September 26, 2023
Write A Financial Plan For Small Business

Write A Financial Plan For Small Business

Building a financial plan can be the most intimidating part of writing your business plan. It’s also one of the most vital. Businesses that have a full financial plan in place more prepared to pitch to investors, receive funding, and achieve long-term success.

Thankfully, you don’t need an accounting degree to successfully put one together. All you need to know is the key elements and what goes into them. Read on for the six components that need to go into your financial plan and successfully launch your business.

What is a financial plan?

A financial plan is simply an overview of your current business financials and projections for growth. Think of any documents that represent your current monetary situation as a snapshot of the health of your business and the projections being your future expectations. 

ALSO READ: HOW TO MAKE MONEY BY SITTING HOME WITHOUT ANY INVESTMENTS

Why is a financial plan important for your business?

As said before, the financial plan is a snapshot of the current state of your business. The projections, inform your short and long-term financial goals and gives you a starting point for developing a strategy. 

It helps you, as a business owner, set realistic expectations regarding the success of your business. You’re less likely to be surprised by your current financial state and more prepared to manage a crisis or incredible growth, simply because you know your financials inside and out. 

And aside from helping you better manage your business, a thorough financial plan also makes you more attractive to investors. It makes you less of a risk and shows that you have a firm plan and track record in place to grow your business. 

Components of a successful financial plan

All business plans, whether you’re just starting a business or building an expansion plan for an existing business, should include the following

Even if you’re in the very beginning stages, these financial statements can still work for you.

ALSO READ: TIPS TO BE REMEMBER BEFORE STARTING ANY BUSINESS

How to write a financial plan for your small business

The good news is that they don’t have to be difficult to create or hard to understand. With just a few educated guesses about how much you might sell and what your expenses will be, you’ll be well on your way to creating a complete financial plan.

1. Profit and loss statement

This is a financial statement that goes by a few different names—profit and loss statement, income statement, pro forma income statement, P&L (short for “profit and loss”)— and is essentially an explanation of how your business made a profit (or incur a loss) over a certain period of time. 

It’s a table that lists all of your revenue streams and all of your expenses—typically over a three-month period—and lists at the very bottom the total amount of net profit or loss.

There are different formats for profit and loss statements, depending on the type of business you’re in and the structure of your business (nonprofit, LLC, C-Corp, etc.).

What to include in your profit and loss statement

  • Your revenue (also called sales) 
  • Your “cost of sale” or “cost of goods sold” (COGS)—keep in mind, some types of companies, such as a services firm, may not have COGS
  • Your gross margin, which is your revenue less your COGS

These three components (revenue, COGS, and gross margin) are the backbone of your business model — i.e., how you make money.

You’ll also list your operating expenses, which are the expenses associated with running your business that isn’t directly associated with making a sale. They’re the fixed expenses that don’t fluctuate depending on the strength or weakness of your revenue in a given month—think rent, utilities, and insurance.

How to find operating income

To find your operating income with the P&L statement you’ll take the gross margin less your operating expenses:

Gross Margin – Operating Expenses = Operating Income

Depending on how you classify some of your expenses, your operating income will typically be equivalent to your “earnings before interest, taxes, depreciation, and amortization” (EBITDA). 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 your “profit before interest and taxes,” gross profit, and “contribution to overhead”—many names, but they all refer to the same number.

How to find net income

Your so-called “bottom line”—officially, your net income, which is found at the very end (or, bottom line) of your profit and loss statement—is your EBITDA less the “ITDA.” Just subtract your expenses for interest, taxes, depreciation, and amortization from your EBITDA, and you have your net income:

Operating Income – Interest, Taxes, Depreciation, and Amortization Expenses = Net Income

For further reading on profit and loss statements (a.k.a., income statements), including an example of what a profit and loss statement actually looks like, check out “How to Read and Analyze an Income Statement.” And if you want to start building your own, download our free Profit and Loss Statement Template.

2. Cash flow statement

Your cash flow statement is just as important as your profit and loss statement. Businesses run on cash—there are no two ways around it. A cash flow statement is an explanation of how much cash your business brought in, how much cash it paid out, and what its ending cash balance was, typically per-month.

Without a thorough understanding of how much cash you have, where your cash is coming from, where it’s going, and on what schedule, you’re going to have a hard time running a healthy business. And without the cash flow statement, which lays that information out neatly for lenders and investors, you’re not going to be able to raise funds. 

The cash flow statement helps you understand the difference between what your profit and loss statement reports as income—your profit—and what your actual cash position is.

It is possible to be extremely profitable and still not have enough cash to pay your expenses and keep your business afloat. It is also possible to be unprofitable but still have enough cash on hand to keep the doors open for several months and buy yourself time to turn things around—that’s why this financial statement is so important to understand.

Cash versus accrual accounting

There are two methods of accounting—the cash method and the accrual method.

The accrual method means that you account for your sales and expenses at the same time—if you got a big preorder for a new product, for example, you’d wait to account for all of your preorder sales revenue until you’d actually started manufacturing and delivering the product. Matching revenue with the related expenses is what’s referred to as “the matching principle,” and is the basis of accrual accounting.

The cash method means that you just account for your sales and expenses as they happen, without worrying about matching up the expenses that are related to a particular sale or vice versa.

If you use the cash method, your cash flow statement isn’t going to be very different from what you see in your profit and loss statement. That might seem like it makes things simpler, but I actually advise against it. 

I think that the accrual method of accounting gives you the best sense of how your business operates and that you should consider switching to it if you aren’t using it already.

Why you should use accrual accounting for cash flow

For the best sense of how your business operates, you should consider switching to accrual accounting if you aren’t using it already.

Here’s why: Let’s say you operate a summer camp business. You might receive payment from a camper in March, several months before camp actually starts in July—using the accrual method, you wouldn’t recognize the revenue until you’ve performed the service, so both the revenue and the expenses for the camp would be accounted for in the month of July.

With the cash method, you would have recognized the revenue back in March, but all of the expenses in July, which would have made it look like you were profitable in all of the months leading up to the camp, but unprofitable during the month that camp actually took place.

Cash accounting can get a little unwieldy when it comes time to evaluate how profitable an event or product was, and can make it harder to really understand the ins and outs of your business operations. For the best look at how your business works, accrual accounting is the way to go.

3. Balance sheet

Your balance sheet is a snapshot of your business’s financial position—at a particular moment in time, how are you doing? How much cash do you have in the bank, how much do your customers owe you, and how much do you owe your vendors?

What to include in your balance sheet

  • Assets: Your accounts receivable, money in the bank, inventory, etc.
  • Liabilities: Your accounts payable, credit card balances, loan repayments, etc.
  • Equity: For most small businesses, this is just the owner’s equity, but it could include investors’ shares, retained earnings, stock proceeds, etc.

It’s called a balance sheet because it’s an equation that needs to balance out:

Assets = Liabilities + Equity

The total of your liabilities plus your total equity always equals the total of your assets.

At the end of the accounting year, your total profit or loss adds to or subtracts from your retained earnings (a component of your equity). That makes your retained earnings your business’s cumulative profit and loss since the business’s inception.

However, if you are a sole proprietor or other pass-through tax entity, “retained earnings” doesn’t really apply to you—your retained earnings will always equal zero, as all profits and losses are passed through to the owners and not rolled over or retained like they are in a corporation.

If you’d like more help creating your balance sheet, check out our free downloadable Balance Sheet Template.

4. Sales forecast

The sales forecast is exactly what it sounds like: your projections, or forecast, of what you think you will sell in a given period. Your sales forecast is an incredibly important part of your business plan, especially when lenders or investors are involved, and should be an ongoing part of your business planning process.

Your sales forecast should be an ongoing part of your business planning process.

You should create a forecast that is consistent with the sales number you use in your profit and loss statement. In fact, in our business planning software, LivePlan, the sales forecast auto-fills the profit and loss statement.

There isn’t a one-size-fits-all kind of sales forecast—every business will have different needs. How you segment and organize your forecast depends on what kind of business you have and how thoroughly you want to track your sales.

Generally, you’ll want to break down your sales forecast into segments that are helpful to you for planning and marketing purposes.

If you own a restaurant, for example, you’ll want to separate your forecasts for dinner and lunch sales. But a gym owner may find it helpful to differentiate between the membership types. If you want to get really specific, you might even break your forecast down by product, with a separate line for every product you sell.

Along with each segment of forecasted sales, you’ll want to include that segment’s “cost of goods sold” (COGS). The difference between your forecasted revenue and your forecasted COGS is your forecasted gross margin.

5. Personnel plan

Think of the personnel plan as a justification of each team member’s necessity to the business. 

The overall importance of the personnel plan depends largely on the type of business you have. If you are a sole proprietor with no employees, this might not be that important and could be summarized in a sentence of two. But if you are a larger business with high labor costs, you should spend the time necessary to figure out how your personnel affects your business.

If you opt to create a full personnel plan, it should include a description of each member of your management team, and what they bring to the table in terms of training, expertise, and product or market knowledge. Think of this as a justification of each team member’s necessity to the business, and a justification of their salary (and/or equity share, if applicable). This would fall in the company overview section of your business plan.

You can also choose to use this section to list entire departments if that is a better fit for your business and the intentions you have for your business plan. There’s no rule that says you have to list only individual members of the management team.

This is also where you would list team members or departments that you’ve budgeted for but haven’t hired yet. Describe who your ideal candidate(s) is/re, and justify your budgeted salary range(s).

6. Business ratios and break-even analysis

Business ratios explained

If you have your profit and loss statement, your cash flow statement, and your balance sheet, you have all the numbers you need to calculate the standard business ratios. These ratios aren’t necessary to include in a business plan—especially for an internal plan—but knowing some key ratios is always a good idea.

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 used by business owners and requested by bankers are probably gross margin, return on investment (ROI), and debt-to-equity.

Break-even analysis explained

Your break-even analysis is a calculation of how much you will need to sell in order to “break-even” i.e. cover all of your expenses.

In determining your break-even point, you’ll need to figure out the contribution margin of what you’re selling. In the case of a restaurant, the contribution margin will be the price of the meal less any associated costs. For example, the customer pays $50 for the meal. The food costs are $10 and the wages paid to prepare and serve the meal are $15. Your contribution margin is $25 ($50 – $10 – $15 = $25).

Using this model you can determine how high your sales revenue needs to be in order for you to break even. If your monthly fixed costs are $5,000 and you average a 50 percent contribution margin (like in our example with the restaurant), you’ll need to have sales of $10,000 in order to break even.

Make financial planning a recurring part of your business

Your financial plan might feel overwhelming when you get started, but the truth is that this section of your business plan is absolutely essential to understand. 

Even if you end up outsourcing your bookkeeping and regular financial analysis to an accounting firm, you—the business owner—should be able to read and understand these documents and make decisions based on what you learn from them. Using a business dashboard tool like LivePlan can help simplify this process, so you’re not wading through spreadsheets to input and alter every single detail.

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 are much higher.

Leave a Reply

Your email address will not be published. Required fields are marked *

---------------