UPI Study › Courses › Business Essentials › Free lessons › Lesson 21.4 Free with a free account
The Financial Planning Process: A Complete Overview
Business Essentials · Chapter 21: Financial Management and PlanningSection 21.4 · lesson 94 of 10512 min · free with a free account
Free preview
Create a free account to keep watching
It takes a minute and costs nothing. Your free account unlocks all of Chapter 1 and 3 more lessons of Business Essentials.
Lesson complete
Earn the 3 college credits for Business Essentials
Enrolling adds a quiz after each lesson, the graded work and the official transcript. Recommended for credit by NCCRS.
Next lesson: Securities Markets and the Role of Investment Bankers →← Short-Term and Long-Term Financing SourcesNext lesson: Securities Markets and the Role of Investment Bankers →
In this lesson
From strategy to forecasts, budgets, and variances.
- Describe the 7 stages of financial planning
- Build a forecast and register its assumptions
- Explain why a monthly cash forecast matters
- Use budgets and variance analysis well
Free study notes
Get this lesson's notes by email
The key points and 4 practice questions with answers, in your inbox. One email, free.
One email. Unsubscribe in one click.
Transcript
Everything said in the video, section by section (1,763 words). Read along, or search it.
Financial Management and Planning
The Financial Planning Process: A Complete Overview
A business can have a profitable year and still run out of cash in May. Financial planning exists so that May doesn't come as a surprise. This is educational content about planning, forecasting, and budgeting. It isn't financial, investment, tax, or legal advice. A business building its own plan should work with a qualified financial professional or accountant. We'll walk through the seven stages of the planning process. We'll see how a sales forecast is built, and why its assumptions need to be written down. We'll find out why the monthly cash forecast matters most. And we'll close with budgets, variance analysis, and when a plan should be revised.
Defined
Turning a Direction Into a Funded Plan
Financial planning answers three questions about funds. What will the business need? When will it need it? And where will it come from? It looks over a horizon longer than a single operating period. It connects directly to the strategic planning process from earlier in the course. And that connection runs in both directions. A strategy without a financial plan is just an intention. It states a direction, but commits no resources to reach it. A financial plan without a strategy is just an extrapolation. It projects numbers, with no reasoning about what the business is actually trying to achieve. Financial planning turns a strategic direction into a concrete statement of what it will require, and when.
The Process
7 Stages of Financial Planning
The process runs through seven stages. First, the business sets its objectives and its horizon. What is it trying to achieve, and over what period? Second, it forecasts sales. Everything that follows rests on this number. Third, it projects the costs and investment needed to support that level of sales. Fourth, it derives the funding need. That's the gap between what the business will generate, and what it will require. Fifth, it evaluates the financing options to meet that need, drawing on the sources from the last section. Sixth, it tests the plan against alternative assumptions. And seventh, it approves the plan, then monitors actual results against it as the period unfolds. Notice that the plan doesn't end at approval. Monitoring is a stage in its own right.
The Foundation
Forecasting Sales
Sales forecasting is the foundation of the whole process. Every later number, from costs to funding needs, rests on an assumption about how much the business will sell. Three methods are commonly used. Historical trend extrapolation projects the pattern of past sales forward. It works when conditions are stable. It's poorly suited to a business undergoing significant change. Market-based estimation starts from the size of the addressable market, and the share the business expects to capture. That suits a new product, or a new business with no sales history of its own. A bottom-up build constructs the forecast from individual customers, contracts, or capacity limits. It's useful when the business can see its specific pipeline or production limits in detail. Whichever method you use, keep an assumption register. That's a written record of what the forecast assumes about volume, price, and conditions. Without one, a forecast is just a final number. When reality departs from it, no one can tell which assumption was wrong.
Pro Forma Statements
The Forecast That Reveals What Others Hide
A financial plan is expressed through three pro forma statements. Pro forma means projected. These are forward-looking versions of the statements from the accounting chapter. There's a projected income statement, a projected balance sheet, and a projected cash flow. Of the three, the cash flow forecast is the one that reveals what the others hide. The reason is one we've met before. Profit and cash are different things under accrual accounting. So a projected income statement can show steady, growing profit. And all the while, the business can be running out of cash. Only a cash flow forecast shows precisely when cash will be tight, even while profit looks healthy. And it has to be built month by month, not for the period as a whole. The next figure shows why that detail matters so much.
Figure 21.4.1
Finding the Funding Gap, and When It Opens
Here's the pattern from a described business's monthly cash forecast, built with illustrative figures. The projected cash balance falls below zero in May. It stays negative through June, starts recovering in July, and is solidly positive again by August. Now imagine the same business planning only for the year as a whole. Its plan would show a healthy ending cash position. And it would miss, entirely, that the business needs extra funding in May and June. That's exactly the kind of gap a monthly forecast is built to reveal. The practical point is important. Financing arranged in advance costs less than financing arranged in a crisis. A business that sees the May need months ahead can approach a lender calmly, with time to shop and negotiate terms. A business that discovers it in April, with its balance already near zero, is negotiating from weakness. Under that time pressure, it will likely accept worse terms for the very same need.
Budgeting
From Plan to Operating Document
Budgeting translates the financial plan into a detailed operating document for the period ahead. It has three parts. The operating budget projects revenue and operating expenses. The capital budget projects spending on long-term assets. And the cash budget projects the timing of inflows and outflows. It's the detailed, near-term version of the cash forecast. The construction order matters. The sales budget drives everything else. Production, staffing, purchasing, and nearly every other operating figure depend on expected sales. There are also three common approaches to building a budget. Incremental budgeting adjusts last period's budget by a stated amount or percentage. It's simple, but it carries forward unexamined inefficiencies. Zero-based budgeting starts from zero, so every line must be justified afresh. It's more rigorous, and much more time-consuming. And a flexible budget adjusts its figures to the volume the business actually achieved.
Variance Analysis
Flexible Budgets, Volume, and Rate
That flexible budget deserves real emphasis. Suppose a business sells more units than it planned. Naturally, it spends more on variable costs, such as materials. Compare that spending against a fixed budget, built for lower volume, and the business looks like it overspent. In fact, its spending simply tracked a higher, and generally favorable, level of activity. A flexible budget restates what spending should have been at the actual volume. That separates genuine cost control from the mechanical effect of selling more or less. Variance analysis then examines the gap between actual and budget, in two parts. A volume variance reflects selling or using more or less than planned, at the planned price or cost. A rate variance reflects the actual price or cost differing from plan, at the actual volume. They call for different responses. A big variance driven by volume may need no corrective action at all. The same total, driven by rate, points to a purchasing or pricing problem worth investigating.
Table 21.4.1
A Flexible Budget Variance Report
Here's a flexible budget variance report for a described period, using illustrative figures. The plan was to sell one thousand units. The business actually sold eleven hundred fifty. Materials were budgeted at twenty thousand dollars. Actual materials cost twenty-five thousand three hundred dollars. Compared against the original plan, that's an alarming five thousand three hundred dollars over. But flex the budget to the actual volume, and materials should have cost twenty-three thousand dollars. So three thousand dollars of the overspend is simply the effect of selling a hundred fifty more units. Only two thousand three hundred dollars reflects materials actually costing more per unit than planned. That smaller rate component is the one worth investigating. Labor tells a similar story, with a twist. Its flexed budget is seventeen thousand two hundred fifty dollars, but actual labor came in at sixteen thousand nine hundred. So labor shows a favorable rate variance of three hundred fifty dollars, even though total spending rose.
Reading Variances
Thresholds and Named Causes
Two disciplines keep variance analysis useful. The first is a materiality threshold. It's a size below which a variance isn't investigated further. It keeps attention on the variances large enough to matter. It's the same materiality idea from the accounting chapter, applied to budgets rather than to disclosure. The second discipline governs every variance above that threshold. A variance is not explained until its cause is named. Blaming market conditions, or a difficult quarter, is not an explanation. Naming the specific driver is. That might be a particular supplier's price increase, or a specific customer's order slipping into a later period. The test is simple. Could someone act on the explanation you've given?
Testing And Monitoring
A Range, Not a Point, and a Plan That Moves
Plans also need testing, and two kinds of test are used. Scenario testing builds a whole alternative version of the plan, under a better or worse set of assumptions. Sensitivity testing, which we met with information systems, varies one specific assumption while holding the others constant. It reveals which assumption the plan actually depends on most heavily. Together, they produce a range, rather than a single point estimate. That gives decision-makers a sense of how much the outcome could reasonably vary. A single number, by contrast, carries a false sense of precision. Finally, a plan isn't filed away once approved. It's monitored against actual results. Revision should be triggered by a meaningful departure from a key assumption, like sales running well above or below forecast. It shouldn't wait for a fixed annual review. Imagine sales departing sharply from forecast within the first two months, in a plan reviewed only once a year. That departure goes unaddressed for most of the year. And that delay is exactly what turns a manageable funding need into a crisis.
Case Vignette
Two Weeks' Notice
Teodora owns a custom furniture workshop. This is a composite case, constructed for instruction. She has never built a monthly cash forecast. She watches her bank balance, and reacts as needed. Two weeks before a large materials payment comes due, alongside payroll, she realizes she can't cover both. And this is in a year that looks profitable overall on her income statement. With two weeks to act, she asks her bank for an emergency short-term loan. The bank agrees, but on noticeably less favorable terms than more lead time might have earned. That reflects the rushed request, and the bank's own caution so close to a payment deadline. She meets her obligations. But the gap costs more than it would have, viewed calmly and in advance. Her trade-off now is between managing informally, and building a monthly forecast. The constraint is real. Building and maintaining a forecast takes time, and her workshop has limited administrative capacity. Still, her reasoning is clear. Even a fairly simple forecast would have shown this gap weeks or months ahead. That would have let her negotiate calmly, rather than under pressure. So she resolves to build one going forward, with her accountant's help.
About Business Essentials at UPI Study
Business Essentials (Business 100) is a self-paced online course of 105 video lessons in 24 chapters, from the business environment, economics and global markets to ownership, management, leadership, operations, people, marketing, accounting, finance and banking. It carries a NCCRS credit recommendation for 3 semester credits.
Every lesson transcript is free on pages like this one, and the videos are free with a free UPI Study account. Enrolling adds a practice quiz after each lesson, the graded work and final exam that earn the credit, lifetime access, and an official transcript on completion. UPI Study has helped over 130,000 students with college credits. ACE and NCCRS have over 2,100 cooperating colleges that will consider accepting credits; the final decision is with the universities.
Enroll now → Course details Download the syllabus All Business courses Every course with PRO →
Why take it here
Why students take Business Essentials with UPI Study
Where the credit goes
Universities that work with NCCRS
Business Essentials carries a NCCRS credit recommendation. These universities work with NCCRS; some are UPI Study's signed partners. ACE and NCCRS have over 2,100 cooperating colleges that will consider accepting credits; the final decision is with the universities.
Thomas Edison State UniversitySigned partner
University of the PeopleSigned partner
Charter Oak State CollegeSigned partner
Strayer UniversitySigned partner
Columbia Southern UniversitySigned partner
Indiana TechSigned partner
Penn StateWorks with NCCRS
Southern New Hampshire UniversityWorks with NCCRS
SUNYWorks with NCCRS
+many more cooperating universitiesFind my college →Find my college → Not listed? Ask Athena in the corner of this page, or book a 15-minute call.
FAQ
Questions students ask us
About The Financial Planning Process: A Complete Overview
What are the steps in the financial planning process?
Why should a cash flow forecast be monthly instead of annual?
What is a flexible budget?
What is the difference between zero-based and incremental budgeting?
About the Business Essentials course
How many college credits is Business Essentials?
How much does Business Essentials cost and what is included?
Which universities accept UPI Study credits?
How long does Business Essentials take?
How are the exams done?
How do my credits reach my college?
Ready for the full course? Earn 3 credits in Business Essentials.
105 video lessons, a quiz after each one, and the graded work that earns the credit. Recommended for credit by NCCRS.
3 credits · NCCRSEnroll →