When it comes to long-term business success, preparation is the name of the game. And the key to that preparation is a solid financial plan. It helps you pitch investors, anticipate growth and weather cash flow shortages. To get started, you need to learn some of the key elements to financial planning.
What is a Financial Plan?
A financial plan helps determine if an idea is sustainable, and then keeps you on track to financial health as your business matures. It’s an integral part to an overall business plan and is made up of three financial statements—cash flow statement, income statement and balance sheet. In your plan, each of these will include a brief explanation or analysis.
- A financial plan helps you know where your business stands and lets you make better informed decisions about resource allocation.
- A financial plan has three major components: a cash flow projection, income statement and balance sheet.
- Your financial plan answers essential questions to set and track progress toward goals.
- Using financial management software gives you 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 business while generating a better understanding of how to allocate resources. It shows your business is committed to spending wisely and its ability to meet financial obligations. A financial plan helps you determine if choices will impact revenue and which occasions call for dipping into reserve funds.
It’s also an important tool when asking investors to consider your business. Your financial plan shows how your organization manages expenses and generates revenue. It shows where your business stands and how much it needs from sales and 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 should include:
Income statement: This shows how your business experienced profit or loss over a specific period—usually over three months. Also known as a profit-and-loss statement (P&L) or pro forma income statement, it lists the following:
- Cost of sale or cost of goods (how much does it costs to produce your goods or services?)
- 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 the future, the balance sheet helps you see where you stand right now. What do you own and 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 this formula 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 out to zero. On one side, list your assets, such as cash on hand. And on the other side list 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 calculate business financial ratios, discussed further below.
Why have a balance sheet? It can provide insight into your business and show important measures like how much cash you have, what your obligations are and what kind of profit you’re making all at a glance.
Personnel plan: You need the right people to meet goals and retain a healthy cash flow. A personnel plan looks at existing positions and helps you see when it’s time to bring on more team members, and whether they should be full-time, part-time, or work on a contractual basis. It looks at compensations levels, including benefits, and forecasts those costs. By looking at growth and costs you can see if the potential benefits that come with a new employee justify the expense.
Business ratios: Sometimes you need to look at more than just the big picture. You need to drill down to specific aspects of your business and keep an eye on how individual areas are doing. Business ratios are a way to see things like your net profit margin, return on equity, accounts payable turnover, assets to sales, working capital and total debt to total assets. Numbers used to calculate these ratios come from your P&L statement, balance sheet and cash flow statement and are often used to help request funding from a bank or investors.
Sales forecast: How much will you sell in a specific period? A sales forecast needs to be an ongoing part of any planning process since it helps predict cash flow and the organization’s overall health. A forecast needs to be consistent with the sales number within your P&L statement. Organizing and segmenting your sales forecast will depend on how thoroughly you want to track sales and the business you have. For example, if you own a hotel and giftshop, you may want to track separately sales from guests staying the night and sales from the shop.
Cash flow projection: Perhaps one of the most critical aspects of your financial plan is your cash flow statement. Your business runs on cash. Understanding how much cash is coming in 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 will come from and a schedule for each activity.
Income projections: How much money will your company make in a given period, usually a year. Take that and then subtract the anticipated expenses and you’ll have the income projections. In some cases, these are rolled into profit and loss statements.
Assets and liabilities: Both of these elements are part of your balance sheet. Assets are what your company owns, including current and long-term assets. Current assets can be converted into cash within a year. Think of things such as stocks, inventory and accounts receivable. Long-term assets are tangible or fixed assets designed for long-term use like furniture, fixtures, buildings, machinery and vehicles.
Liabilities are business obligations that are divided into current and long-term categories. Examples of current liabilities in a financial plan are accrued payroll, taxes payable, short-term loans and other obligations due within a year. Long-term liabilities include shareholder loans or bank debt that matures more than a year later.
Break-even analysis: Your break-even point—how much you need to sell to cover all your expenses—will guide your sales revenue and volume goals. Start by calculating your contribution margin by subtracting the costs of a good or service from the amount you pay. In the case of a bicycle store, the sale price of a new bike 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 much you’ll need to markup goods and services and what sales and revenue goals to set 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 you think 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 more equipment or hire more staff? Is there a chance of new goals affecting your cash flow? What other resources will you need?
Determine the impact on your company’s finances and create a list of existing expenses and assets to help with your next steps.
Create financial projections: This should be based on anticipated expenses and sales forecasts. Look at your goals and plug in the costs needed to achieve them. Include different scenarios. 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 an accountant, go over the plan together to understand how to explain it when seeking funding 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 has taken an unexpected turn. Consider having cash reserves or a substantial line of credit if you need cash fast. You may also need to plot ways to sell off assets to help break even.
Monitor and compare goals: Look at the actual results in your cash flow statement, income projections and even business ratios as necessary throughout the 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, you risk starting a new venture without a clear path and leave behind valuable insight.
Improve Your Financial Planning With Financial Management Software
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 in your organization.
Financial management software is worth the expense because it offers automated capabilities such as analysis, reporting and forecasting. Plus, using cloud-based financial planning tools like NetSuite can help you automatically consolidate data and improve efficiency. Everyone across your organization can access and analyze up-to-date information, which leads to 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 your business’ finances, you can make strategic decisions to ensure its longevity.