A financial plan is a component of a business plan that serves more than just one purpose. The projections made determine the viability of a business, making it the essential part of any loan or venture capital application. Investors need to know they can get a return on their investment, and banks need to know that loan repayments can be managed. In essence, the financial plan becomes the reference against which you monitor your business’s performance. So how can you develop a financial plan for your small business?A financial plan has three major sections:
- Income statement
- Cash flow projection
- Balance sheet
Plan preparation
Before we begin, let’s first outline the data required for a financial plan. If you’re starting a new business, you’ll need to estimate start-up costs. If, on the other hand, you’re preparing a financial plan for an existing business, you can use its existing financial data.
It’s always a good idea to work with an accountant in compiling this information, as you can then rely upon their expertise to guide you in areas where you have a lack of industry knowledge. An accountant can provide an advantage in their ability to foresee results in particular industries and economic climates, look for economies of scale, and anticipate what banks will be looking for when considering a financial application. For those who don’t have an accountant, or have the capability to organise this information on their own, here’s how it’s done:
Step 1 – Estimate your start-up expenses. These expenses include such items as:
- Business registration fees; this involves obtaining an Australian Business Number (ABN) and registering a business name. The Australian Business Register, and ASIC Connect are the website you need to access in order to complete these tasks and find the appropriate fees. Australian Government Business also has resources that you may find useful,
- Rent deposit and initial monthly rent for business premises,
- Insurance fees payable,
- Cost of initial inventory,
- Initial outlay for business equipment,
- Initial outlay for business vehicle,
- Utility fees, and
- Any other start-up costs.
Step 2 – Estimate business operating costs by month. These expenses include:
- Staff salaries including own cash withdrawals,
- Recurring property costs like rent or mortgage payments,
- Telecommunications costs like Internet, mobile phone charges, fax, etc.,
- Utility costs including electricity and water,
- Raw material costs,
- Distribution and transportation costs,
- Promotional and advertising costs,
- Bank fees and loan repayments,
- Office supplies, and
- Maintenance fees, and
- Any other recurring business expenses.
Your best approach for this is to set up a spreadsheet and divide the data into fixed costs and variable costs. Fixed costs include items like rent, payroll, interest repayments, tax liabilities, and utilities. Variable costs include advertising, promotional activities, transport, and business facilities like furniture and equipment.
Step 3 – Produce a sales forecast by month. In a spreadsheet, designate columns for the following data:
- Unit sales,
- Price per unit,
- Sales by value (unit sales x unit price),
- Unit cost, and
- Cost of sales (unit sales x unit cost).
These columns enable you to calculate the gross profit margin per product (the sales less than cost of sales). You want to create spreadsheet rows for each of the products or services you supply to the market. From here, you can proceed to prepare the income statement, cash flow projection, and balance sheet.
Income statement
In its simplest form, an income statement shows your revenue (sales), expenses, plus gross and net profit after tax.
Revenue – expenses = Profit/loss
- Revenue includes income earned from the sale of products or services, plus any other sources of income,
- Expenses include items such as the cost of goods sold, payroll costs, taxes, and interest payments,
- The bottom line of this report shows the company’s net income,
- Estimate tax liabilities by multiplying net profits by the current tax percentage, and
- Estimate interest payments by multiplying debt balance by current interest rate.
Cash flow projection
For the purposes of seeking a bank loan or venture capital, this part of the financial plan is possibly the most important. It reveals the estimated amount of cash that will be available to run the business and pay for the required expenses. A cash flow statement, on the other hand, is not a projection but a report of how cash flowed in and out of the business in the recent past. There are three major segments in a cash flow projection. The cash amount should be shown on a month-by-month basis over a period of one year.
- Cash revenue (sales paid and collected),
- Cash disbursements (all expenses paid and in cash or from on-call deposits),
- Cash flow projection (opening cash balance + cash revenue – cash expenses).
Balance sheet
A balance sheet is normally produced once per year. It shows the net worth of a company at a particular time. The figures reported in a balance sheet correspond with data contained in the company’s General Ledger.The balance sheet contains the following sections:
- Assets
- Liabilities
- Equity
Assets represent objects of tangible value to the company. This includes money owed in accounts receivable, inventory, land, buildings, equipment, vehicles, and so on. Liabilities are debt owed to creditors like unpaid bills in accounts payable and debts on outstanding loans. Equity is the difference between total assets and total liabilities.
Manual process vs. automation
A manual process for preparing a financial plan would rely on using a spreadsheet application such as MS. Excel. Raw data is entered manually, but certain results can be calculated automatically using inbuilt functions that calculate different ratios. A lot of work can be saved by using an accounting package. Only raw data needs to be data entered, and the software automatically produces the reports.
Summary
The income statement, cash flow projection, and balance sheet are essential business documents, and are useful to use as business planning tools. The data contained in these statements can also be used to calculate financial ratios like gross profit margin, return on investment, and return on equity. These ratios can be calculated using spreadsheet functions, while a professional accounting package will produce these reports automatically. Benefits derived include short term tax planning, and strategic business planning:
- Use the balance sheet and income statement to calculate the quarterly tax bill,
- Provided income projections and historical data is kept up-to-date, the income statement will reveal your likely income.