Financial Plan

What Is A Financial Plan?

A financial plan is a comprehensive strategy or a document that details an individual's or company's present expenditures and future financial situation by predicting future income, asset values, and withdrawal plans based on known variables.

It includes a roadmap to aid in organizing a person's finances and may include actions or precise goals for future spending and saving. This allocation distributes future earnings to various expenses, such as rent or utilities.

In addition, financial planning is considered more than that; a lot more goes into business and regular life planning. It also involves setting aside some funds for both short—and long-term financial goals.

A financial plan is sometimes confused with an investment plan; however, in personal finance, it can focus on other areas such as risk management, estate planning, college planning, or retirement planning.

A financial plan will include strategic considerations for

• Income
• Expenses
• Investments
• Managing risks
• Debt management,
• Savings

Sound financial planning will help you achieve future goals, such as making money, planning for retirement, funding a child's education, saving taxes, and starting a business.

In this article, we will understand financial plans' fundamentals, components, purpose in personal and business life, and unique considerations.

Understanding a Financial Plan

The financial plan is considered a comprehensive picture of the current economic situation, financial goals, and any strategies to accomplish them. Cash, savings, debt, investments, insurance, and other elements of financial life can be included in financial planning.

In addition, it is a continuous process that will lower any financial stress about money; it helps to save for long-term goals such as retirement. Financial planning is essential because it allows you to maximize your assets while achieving your plans.

'Financial planning is not only for the wealthy; anyone can benefit from creating a future financial roadmap.'

Whether you are making a financial plan on your own or with the help of a financial planner, the first step is collecting many needed documents and clipping and pasting numbers from multiple web-based accounts into a document or spreadsheet.

It is impossible to overestimate the value of financial planning. It is not simply about increasing money away and cutting costs because Financial planning is more than that; a lot more goes into financial planning. This includes achieving future goals like the following.

Making Money

Once the cost of standard products increases, you will need to save up enough money if you want to maintain or improve your current lifestyle in the future. 

Also, we must not forget that all this requires money to grow wealth. Therefore, effectively investing your money in the right areas can help you achieve your goals.

Equity mutual funds can also be a good choice for long-term goals. In the long run, these funds can help the investor build wealth.

Retirement Planning

Your retirement can be between 25-30 years in the future. However, this does not mean you should plan for it when you retire. However, it will help if you begin planning your safety net to live a happy and comfortable retirement.|

Early planning can help secure your financial future in the face of economic uncertainty. Furthermore, if you start early, you can benefit from the force of compounding, which can help you develop a large enough corpus over a 25-30-year period.

Child's Education

As we know, education has become very expensive, and it will keep increasing in the future. This is why it is necessary to begin planning as soon as your child is born. Knowing how much money you want to earn and starting investing can help you reach your objective.

Saving Tax

Everyone is most likely to pay a substantial amount of tax each year. But you can now be able to reduce your tax bill legally. The Income Tax Act contains various provisions that allow people to lower their tax outgo.

You may determine the best ways to invest your money and lower your taxable income by preparing your taxes ahead of time. Also, mutual funds are considered tax-efficient for investing in your long-term goals.

Benefits Of a Financial Plan

Financial planning has various practical advantages. It helps many things, like boosting your savings, affording a standard life, retirement planning, making an emergency fund, reserve fund, saving money for education loans for their children, and more. 

Without a financial plan, it may be possible to save money, but it may not be the most efficient method.

1. Business Planning: Making a financial plan can give you a lot of insight into your income and expenses. In the long run, it increases your savings and tracks and consciously cuts down your costs.
2. Promoting A Better Standard Of Living: Another benefit is a better, higher standard of living. Unfortunately, most people believe that they will have to reduce their living level to pay their monthly bills and EMI repayments. However, if you had a solid financial strategy, you would not have to compromise your lifestyle.
3. Establishing an Emergency Fund: Forming an emergency fund is an essential part of financial planning, which is considered one of the benefits. The person must ensure that he or she has at least six months of monthly salary because you can not know when precisely the emergency might happen.
4. Reserve Fund: As we know, the future is unpredictable, and anything could happen at any time. Imagine a father who has taken out an education loan to help his daughter pay for college. He is also saving money for his upcoming retirement, which is a few years away.
   • But, a medical emergency occurs in the family. Unfortunately, he will have to pay for medical expenses out of his pocket because he does not have medical insurance. This depletes his retirement fund and adds to his financial obligations.
5. Better Management Of Personal Finances: A financial plan encompasses a thorough examination of all the sources of revenues and expenses of a person. Having plan will ensure that you save a certain amount of money, spend a certain amount, and invest a certain amount.
   • This will guide an individual in better planning for future expenses and of personal income.

All of these benefits can be realized only when the user of a financial plan sets clear goals. Apart from this, a thorough examination of financial statements and risks involved, along with constant monitoring and review of the implemented plan, can help reap the benefits of this plan.

How do financial plans save real-life situations?

A sudden job loss or a medical emergency might completely destabilize your finances; this is why an emergency fund is needed to deal with such situations.

Financial experts urge investors to set aside a contingency fund equal to six months' salary. This fund can be invested in a liquid fund to receive money immediately in an emergency.

If you have enough money, you can also cover monthly costs, invest in your future objectives, and spend a bit for yourself and your family without stress. Financial planning allows you to manage your money effectively while also providing you with peace of mind. 

Example Of Real-Life Application Of Financial Planning

Imagine you have $100, and a chocolate bar costs $10. With this amount, you can buy 10 chocolate bars. Consider keeping $100 in a bank for the next year at a 5% yearly interest rate. At the end of the year, you will have $105 left.

However, say the price of the chocolate bar rises to $11 in a year. This implies you will have to pay $110 next year to get the same 10 chocolate bars. But you are short of $5 because you only have $105. This is how Inflation eats at one's savings.

Inflation reduces purchasing power over time, and you have to pay more to buy the same goods. You can fight Inflation by investing your money in things that will give you better returns over time. However, financial planning is essential.

You may spend more time with your family, pursue your passions, and travel the world. However, you must consider one important question: how will I be able to cover all of these costs? To fully enjoy your retired life, you must have enough money.

This is doable if you have financial planning that ensures regular income post-retirement.

Steps to create a financial plan

There can be no exhaustive list of steps to be taken in assembling a financial plan. These plans can change, and the steps could overlap, or some can be omitted due to irrelevance.

There are a few steps to create a financial plan that is discussed below.

Establish Financial Goals

Start by clearly identifying and stating the financial goals. These should include short-, medium-, and long-term financial goals. Goals should be prioritized based on urgency or need. 

These goals should include planning for retirement and emergencies, funding education, initiating a business, and paying off debt.

Your financial goals guide an excellent financial plan. It is possible to feel more intentional about saving if you approach financial planning from the perspective of what your money can do for you, whether buying a house or helping you retire early.

Assessing Current Financial Situation

We need to get a picture of all sources of income and track the expenses. Apart from this, we need to assess the net worth, that is the difference between total assets owned and liabilities owed.

Get a sense of monthly financial flow - how much money comes in and leaves. An accurate image is vital for making a financial plan, as it can identify opportunities to increase savings or debt repayment.

It's recommended that you track expenses by categorizing them, such as rent, utilities, general expenses, and so on. 

Evaluating The Risks Involved

It's imperative that we understand the risks involved. More importantly, we need to assess our risk tolerance. This will help us allocate resources appropriately.

Risk tolerance can often be assessed based on an individual's age, financial goals, time horizon, and economic and emotional ability to handle market fluctuations.

Creating A Budget

In this stage, it is imperative that a budget should be created. A budget that aligns with the financial goals and suits the income and expenses efficiently. 

Allocations should be made for different expenses, debt repayment (if any), discretionary expenses (if any), savings, emergencies, and reserve funds.

Developing An Emergency Fund

Putting money aside for unexpected needs is the cornerstone of every financial plan. Starting with a small amount, like $500, will be plenty to cover minor emergencies and repairs and prevent credit card debt from accumulating.

Another way to protect your budget is to build credit. When you have good credit, you have more options, such as the potential to secure a reasonable vehicle loan rate. In addition, it can boost your budget by lowering your insurance rates and allowing you to skip utility deposits.

Debt Management

Paying down "toxic" high-interest debt, such as credit card balances, payday loans, title loans, and rent-to-own payments, is an integral part of any financial strategy. Some of these have such interest rates that you will have to return two or three times what you borrowed. 

If you are struggling with revolving debt, a debt consolidation loan or debt management plan may help you consolidate multiple bills into a single monthly payment with a lower interest rate.

The priority should be to pay the high-interest debts first, while also making the minimum payment on other debts.

Investment Management

Before starting investing, it is of priority to set an investing strategy that reflects financial goals, risk tolerance, and time horizon. 

The investor should consider different financial instruments, such as stocks, bonds, real estate, and alternative investments.

There should be regular reviews on how the portfolio is performing, and there should be an alternate plan ready on where to invest next or when the current portfolio isn't performing well.

Tax And Retirement Planning

If you go to a financial advisor, he or she will inquire if you have an employer-sponsored retirement plan, such as a 401(k), and if so, does your employer matches any of your contributions.

Note that 401(k) contributions reduce your take-home pay today, but it's worth it to contribute enough to obtain the total match amount because that match is free money.

Building a moat to protect yourself and your family from financial failures with previous steps is possible. Also, you can continue to improve your economic moat as your career grows by:

• Increasing your retirement account contributions.
• Increasing the size of your emergency fund until you have three to six months' worth of living expenses.
• Using insurance helps protect your financial stability in the event of a car accident or illness. Life insurance protects those who rely on your income. Term life insurance, which covers 10—to 30-year intervals, meets most people's needs.

Regular Review And Monitoring

Review your financial plan regularly to monitor your progress toward your objectives, identify any changes to your financial circumstances or goals, and make the required modifications.

Your plan may need to be updated as your financial goals, life circumstances, and the state of the economy change over time.

Why is a financial plan important for your business?

The financial plan, as previously said, is a snapshot of your company's current situation. The projections will inform your short- and long-term financial goals, which will be a starting point for developing a strategy.

Goal Setting And Strategic Direction

A financial plan assists you in setting realistic expectations for your company's performance as a business owner.

A comprehensive financial plan also makes you more appealing to investors, aside from helping you better manage your business. It lowers your risks and demonstrates that you have a solid strategy and track record for expanding your business.

It results in immediate productivity, efficiency, or market penetration increases versus those that can be postponed until cash is more abundant. Most companies go through this prioritization process, weighing the costs and advantages of each planned spending.

Budgets And Expenses Management

It should be of high priority that any business should be able to project revenues and expenses over time. Apart from this, identifying and prioritizing costs and their coverage will prove to be beneficial for the organization.

Whether you are beginning a new firm or expanding an existing one, all business plans should include the following elements:

• A profit and loss statement
• Statement of cash flows
• Balance sheet
• Expected sales (sales forecast)
• Personnel plan
• Break-even analysis and
• Financial ratios

These financial statements can be helpful even if you are just getting started. Preparing these financial statements can help a great deal in understanding the expected and actual figures of the business.

Resource Allocation

A business's ability to conserve financial resources and allocate capital wisely is vital to its success. The advantages of business financial planning include recognizing the most significant expenditures.

With its forward-looking focus, the financial plan allows the business owner to better determine which resources are being utilized well and where the organization is underutilizing.

With plans and budgets in sight, the organization can better understand the expenditures required to improve operational functionality. This will provide an organization with a boost for growth and staying ahead of competitors.

Risk Management

Financial planning helps businesses understand various scenarios through which the business has to go through. Conducting a scenario analysis can help business owners understand potential risks such as market volatility, economic downturns, changes in industrial trends, and more.

It is easy in business to focus on daily crises or challenges. However, being too short-term may cause the owner to not devote enough time to preparing to grow the company over time.

Financial planning helps a great deal in identifying and mitigating the financial risks involved. Motivating the management to carve strategies to minimize such risks.

Capital Management And Financing

In addition, having a firm financial strategy allows you to break down what is required in your short-term finances. For example, many firms experience monthly or seasonal revenue fluctuations, resulting in times when cash is plentiful and cash shortages occur.

Poor capital and cash management can lead to problems such as not being able to pay your investors, shareholders, and employees.

On the other hand, a well-structured financial plan that includes a cash cushion allows the business owner to sleep better at night. The financial cushion enables the company to take advantage of opportunities that arise, such as buying inventory from a supplier at a discounted price for a limited time.

Performance Evaluation And Decision-Making

One of the primary advantages of using a budget is to be able to compare the performance of the different line items. This helps in the performance evaluation of different costs and line items.

The business owner can examine whether an increase in advertising costs resulted in the expected increase in sales and judge how to distribute marketing resources based on trends in particular product sales.

The figures can be favorable and unfavorable, indicating how well the department's performance was over the years.

If actual outcomes are better than expected, it provides much-needed encouragement to the small business owner. For example, a graph demonstrating consistent month-over-month revenue growth or a rising cash balance is a powerful motivator. 

The importance of a financial plan in the company is similar to the extent of financial planning for students: it allows the owner to understand, with the clarity of complex data, whether or not the business is on track to succeed.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Analysis of Financial Statements

• Degree of Financial Leverage

• Financial Controls

• Financial Distress

• Types of Financial Analysis