plans, budgets and company development forecasts. Usually, financial information forecasts are gathered in three interrelated financial forecasts – cash flow forecast, profit and loss statement forecast and balance sheet forecast. These form the traditional “set", which is included in the majority of business plans. Quite frequently, other forecasts such as, for example, investment plans, etc. are also added, depending on the objective of the forecasts included in this “set”.

In practice, financial planning is frequently performed by applying simple methods and techniques. One of the most common methods used in different variations is the so-called turnover percentage method. This method is relatively simple and allows for a relatively fast preparation of financial plans. However, at the same time, it is inaccurate, because the coherences between revenue, costs and balance sheet items are viewed in an overly simplified manner, and many aspects, such as taxes, differences in payment periods involving various debtors and creditors, differences in the circulation of various materials, goods and inventories are not fully taken into consideration.

This method can be considered to be suitable when preparing formal financial forecasts for external users. However, this can be done only provided that the external users accept such forecasts. Nowadays, more and more external users require more substantial financial forecasts, especially, if it regards the attraction of credits or other types of funding from private institutions (banks, venture capital funds, etc.). Also, when preparing financial forecasts for internal use, a much higher degree of substance and detail is required.

When preparing financial forecasts for its customers, SIA EDO Consult uses its own method allowing for the preparation of forecasts with a higher degree of substance and detail. This method allows for the preparation of financial forecasts with the level of substance and detail required by the client.
The idea of this method can be relatively described as planning “from the bottom up”. The planning begins with the so-called core elements. Afterwards, based on the mutual relationship between these core elements, forecasts of revenue, costs, cash revenue and expenses, taxes, debtors, inventories, creditors etc. are planned. Finally, based on these forecasts, a cash flow forecast, profit or loss statement forecast, balance sheet forecast and, if necessary, other forecasts are prepared. The planning process used in this method resembles actual processes within the company, where the results of the company’s operations are comprised of separate transactions and these transactions then affect other transactions and operations.

The selection and formulation of specific core elements depends on several factors: i.e., the specifics of the industry (field of activity) of the company, particulars of the company, as well as the necessary level of substance and detail of the financial forecasts. The latter is especially important. The core elements are formulated separately for revenue, costs, inventories, taxes, long-term investments, credits etc., at the same time, by taking into account the correlations between them. The core elements of revenue are the types of revenue, for costs – types of costs, for inventories – major groups of materials/goods/products, for taxes – types of taxes, etc. Depending on the number of core elements used and the level of detail, it is possible to adjust the degree of substance and detail of the financial forecasts.

The following significant advantages can be identified for financial planning by using this method :

  1. Ample opportunities for choosing the level of substance and detail of the financial forecasts. Furthermore, these opportunities pertain not only to forecasts in general, but also to separate components and aspects of the company’s operations. Thus, separate aspects of planning can be examined in great detail, while at the same time examining less significant aspects more generally.
  2. All financial forecasts are prepared for each and every period included in those forecasts. Thus, the cash flow forecast, the profit or loss statement forecast and the balance sheet forecast are available for any of the periods. Such full set of forecasts is also available on a monthly basis, if the financial information is forecasted by month.
  3. It is possible to plan payments of various taxes, especially VAT, as well as repayment of overpaid VAT and other taxes from the State budget in more detail.
  4. It is possible to take into consideration the differences in seasonality of various revenue and expense groups.
  5. It is possible to take into consideration the differences in payment periods for various groups of buyers and suppliers.
  6. It is possible to take into consideration the differences in the period of circulation of various groups of materials, goods and products.
  7. It is possible to plan the investment expenditure and the necessity for additional funding more precisely.
  8. It is possible to more precisely identify possible problems and additional opportunities. Thus, it is possible to plan measures for prevention of these problems or more efficient use of additional opportunities in a timelier manner.

It should be noted that preparing financial forecasts by using this method excludes the option of “covering” all imperfections of a balance sheet item. The only time there is a need for some very insignificant cosmetic corrections may be due to rounding-off of calculation results.
Therefore, the obtained result corresponds to the actual situation of the company and provides more accurate information about the impact of the expected future factors on the results of the company’s economic activity.

Alberts Auziņš, Financial Analyst, SIA EDO Consult