When it comes to long-term business success, preparation is the name of the game. And the keyto that preparation is a solid financial plan. It helps you pitch investors, anticipategrowth and weather cash flow shortages. To get started, you need to learn some of the keyelements to financial planning.
What Is a Financial Plan?
A financial plan helps determine if an idea is sustainable, and then keeps you on track tofinancial health as your business matures. It’s an integral part to an overallbusiness plan and is made up of three financial statements—cash flow statement, incomestatement and balance sheet. In your plan, each of these will include a brief explanation oranalysis.
Key Takeaways
- A financial plan helps you know where your business stands and lets you make betterinformed decisions about resource allocation.
- A financial plan has three major components: a cash flow projection,income statementand balance sheet.
- Your financial plan answers essential questions to set and track progress toward goals.
- Using financial management software givesyou the tools to make strategic decisions efficiently.
Why Is a Financial Plan Important to Your Small Business?
A well-put-together financial plan can help you achieve greater confidence in your businesswhile generating a better understanding of how to allocate resources. It shows your businessis committed to spending wisely and its ability to meet financial obligations. A financialplan helps you determine if choices will impact revenue and which occasions call for dippinginto reserve funds.
It’s also an important tool when asking investors to consider your business. Yourfinancial plan shows how your organisation manages expenses and generates revenue. It showswhere your business stands and how much it needs from salesand investors to meet important financial benchmarks.
Components of a Small Business Financial Plan
Whether you’re modifying your plan or starting from scratch, a financial plan shouldinclude:
Income statement: This shows how your business experienced profit orloss over a specific period—usually over three months. Also known as aprofit-and-loss statement (P&L) or pro forma income statement, it lists thefollowing:
- Cost of sale or cost of goods (how much does it costs to produce your goods orservices?)
- Operating expenses like rent and utilities
- Revenue streams, usually in the form of sales
- Amount of total net profit or loss, also known as a gross margin
Balance sheet: Rather than looking backward or peering into thefuture, the balance sheet helps you see where you stand right now. What do you ownand what do you owe? To figure it out, you’ll need to consider the following:
- Assets: How much cash, goods and resources do you have available?
- Liabilities: What do you owe to suppliers, personnel, landlords, creditors,etc.?
Shareholder equity (the amount of money generated by your business): Use thisformula to calculate it:
Shareholder Equity= Assets -Liability
Now that you have these three items, you’re ready to create your balance sheet.And just as the name implies, when complete, you’ll want this to balance outto zero. On one side, list your assets, such as cash on hand. And on the other sidelist your liabilities and equity (or how much money is generated by the business).The balance sheet is used along the other financial statements in order to calculatebusiness financial ratios, discussed further below.
Balance Sheet
Assets =
Liabilities + ShareholderEquity
Debit Balance
Credit Balance
Assets Liabilities Shareholder Equity - Cash: $175,000
- Inventory: $225,000
- Land/Real Estate: $645,000
- Accounts Payable: $17,000
- Long-term Debt: $450,000
- Common Stock: $150,000
- Retained Earnings: $428,000
Why have a balance sheet? It can provide insight into your business and showimportant measures like how much cash you have, what your obligations are and whatkind of profit you’re making all at a glance.
Personnel plan: You need the right people to meet goals and retain ahealthy cash flow. A personnel plan looks at existing positions and helps you seewhen it’s time to bring on more team members, and whether they should befull-time, part-time, or work on a contractual basis. It looks at compensationslevels, including benefits, and forecasts those costs. By looking at growth andcosts you can see if the potential benefits that come with a new employee justifythe expense.
Business ratios: Sometimes you need to look at more than just thebig picture. You need to drill down to specific aspects of your business and keep aneye on how individual areas are doing. Business ratios are away to see things like your net profit margin, return on equity, accounts payableturnover, assets to sales, working capital and total debt to total assets.Numbers used to calculate these ratios come from your P&L statement, balancesheet and cash flow statement and are often used to help request funding from a bankor investors.
Sales forecast: How much will you sell in a specific period? A sales forecast needsto be an ongoing part of any planning process since it helps predict cash flow andthe organisation’s overall health. A forecast needs to be consistent with thesales number within your P&L statement. Organising and segmenting your salesforecast will depend on how thoroughly you want to track sales and the business youhave. For example, if you own a hotel and giftshop, you may want to track separatelysales from guests staying the night and sales from the shop.
Cash flow projection: Perhaps one of the most critical aspects ofyour financial plan is your cash flow statement. Your business runson cash. Understanding how much cash is comingin and when to expect it shows the difference between your profit and cash position.It should display how much cash you have now, where it’s going, where it willcome from and a schedule for each activity.
Income projections: How much money will your company make in a givenperiod, usually a year. Take that and then subtract the anticipated expenses andyou’ll have the income projections. In some cases, these are rolled intoprofit and loss statements.
Assets and liabilities: Both of these elements are part of yourbalance sheet. Assets are what your company owns, including current and long-termassets. Current assets can be converted into cash within a year. Think of thingssuch as stocks, inventory and accountsreceivable. Long-term assets are tangible or fixed assets designed forlong-term use like furniture, fixtures, buildings, machinery and vehicles.
Liabilities are business obligations that are divided into current and long-termcategories. Examples of current liabilities in a financial plan are accrued payroll,taxes payable, short-term loans and other obligations due within a year. Long-termliabilities include shareholder loans or bank debt that matures more than a yearlater.
Break-even analysis: Your break-even point—how much you need to sellto cover all yourexpenses — will guide your sales revenue and volume goals. Start bycalculating your contribution margin by subtracting the costs of a good or servicefrom the amount you pay. In the case of a bicycle store, the sale price of a newbike minus what you paid for it and the salary of your bike salesperson, your rent,etc. By understanding your fixed costs, you can then begin to understand how muchyou’ll need to markup goods and services and what sales and revenue goals toset in order to stay afloat or turn a profit.
4 Steps to Creating a Financial Plan for Your Small Business
Create a strategic plan: Starting with a strategic plan helps youthink about what you want your company to accomplish. Before looking at the numbers,think about what you’ll need to achieve these goals. Will you need to buy moreequipment or hire more staff? Is there a chance of new goals affecting your cashflow? What other resources will you need?
Determine the impact on your company’s finances and create a list of existingexpenses and assets to help with your next steps.
Create financial projections: This should be based on anticipatedexpenses and sales forecasts. Look atyour goals and plug in the costs needed to achieve them. Include differentscenarios. Create a range that is optimistic, pessimistic and most likely to happen,so you can anticipate the impact each one will have. If you’re working with anaccountant, go over the plan together to understand how to explain it when seekingfunding from investors and lenders.
Plan for contingencies: Look at your cash flow statement and assets,and create a plan for when there’s no money coming in or your business hastaken an unexpected turn. Consider having cash reserves or a substantial line ofcredit if you need cash fast. You may also need to plot ways to sell off assets tohelp break even.
Monitor and compare goals: Look at the actual results in your cashflow statement, income projections and even business ratios as necessary throughoutthe year to see if you need to modify your plan or if you’re right on target.Regularly checking in helps you spot potential problems before they get worse.
Three Questions Your Financial Plan Should Answer
Once you’ve created your plan, you should have answers to the following questions:
- How will your business make money?
- What does your business need to get off of the ground?
- What is the operating budget?
Financial plans that can’t answer these questions need more tweaking. Otherwise, yourisk starting a new venture without a clear path and leave behind valuable insight.
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Using spreadsheets can get the job done when you’re just getting started. However,it’s easy to get overwhelmed, especially if you’re collaborating with others inyour organisation.
Financial management software is worth the expense because it offers automated capabilitiessuch as analysis, reporting and forecasting. Plus, using cloud-based financial planning toolslike NetSuite can help you automatically consolidate data and improve efficiency.Everyone across your organisation can access and analyse up-to-date information, which leadsto better informed decisions.
Whether you’re looking to secure outside funding or just monitor your business growth,understanding and creating a financial plan is crucial. Once you have an overview of yourbusiness’ finances, you can make strategic decisions to ensure its longevity.
