IMPACT OF FINANCIAL PLANNING ON THE PROFITABILITY AND EFFICIENCY OF SMALL SCALE FIRMS

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IMPACT OF FINANCIAL PLANNING ON THE PROFITABILITY AND EFFICIENCY OF SMALL SCALE FIRMS

ABSTRACT

Financial planning is an integral part of financial management which deals with the management of a firm’s funds with a view to maximizing profit and the wealth of shareholders. The purpose of financial planning is to determine where the firm has been, where it is now, and where it is going. It also determines deviations from the most likely outcome. Finance is concerned with the study of the problems involved in acquisition and use of funds by a business enterprise. Financial planning involves analyzing financial flows of a firm as a whole, forecasting the consequences of various investment, financing and dividend decisions and weighting the effects of various alternatives. Financial planning is the core of financial management. It helps management to avoid waste by furnishing policies and procedures which make possible a closer coordination between the various functions of the business.

The design of the study is descriptive research method. In addition both qualitative and quantitative methods were applied in data collection and analysis. The descriptive design is found to be suitable because it addresses major objectives and research questions proposed in the study adequately. The study gathered primary data. Primary data was obtained through questionnaires to randomly selected employees from the selected companies. The use of questionnaires was recommended since it guaranteed confidentiality to the respondents thus they acted without any fear or embarrassment.

The aim of this study was to find out whether financial planning has an impact on the profitability and efficiency of the firms in the small scale industry in Nigeria. The results of the study indicated that the financial planning measures such as earnings before interest and tax and the capital employed which comprises of fixed assets and working capital had an impact on the profitability and efficiency of the firm measured by return on capital employed(ROCE). This implies that a percentage change in the financial planning measures will have an effect on the profitability and efficiency of a firm. This study showed that there is strong relationship between financial planning and profitability and efficiency of a firm. The success of any business depends on the manner the financial plans are formulated. Therefore, it can be concluded that financial planning has an effect on the profitability and efficiency of small scale companies in Nigeria.

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

Financial planning involves analyzing financial flows of a firm as a whole, forecasting the consequences of various investments, financing and dividend decisions and weighting the effects of various alternatives. Financial planning is the core of financial management. The complex nature of business demands that management should place greater emphasis upon financial planning to secure and employ capital resources in the amount and proportion necessary to increase the efficiency of remaining factors of production. Financial planning is needed both in dynamic and perfect economic conditions. It helps management to avoid waste by furnishing policies and procedures which make possible a closer co-ordination between the various functions of business (Oye, 2006).

Financial planning must however be complemented by control in order to achieve the basic aim of planning. The actual results must be measured concurrently against projections. Control is the financial management function which must be exercised by executive personnel of the business enterprise to achieve the goals established by the planning function. It deals with testing the degree of management performance in the attainment of the set objectives. It is also a check to deviations from the planning function, and once the causes for the difference between the actual and expected performance have been identified, a corrective action should be initiated. Financial planning can be defined as the process which assures that financial resources are obtained economically and used efficiently and effectively in the accomplishment of desired goals. It covers the entire process of monitoring actions emanating from the decisions. Seen as an integral part of financial management, it also forms part of budgeting, accounting, reporting and review. The budget is then put in practice and results expected. Budgetary control system forms a good basis of controlling plans. Definitely, actual activities are monitored and their results measured and then compared with plan. Then significant deviations from plan are identified and reported upon. The last step is to investigate the deviations accordingly and take corrective measures (Samuel, 1980).

The success of any business depends on the manner the production and distribution functions are coordinated. An important function of financial planning is the coordination of the various decisions taken within a company so that they are mutually consistent, having regard for financial aims and constraints. The exercise of this function is perhaps most clearly seen in formulating financial plans which involves merging of estimates of each department into a budget for the whole firm. In this process the financial manager holds a strategic position. Without coordination, individuals and departments would lose sight of their roles within the organization. They would begin to pursue their own specialized interests, often at the expense of the large organizational goals. Also, the point to be emphasized is that the activities of all departments must mesh. It is through budgeting that the activities of various departments are coordinated and unnecessary wastage of resources and efforts is stopped. Budgeting requires each manager to establish a proper rapport between the activities of his department and that of other departments. Any imbalance in the relationship between the departmental activities should be identified and corrective measure taken (Brockinton, 1987).

Many organizations adopt various strategies among which is the financial planning and control. Financial planning and control is an integral part of financial management which deals with the management of a firm’s funds with a view to maximizing profit and the wealth of shareholders. The purpose of financial planning is to determine where the firm has been, where it is now, and where it is going. It also determines deviations from the most likely outcome. Financial planning is concerned with the study of the problems involved in the acquisition and use of funds by a business as well as the function of profit planning for the business organization. Planning can be defined as a managerial tool through which objectives and goals are determined and the future course of action to attain them, while control is a management action to ensure conformity with a plan or budget. Many will produce detailed plans for one year and more general financial plans for three to five years (Koontz, 1988).

Financial Planning is a continuous process that flows with strategic decision making. The Operating Plan and the Financial Plan will both support the Strategic Plan. The best place to start in preparing a budget is with sales since this is a driving force behind much of our financial activity. However, we have to take into account numerous factors before we can finalize our budgets. The Budgets include sales forecasts, production forecasts, and other estimates in support of the Financial Plan. Collectively, all of these budgets are referred to as the Master Budget that will act as a basis of carrying out a comprehensive financial plan in the firm. Budgeting should be flexible, allowing modification when something changes (Matt, 2000).

Profitability and efficiency in a firm is mainly measured by financial statements. A financial statement is an organized collection of data according to logical and consistent accounting procedures. Its purpose is to convey an understanding of some financial aspects of a business firm. It may show a position at a moment of time as in the case of a Balance Sheet, or may reveal a series of activities over a given period of time, as in the case of an Income Statement. Financial analysts often assess firm’s production and productivity performance, profitability performance, liquidity performance, working capital performance, fixed assets performance, fund flow performance and social performance. However in the present study financial health of a firm is measured from the following perspectives; Working capital Analysis, Financial structure Analysis, Activity Analysis and Profitability Analysis (Lundberg, 1982).

One of the biggest challenges within financial planning and budgeting is how do we make it valueadded. Budgeting requires clear channels of communication, support from upper-level management, participation from various personnel, and predictive characteristics. Budgeting should not strive for accuracy, but should strive to support the decision making process. If we focus too much on accuracy, we will end-up with a budgeting process that incurs time and costs in excess of the benefits derived. The challenge is to make financial planning a value-added activity that helps the organization achieve its strategic goals and objectives. Budgeting should be both top down and bottom up; i.e. upper level management and middle level management will both work to finalize a budget. We can streamline the budgeting process by developing a financial model. Financial models can facilitate “what if” analysis so we can assess decisions before they are made. This can dramatically improve the financial planning process (Matt, 2000).

A company will carry out an intensive financial plan if the financial condition is poor so as to try and improve the profitability and efficiency of the firm in the future. Without carrying out a financial plan a firm will risk been a going concern. A company will have to adjust to the prevailing economic conditions that exist. It will come up with a high level financial planning and forecasting model that will ensure that the company safe guards its financial assets and achieve high profitability and efficiency (Koontz, 1988).

The competitive situation varies from one industry to another. Some industries have a high competitive situation than others. A firm that operates in a highly competitive situation will have to come up with a detailed financial plan that will address the competitive situation so as to ensure high profitability and efficiency of a firm at any given point in time. The current technological trend has enable firms to easily come up with a detailed and complex financial plan and budgets that will provide a guide on how the company will increase its profitability and efficiency in the future. This has enabled many firms and also industry to develop a master financial plan to boost profitability and efficiency in the industry such as the banking industry (White, 1997).

The Automotive industry in Nigeria is primarily involved in the retail and distribution of motor vehicles. There are a number of motor vehicle dealers operating in the country, with the most established being Toyota (East Africa), Cooper Motor Corporation, General Motors, Simba Colt and DT Dobie Nigeria. There are also three vehicle assembly plants in the country, which concentrate on the assembly of pick-ups and heavy commercial vehicles like the small scale vehicle assemblers. The established dealers face intense competition from imported second-hand vehicles, mainly from Japan and United Arab Emirates. These imports now account for about 70% of the market. The last decade witnessed a significant decline in the number of new vehicles sold in the country. There has been a steady recovery in the last four years, but the numbers achieved still fall far short of the numbers recorded a decade ago. In 2004, the leading motor vehicle companies recorded sales of 9,979 units. Although 27% better than the previous year, this is still well below the levels achieved in the early 1990’s.The slump in the volume of new cars sold is attributable the increased competition from second hand vehicles and the depressed economic environment. The Nigeria Motor Industry Association (KMI), the representative body of the corporate participants in the motor industry, has been lobbying hard to reverse this trend. Some of these measures have helped the industry recover from its lowest point in 2000, when only 5,869 units were sold. On their part, the companies themselves have become more innovative in responding to customer needs. Some of the measures that KMI has been advocating include, Implementation of strict criteria on importation of second hand vehicles, Incentives to promote local assembling of commercial vehicles and Export incentives aimed at encouraging car manufacturers to expand operations in the region.

(http://www.pwc.com/ke/en/industries/small scale.jhtml)

1.2 RESEARCH PROBLEM

Managing business performance in today’s complex and rapidly changing business climate is crucial for any organization’s short-term and long-term success. In order to maintain investor confidence and provide insight to top management, there is an increased demand for organizations to provide prospective insights on business trends and drivers of performance. Financial planning, a key component of managing and driving business performance, continues to be of limited value and mired with conservatism for many organizations. Extended financial planning and forecasting cycle times that delay decision making, financial drivers and metrics that don’t align with strategies and the ownership of planning projections that often gets attached to finance adds to the frustration with many planning and forecasting functions (Brigham,1992).

Most firms seem to be applying financial planning but not generating high profitability and efficiency as compared to other firms like the banking and insurance industry which heavily apply financial planning strategies. Financial planning provides a solution where by firms come up with financial objectives for both short and long term goals. The company in turn formulate policies relating to cash flows, borrowing of funds, investment and expansion strategies. Financial planning is important to plan for coming up with value adding budgets and raising finance from different sources so that the requisite amounts of finance are made available to compensate the requirement of business processes. These requirements may be in the nature of short-term (temporary overdraft, etc.), medium-term (acquisition of assets, etc.) and long-term (term loans, etc.).Financial planning in turn ensures that a firm aligns its financial objectives with its vision and objectives (Adeniyi, 2004).

Financial planning involves a strategic plan which includes the plan that supports the mission, vision and values of the organization. Operating plans which includes a detailed guidance to help organizations realize its strategic vision. Financial Plan which involve the forecasting of financial statements, the amount of money that supports the plan, forecasting of funds, performance-based management system, and the monitoring of operations after executing the plan to check any nonconformities and take actions towards it (Ehrhardt and Brigham, 2011).

1.3 OBJECTIVE OF THE STUDY

To determine the effect of financial planning on profitability and efficiency of small scale firms in Nigeria.

1.4 SIGNIFICANCE OF THE STUDY

There are two factors related to the process of financial planning that in themselves already are of great importance for the organizations, first the fact that planning imposes the agents to project the conjugated effects of all the decisions of investments and financings of the companies and according to the necessity of pondering on the possible events that could directly or indirectly affect the company as well as the formulation of alternative strategies to combat possible difficulties or of taking advantage of new opportunities (Brealy and Myers, 1998).

This study benefits business firms as they are able to appreciate how financial planning can enhance a firm’s competitive advantage in managing costs and risks. This study also enables firms to appreciate the importance of financial planning and how it enables a firm to come up with both short term and long term goals of managing and increasing its resources. Financial planning serves as a blue print of a firm’s future financial plan in terms of cash flow management, investments and expansion plans.

This study enables researchers to have an insight of financial planning and appreciate its magnitude within the business sector in Nigeria. A researcher can be able to analyze the study and identify any possible research gaps that would enable a further research on the field of financial planning that would help improve its application in the business sector such as the small scale industry.

This study enables investors to normally look at areas to pin point on before making a decision to invest in any corporate institution. An investor needs to be certain on the future financial plans of a firm they are intending to provide their capital. An investor will invest only in those firms that have a financial plans which provides a comprehensive forecast on areas like sales, production, investments and any expansion plans that will maximize shareholders wealth. This study enables the government to consider enhancing its laws to encourage financial planning so that a firm would be able to pay its taxes on time. It’s through financial planning that a firm may be able to determine its current and future taxation plans. Such information would be useful to the government through the treasury department to determine its estimated future revenues and thus enable the government to determine its taxation plans and policies for the future.

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