Question

Explain the factors influencing financial planning.

Answer 1

1. Objectives: All financial plans must be created with the goal of achieving the enterprise’s financial objectives. The primary objective is to obtain funds at the minimum possible cost and ensure their optimal use.
2. Nature of Industry: The financial requirements of a business and how funds are invested depend largely on the nature of the industry in which it operates. Industries that are capital-intensive, such as petrochemicals or iron and steel, require substantial funds for setting up and maintaining production facilities. Additionally, industries that are expanding or growing will need more funds to support their growth plans. If the industry faces intense competition, businesses must invest in modernisation and research to stay competitive.
3. Size of the Firm: A large business with plans for consistent growth will require higher amounts of capital. Financial planning is also influenced by factors such as the firm’s past performance and credit reputation, the management’s approach and philosophy, and the level of risk the company is prepared to take.
4. Capital Market Conditions: Financial planning is largely influenced by the cost of different financing options and the policies of financial institutions and banks. The availability of alternative sources of funds, along with their respective advantages and disadvantages, plays a crucial role in determining which type of securities the company should issue.
5. Government Regulations: Government financial policies and regulations influence both the accessibility and the cost of funds. For instance, lower interest rates in India have decreased the cost of borrowing through debt.
6. Degree of Risk: The amount of risk an enterprise is willing to take plays a key role in shaping its financial planning. Raising funds through shares involves less risk, as dividend payments are not mandatory when profits are low. However, excessive reliance on equity financing can lead to a dilution of control over the company. Therefore, the ratio of equity to debt capital is determined based on the company’s profit levels and the management’s risk preferences.