Why is it important to understand the key elements of a financial plan for your business? Creating a financial plan for your business can seem quite challenging, but once you understand the key elements, it becomes a much simpler task.
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What is a Financial Plan?
Know that a financial plan is an overview of your business’s current financial situation and the future projection of its growth. A financial plan for your business helps you understand everything about your finances, to set realistic goals, and build a strategy to grow your business while avoiding potential setbacks.
A financial plan is the key to a successful business and helps you plan for the future.
What Makes Up a Financial Plan?
A financial plan is made up of eight elements:
- Profit and loss statement
- Operating income
- Net income
- Cash flow statement
- Balance sheet
- Sales forecasting
- Break-even analysis
- Operations plan
Whether your company is new or well-established, a financial plan is essential to make your business succeed. As well as for borrowing or raising capital, bringing in partners and obtaining licenses.
The Eight Key Elements of a Business Financial Plan
Before you get started, make sure you understand the key elements of a financial plan for your business.
Profit and Loss Statement
The profit and loss statement is an income statement and indicates your business’s profit or loss over a period by analyzing your income and expenses.
- Revenue is not the same as profit. Revenue is the total income your business makes from its regular business activities.
- A variable expense is the funds used to generate revenue and includes marketing and employee compensation, etc.
- Expenses that are fixed are operating expenses and are not connected with sales.
- Variable costs are the cost of goods that get sold and fluctuates based on your inventory and sales.
Your gross margin is the net profit or loss. You’ll calculate it by subtracting total expenses from total revenue. Revenue, expenses, and gross margin indicate how your business makes a profit or loss.
Gross margin – Operating expenses = Operating income
Operational costs are fixed and don’t change and include rent, electricity, etc. By subtracting these costs from the gross margin, you will get the operating income.
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Operating income has not gotten taxed, and there’s no interest. This concept is also known as profit before tax or earnings before tax and interest (EBIT).
EBIT – Tax & Interest = Net profit
This formula determines your business’s net profit or net income and is very important for any company. It is helpful when estimating the price and value of your company.
Operating income – Interest + Taxes + Depreciation + Amortization = Net income
Your business’s net income is equal to the amount that remains after subtracting all the costs and expenses from revenue.
A publicly traded company will use net income to calculate its earnings per share (EPS).
Your bottom line is your net income and differs from your operating income. Your net income will determine if your business will be successful or not.
Investors and shareholders use the business’s net income to determine the health of their investment.
It also helps banks or lenders determine if the company is eligible for a loan. The value of a company’s shares will drop if there’s a negative income result.
And that makes it one of the key elements of a financial plan for your business.
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Cash Flow Statement
A business owner should know how to predict their cash flow monthly, quarterly, and annually.
By projecting your cash flow for the year ahead, you can get ahead of financial challenges or struggles before they negatively impact your business.
Payment terms can get set by you, such as how soon you need payment after invoicing or how much you will charge upfront. Projecting cash flow lets you understand how much money to expect at the end of every month.
This helps you make more intelligent choices when budgeting. An example is when you anticipate the need for additional cash flow for the following month and spend less the current month to budget for it.
An income statement can predict a company’s profit, but the company might have no cash due to various reasons.
In contrast, the income statement can also show a loss, but there can be enough cash in the company.
A cash flow statement reflects the amount of cash your business has earned and paid out and how you calculate the ending cash balance, which you’ll calculate monthly.
The cash flow statement can also help you understand the following:
- How much cash on hand that your company has
- From where the cash is coming
- On what you’re spending the cash
- How often you’re spending the cash
A cash flow statement can give lenders and investors an idea of the company’s inflow and outflow of cash.
There are two important methods for you to understand:
Cash Accounting Method
You account for the expenses and sales in the period they occur in. The cash method gives you a picture of your business’s current finances.
The cash method is popular amongst small business owners due to its simplicity and because they don’t have to pay taxes until the money is received.
You might want to understand the process as one of the key elements of a financial plan for your business.
Cash Accrual Method
You account for the revenue when you earn it and expenses when they get billed and not paid.
When you match sales to expenses, you get a complete image of how the expenses and income relate to one another in the same time period.
An example is when you leave an expense payment for the following month after the sale got made, and your second month looks less profitable than the previous month when it’s not the case.
Accountants prefer the cash accrual method, as it’s an accurate view of your business’s finances.
The cash accrual method lets you peek into how your company handles cash, allowing you to make informed decisions.
Your balance sheet indicates how your business is doing at a specific time, how much cash you have on hand, how much money is owed to you, and how much you owe.
Assets and liabilities determine your net worth, and by tracking them, you capitalize on the potential value of your business.
- Liabilities: Includes money that you owe others (accounts payable), loan repayments, credit card balances that need to get paid, etc.
- Equity: The value assigned to your business can include shares that the investors in your business own, earnings that are retained (does not apply if you’re the only owner in the company), stock proceeds, etc.
- Assets: Includes money that’s owed to you, usually by customers, inventory, cash in the bank, etc. These are all known as your accounts receivable.
- Retained earnings: Net income amount that remains after your business has paid shareholders’ dividends out.
Your balance sheet determines your company’s financial position on any given day.
Sales forecasting indicates how much you think your business will sell in a certain period. Calculating your sales projections creates a forecast that corresponds to the sales number in your Income Statement.
You want to avoid under-predicting your sales, as well as not over-predicting your sales. Be realistic with your predictions based on past performances.
Sales forecasting should be ongoing to set company growth goals and future planning.
Projecting sales is essential for lenders and investors, as it will bring certainty when it feels uncertain.
Gross margin can be forecasted if you project the cost of goods sold (COGS).
An estimate of your sales revenue should get calculated monthly, quarterly, and annually.
Identifying patterns in your sales cycles can help you understand your business more. And assist you in future marketing and growth strategies.
To determine your pricing, you use break-even analysis. A break-even analysis informs you of the number of units to get sold at various prices to cover your costs without making a profit.
Set a price that allows your business to remain competitive by giving yourself a comfortable margin over your expenses.
It’s not advisable to run your business at a break-even point, as you want to make a profit.
However, it’s preferable to be at a break-even point instead of operating at a loss.
Break-even point = Fixed costs / Contribution margin
Contribution margin = Sales price per unit – Variable cost per unit
Learning how to calculate these figures is critical since they are one of the key elements of a financial plan for your business.
A comprehensive overview of your operational needs is needed to run your business effectively.
The following can help you make informed decisions regarding your business’s efficiency and growth:
- Insight into the roles that are needed to operate your business at several volumes of output
- The amount of work or output each employee can handle and the time it will take for them to get the job done
- Costs of every stage of your supply chain
- The strategy you will use to yield better results and return of investments
- Duration of the specific operational tasks that need to get done/completed
- Quality of the results that can get assessed with the help of the operational plan
- The timeline that’s required to execute the entire operational guideline of the business plan
An operations plan can help you determine if your business can migrate to new technology. Or to superior supply chain vendors to optimize your operations.
Therefore, business owners must educate themselves about merchant services before acquiring an account.
A contract can’t get altered once it’s signed unless the business owner breaks the contract.
Using an operations plan for your business ensures that the company’s goals and objectives can get achieved.
Working out your financials also becomes critical when your business is not gaining adequate income and you want to raise funding. Check out this video I have put together offering a few tips on how to present financials for a startup with no revenue.
Guideline on Writing a Financial Plan for Your Business
A business financial plan should get created annually at the beginning of the calendar year.
This will give the business an accurate indication of the business’s finances, including a sign of future expansion or growth.
A financial plan helps business owners make informed decisions about debt, purchases, expense control, and hiring. And the overall operations for the coming year.
Having a plan can also assist a business owner in selling the business and finding additional investors. Or when entering a partnership with another company.
The person who does the business’s financial plan, often the business owner, must review the past performance and finances of the previous year. That will help determine if their forecasting was accurate or not.
The business owner can then address any discrepancies that got overlooked before and implement these changes in the coming year.
A business owner must collaborate with the various department heads to create a detailed financial picture of the business.
Each division needs to provide projections, expenses, and value. The departments to collaborate with include:
- Finance department
- Sales team
- Human resources department
- Operations leader
- The person in charge of all the vehicles, machinery, or any other business tools
Suppose you still find creating a financial plan for your business challenging.
If that’s the case, you can obtain assistance from your accountant or local business owners within your network. Choose people who have the knowledge and experience to do so.
A business owner’s main objective is to create a positive cash flow to generate a profit.
By understanding your business’s key elements of a financial plan, you can understand your business and how it operates.
Your business’s financial plan is vital to the success of your business. If you don’t understand how it works and outsource the work, you still need to understand the basics to help you make informed decisions.
Lastly, making a profit over a short-term period isn’t what’s important; it’s the continual long-term growth you should strive for.
Keep your financial plan updated and ensure it’s accurate to run your business successfully.
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