What is business financial planning?
A business financial plan clearly shows a company’s current economic situation, lays out its strategies, goals, and forecasts, and helps determine if an idea is worth investing in. It can also track the business’s financial health as it grows. This plan is integral to your business plan and aligns financial goals with company objectives. It typically includes a business description, financial statements, a personnel plan, risk analysis, and key performance indicators (KPIs). A detailed view of your company’s finances and future plans can attract investors and funding.
Why do businesses need a financial plan?
A financial plan can help businesses feel more confident about the future by providing guidance on how to best use and invest their resources. This plan can influence how different choices affect revenue and when it is necessary to tap into savings. It can also help keep track of performance, manage cash flow, and monitor key financial numbers.
A financial plan shows the current state of your business and, over time, will tell you if previous investments were successful and worth repeating. A solid financial plan generally highlights the business’s dedication to smart spending and achieving its financial responsibilities when seeking partnerships, investors, or loans.
Key parts of a business financial plan
A strong financial plan can keep a business stable and successful. Whether you’re a new business owner or updating an existing plan, consider the following elements:
Income statement
An income statement shows profits or losses over a particular period, such as monthly, quarterly, or yearly. Also called a profit-and-loss statement (P&L), the statement typically includes:
- Cost of goods sold (COGS): Direct costs of producing goods or services
- Operating expenses: Costs like rent, utilities, and other business expenses
- Revenue streams: Income from sales, subscriptions, and other sources
- Total net profit or loss: The overall profit or loss after subtracting costs and taxes from sales
Balance sheet
This snapshot of a business’s financial health highlights what the company owns, owes, and the value held by shareholders:
- Assets: Cash, goods, and other owned resources
- Liabilities: Debts to suppliers, employees, landlords, and creditors
- Shareholder equity: Calculates the company’s net worth with this formula: shareholder equity = assets – liabilities
Business ratios
Using business ratios like net profit margin, accounts payable turnover, working capital, return on equity, assets to sales, and total debt to total assets can give you a clearer view of specific areas within your business. Calculating these ratios using data from your balance sheet, P&L, and cash flow statements can offer insights into your company’s financial health. For example, the net profit margin looks at the profitability of operations compared to revenue. These ratios may also be helpful when discussing funding with banks or investors.
Sales forecast
Regularly updating your sales forecasts can help predict cash flow and business health. It can keep your estimates consistent with the sales figures in your P&L statement. Depending on the amount of detail, consider organizing your forecasts by segments. For example, if you own a hotel with a gift shop, tracking room bookings and shop sales separately could provide valuable insights.
Cash flow projection
An essential aspect of a financial plan is the cash flow statement, as businesses generally rely on cash to operate. Understanding cash flow—how much comes in, when it arrives, and where it goes—shows the difference between your profit and the cash you have on hand.
Income projections
Using sales forecasts, business owners can estimate their potential earnings over a set period, often yearly. This projection involves subtracting expected expenses from anticipated revenue, which forecasters typically include in their P&L statement.
Assets and liabilities
Assets and liabilities show what a business owns and owes. Assets typically fall into two categories: current and long-term. Current assets, like stocks, inventory, and accounts receivable, convert to cash within a year. Long-term investments, such as furniture, buildings, machinery, and vehicles, serve the business longer. Liabilities, also split into current and long-term categories, reflect the business’s obligations. Current liabilities, including payroll, taxes payable, and short-term loans, frequently require payment within a year. Long-term liabilities cover debts like shareholder loans or bank debt maturing after a year.
Break-even analysis
This analysis helps determine how much a business must sell to cover its variable and fixed expenses, including COGS, salaries, and rent. Once revenue surpasses expenses, the company begins to make a profit. The break-even point can help set sales targets and volume goals by calculating the contribution margin—the difference between sales revenue and variable costs that the company can use to cover fixed costs. Break-even analysis can also help evaluate expenses and decide how much to mark up goods and services to make a profit.
Advantages of having a financial plan
A financial plan generally works best when you build it on solid data, allowing it to remain adaptable to changing market conditions. It can help businesses stay focused and reach their short-term and long-term goals. Here are some key benefits:
Clear goals and objectives
A financial plan can help everyone in the company understand the organization’s financial goals and their role in achieving them. With clear responsibilities and expected outcomes, team members know what to do, when, and why it matters.
Realistic budgets and projections
A good financial plan can lead to practical budgets that allocate resources effectively and anticipate future revenue and expenses. It can also help businesses outline steps to maintain stability during cash flow challenges or market changes.
Opportunities for external funding
A detailed financial plan can make attracting partners, lenders, and investors easier by showing how you will use their money. Including strong financial records, such as details on past and current liabilities, can also build confidence in a positive return on their investment.
Ongoing performance monitoring
A financial plan continues to offer value long after you create it. By regularly checking actual results against initial projections, companies can make adjustments to maintain their direction.
Creating a financial plan for your business
With preparation and careful execution, you can create a well-designed financial plan. The following steps can help you get started:
Outlining a strategic vision
Before analyzing numbers, it can be helpful to define what your company wants to achieve and what might be required to reach those goals. Consider if more equipment, additional staff, or other resources are necessary and how these objectives could impact cash flow. A strategic financial plan addresses these needs and evaluates their economic impact. Listing current expenses and assets can offer a good foundation for the rest of your planning process.
Estimating future financials
Understanding anticipated expenses and sales forecasts can help you estimate the costs of reaching business goals under different scenarios, such as worst-case, best-case, and most likely. You might also consider working with an accountant when reviewing the plan with stakeholders and presenting it to investors or lenders.
Preparing for the unexpected
Use your cash flow statement and balance sheet to plan for potential challenges, such as cash shortages or unexpected downturns. Also, consider maintaining cash reserves or securing a line of credit for quick access during slow periods. Another strategy involves planning to sell off assets to cover expenses.
Tracking and adjusting goals
Compare actual results from cash flow statements, income projections, and business ratios to your original predictions. These ongoing reviews can help you find potential issues early, allowing course corrections and quick adjustments.
Effective business financial planning can boost long-term success. By setting clear goals, creating realistic budgets, and regularly monitoring performance, business owners can navigate financial challenges, achieve their objectives, and secure a stable future.