A financial plan is a document that contains information about a person’s current financial situation, long-term financial goals, and strategies for achieving those goals.
A financial plan begins with a thorough assessment of a person’s present financial situation and future goals, and it can be developed independently or with the assistance of a certified financial planner.
KEY TAKEAWAYS
- A financial plan outlines a person’s long-term financial objectives and develops a strategy to achieve them.
- The strategy should be comprehensive but also highly personalised, taking into account the individual’s personal and family circumstances, risk tolerance, and long-term goals.
- The strategy begins with a calculation of the individual’s existing net worth and cash flow and concludes with a plan.
The Fundamentals of Financial Plans
Whether you’re going it alone or with a financial planner, the first step in creating a financial plan is gathering a lot of bits of paper—or, more likely these days, cutting and pasting numbers from various web-based accounts into a document or spreadsheet.
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You may complete the following steps as an individual or a couple:
Calculating net worth
To figure out your current net worth, list all of the following:
- Your assets: These may include a home and a car, some cash in the bank, money invested in a 401(k) plan, and anything else of value that you own.
- Your liabilities: these may include credit card debt, student debt, an outstanding mortgage, and a car loan. In some cases, you may have access to a grace period or moratorium.
The formula for your current net worth is your total assets minus your total liabilities.
Determine cash flow
You can’t make a financial plan until you know where and when your money is going. Documenting transactions—the flow of money in and out—will help you figure out how much money you need for basics each month, how much money you have leftover for saving and investing, and even where you can save a little—or a lot.
Skimming through your bank and credit card statements is one way to accomplish this. They should provide a fairly detailed history of your spending if you put them all together.
If your expenses vary a lot from month to month, it’s better to go through the year and total all of your expenses in each area, then divide by 12 to get an average monthly estimate of your spending.
This way, you won’t under- or overestimate your utility costs, and you won’t forget to budget for holiday gifts or a vacation.
Don’t forget about cash withdrawals, which can be used for everything from shampoo to soda.
Keep track of how much you spent on essential housing expenses like rent or mortgage payments, utilities, credit card interest, and even home furnishings over the course of a year.
Add categories for food, clothing, transportation, medical insurance, and non-covered medical expenses, then track your actual entertainment, dining out, and vacation travel spending separately.
Your personal spending categories will stand out as you review your financial information. You can have a pricey hobby or a spoiled pet. Keep track of the expenses.
When you tally together all of these statistics for a year and divide them by 12, you’ll have a precise estimate of your cash flow.
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Consider your priorities.
The core of a financial plan is a person’s clearly defined goals. These may include funding a college education for the children, buying a larger home, starting a business, retiring on time, or leaving a legacy.
No one can tell you how to prioritize these goals. However, a professional financial planner may be able to help you choose a detailed savings plan and specific investments that will help you tick them off, one by one.
The main elements of a financial plan include a retirement strategy, a risk management plan, a long-term investment plan, a tax reduction strategy, and an estate plan.
Special Considerations of a Financial Plan
Financial plans don’t have a set template. A licensed financial planner will be able to create one that fits you and your expectations. Once complete, it may prompt you to make changes in the short term that will help ensure a smooth transition through life’s financial phases.
The following elements should be addressed and revised as necessary:
- Retirement strategy: No matter what your priorities are, the plan should include a strategy for accumulating the retirement income that you need.
- Comprehensive risk management plan: This includes a review of life and disability insurance, personal liability coverage, property and casualty coverage, and catastrophic coverage.
- Long-term investment plan: A customized plan based on specific investment objectives and a personal risk tolerance profile.
- Tax reduction strategy: A strategy for minimizing taxes on personal income to the extent allowed by the tax code.
- Estate plan: Arrangements for the benefit and protection of your heirs.
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The key elements of financial planning
Financial success can be planned. Meticulous financial planning helps you to assess the impact of your decisions on your company’s liquidity, profit, and balance sheet structure. Financial planning helps to avoid mistakes, minimize risks, secure liquidity and achieve financial objectives.
It involves the comprehensive analysis of all cash flows and transactions in your company. Financial planning comprises six elements.
Revenue planning
Revenue planning represents the basis for the budgeted income statement and liquidity statement. It forecasts future sales volumes based on historical values. This ensures you retain an overview of which products are being sold to which customers and at what price.
Investment planning
As part of investment planning, the finance and economic viability of additional projects in the future are reviewed. First, data on the target investment is obtained, then analyzed and appraised using a critical analysis and performance audit.
Is it truly worth it to invest? What kind of financial resources are necessary? When it comes to financial planning, these questions must be addressed.
Capital requirements plan
The capital requirements plan determines when and how much investment has to be made in the company. It puts a figure on your financial requirements.
A distinction is made here between long-term capital requirements, such as vehicles or machinery, and short-term ones, like materials and current expenses.
Liquidity planning
Liquidity planning compares all predicted income and spending over a specified time period (generally no longer than 12 months).
It gives precise information about when cash must be available to cover upcoming expenses. Such planning is critical for avoiding dangerous financial situations and ensuring the company’s long-term viability.
Budgeted income statement
The budgeted income statement is the most important part of any financial plan. It shows whether or not a firm will generate a profit and how much profit it will make.
In the first phase, a sales plan is created, which details the product and service sales volumes that must be attained within a certain time period. This is then used to relate the prices and variable costs. This represents the total profit.
The gross profit is reduced by fixed costs such as salary and interest. The end outcome is a profit for the corporation.
Budgeted balance sheet
The budgeted balance sheet shows how assets and liabilities will develop over a certain period of time – usually over a financial year. It is divided into assets (non-current assets, current assets, accruals, and deferrals) and liabilities (equity, provisions, liabilities, accruals, and deferrals).
How long-term and short-term financial planning interact
Financial planning is critical to a company’s financial security, despite the fact that business decisions are frequently based on present circumstances. A long-term financial strategy aids in achieving defined goals and ensuring the company’s long-term success.
It is the foundation for long-term optimization. Short-term financial planning is critical for detecting liquidity issues early on and taking relevant remedies.
You won’t have a complete picture of your financial situation until you’ve handled all six areas of financial planning. Only then will you be able to identify the best answers for your company’s problems.