How to Write Financial Plans for Your Small Business:
The most daunting part of drafting your business plan is naturally the finances. A well-organized financial strategy can give you an edge on other companies in terms of pitching to investors, receiving funding, and achieving long-term success.
Thankfully you don't need a degree to create accurate financial plans - just this article. Having a startup or running your own business can be terrifying especially with Covid 19, but with these tools in your belt, it'll be a breeze.
What is a Financial Plan?
A financial plan is a document that summarizes your current business finances and projects future growth. Consider when looking at your data whether your financial documents paint a picture of a healthy business and use them to make decisions.
It's a common misconception that a financial plan are only important to large corporations or businesses when in reality even entrepreneurs with little experience can benefit from one. For example, you might decide to launch a new product but don't know if it'll work - your financial plan will help you determine whether or not the potential investment is worth it.
Why do I need a financial plan?
Financial plans are used to help businesses make decisions, whether that be things as simple as if the owner should invest in a new office chair or something much more involved like acquiring another business.
A financial plan can also show you exactly what you need to do to meet your goals and how likely it is that you'll reach them. Additionally, aside from helping you better manage your business, a detailed financial plan will also make you more attractive to investors. It shows that you have a solid game plan in place, which makes your business less of a risk and demonstrates your potential for steady growth.
As a startup, what components should I use for my business plan?
1) Income statement
2) Cash flow statement
3) Personnel Plan
4) Balance Sheet
5) Sales Forecast
6) Break-even analysis and business ratios
Combining all of these documents and data is the key to creating a solid plan. Together they provide the framework for your business idea, including what you have to do in order to achieve your goals. For example, if you want to grow by increasing sales, then your sales forecast will show how many additional revenue streams you'll need and what kind of growth you'd expect from them over time. By outlining each section, you can assure that your business has the future you always planned in your head.
Section 1 - Income statement
An income statement, also known as a profit and loss statement is a summary of your business's revenues, expenses and profits. It calculates gross revenue, cost of goods sold (which is the direct costs to generate that revenue) operating income, and net profit. If you plan on using any financing or outside investment then this particular document will most likely be one of the first steps in getting the funding you need.
What to include:
- Your sales/revenue
- Your cost of goods sold (COGS) — keep in mind, some types of businesses, may not have COGS
- Your gross margin, which is your revenue minus your COGS
How to find your operating income:
Gross Margin – Operating Expenses = Operating Income
Your business income typically takes into account “earnings before interest, taxes, depreciation, and amortization.” This is basically, how much money you made in profit before you take your accounting and tax obligations into consideration. It may also be called "contribution to overhead" to name one of its many other names, however, they all refer to the same thing.
How to find net income:
Operating Income – Interest, Taxes, Depreciation, and Amortization Expenses = Net Income
Your net income, or your bottom line, is the amount of money you actually keep to yourself when all is said and done. The other numbers are essential for keeping your business running smoothly, but this number is how much you have to pay your employees, build up your systems, and take home to buy stuff like a house or car or even just put back into savings.
Section 2 - Cashflow Statement
A cash flow statement is, as the name suggests, a statement of cash flow. It shows how money comes into your business and where it goes out. This is particularly important for small businesses or a startup because they don't use credit cards or lines of credit to pay expenses — every dollar or pound that enters your business must come from somewhere and everything that leaves must go somewhere else.
Without a thorough understanding of your cash flow, you may find it difficult to run a successful business. As such, the cash flow statement presents insights that are leveraged by both lenders and investors, so the key to standing out to investors is knowing your cash flow.
Even when you are profitable, it is possible to be in a position where you do not have enough reserves on hand to pay your expenses and keep the doors open for several months. You can also be unprofitable but still have enough cash available to buy some time to turn your business around; so this statement should always be examined carefully. It's a relative document to every business, a great cashflow statement to one, may be earth-shattering for the next.
Section 3 - Personel Plan
A personnel plan is an important part of any financial plan because it provides the framework for several key components as listed in Section 2. As a business owner, you have to be aware of your growth and development strategy not only as an individual but also as a business. A personnel plan is essential because it sets up parameters for employee compensation and promotion. In simple terms, it is justification as to why each employee is necessary, and what they bring to the table.
The importance of your staffing plan largely hinges on the type of business you have. Sole proprietorships with no employees may not need to factor the cost of labour into their budget. For larger businesses with many workers, the average yearly employee expenses should be estimated and included in your business plan.
You can also list entire departments if that’s better for your business and what you hope to accomplish. There’s no requirement to simply name individual members of the management team. You would also list team members or departments that you have not yet hired. Describe each candidate’s qualifications and your salary range for them.
Section 4 - Balance Sheet
A balance sheet is a snapshot of your company's assets, liabilities and net worth. It helps you determine your business's current financial situation. You can also use it to predict how much capital you'll need in the future to run your business or expand into new ventures. How close to being out of cash do you feel today? Are your customers happy with the prices they're paying, or would you like to adjust your pricing if so? Do any of your suppliers have a problem with their payment arrangement and are they waiting on payment from you?
What to include in your balance sheet
- Liabilities: Your accounts payable, credit card balances, loan repayments, etc.
- Assets: Your accounts receivable, money in the bank, inventory, etc.
- Equity: Small businesses usually only have to include the owner’s equity in their net worth statement, but this might also include investors' stake, retained earnings, and stock proceeds.
It is called a balance sheet because it balances out:
Assets = Liabilities + Equity
For every year that the business is open, your total profit and loss are calculated. The cumulative balance of the total profit and loss determines your retained earnings. A sole proprietor or pass-through entity like an S-Corporation will always have zero retained earnings, as the profits and losses of the business are not saved or rolled over.
Section 5 - Sales Forecast
The sales forecast is a written assessment of the company's potential future volume and sales pricing. The purpose is to estimate how much money they can make over a period of time. For most small businesses, it is easiest to forecast by quarter, then a year, if possible, for five years.
The sales forecast should be a long-term aspect of your operations planning.
There are two types of forecasting methods to track sales: forward-looking and retrospective. Which you use depends on your needs, but a big difference is how detailed you want the forecast to be working backwards or looking forward. The business determines which type of forecast it has for three main reasons: volume, staff, and key customers.
Generally, breaking down your sales forecast by month and product will be helpful for you as a starting point for your financial plan.
If you own a restaurant, for example, you'll want to separate your forecasts by dinner and lunch sales. But if you own a gym, it can be helpful to differentiate between membership types. If you want to get really specific, break your forecast down by-product with lines for every product that the business sells.
Section 6 - Break-even analysis and business ratios
What are business ratios:
Business ratios are a way of comparing your business and its performance. If you have your cash flow statement, your balance sheet, and your profit and loss statement, you have all the numbers necessary to calculate important ratios for a business idea or plan. These ratios are not necessary to include in a financial plan—especially for an internal plan.
Common profitability ratios include:
- Gross margin
- Return on sales
- Return on assets
- Return on investment
Common liquidity ratios include:
- Debt-to-equity
- Current ratio
- Working capital
Of these, the most common ratios that lenders and business owners use are probably gross margin, return on investment (ROI), and debt-to-equity.
Consider financial planning as one of the recurring tasks in your business plan
With startups, the financial plan might feel overwhelming at first. The truth is that this part of your business plan is extremely important for understanding. If you create and present financial statements that all work together to tell the story of your business, and if you can answer questions about where your numbers are coming from, your chances of securing funding from investors or lenders will be much higher.