So you want to become a business owner? Great! Entrepreneurship is one of the greatest endeavors you will ever face and the reward is sensational. However, being a successful business owner is not easy. In fact, 80% of small businesses fail within the first five years. Why is this? Well, I've helped countless business owners and the most common theme I notice is most business owners don't take time to create a Financial Plan for their business. Just like your personal life, if you don't create a financial plan financial success is virtual impossible. Okay well, "How do I create a financial plan for my business"? Great question! The Funding Circle (a website for small business owners) reached out to me with this question and wrote an amazing article on the answers that I provided. So I highly recommend you take out and note pad and keep reading on!
How do you write a business financial plan?
It’s important to be realistic when first learning how to write up a business financial plan, Cofield said. “The worst thing you can do is make overly optimistic sales projections,” he said, “while underestimating cost projections.”
If your business is just getting off the ground, most of your numbers will be projections. However, if your business has been around for a while, you can use past financial data to help inform you as you write a business financial plan.
Creger advised, “If you want to write your own business financial plan, you should periodically seek out second opinions from CPAs or financial advisors.” Having someone else evaluate your methods and provide feedback may result in a more thorough, effective plan, he explained.
Ready to crunch some numbers and understand how to make a financial plan? These are the five components you should include in a financial plan:
1. Expenses analysis
Tallying all your expenses when you write a business financial plan gives you a better idea of exactly how much it costs to run your business, said Cofield. To begin, separate your expenses into two main categories, he advised: fixed costs and variable costs.
Fixed costs include things like rent, payroll, and any loan payments you have. Variable costs, on the other hand, include costs associated with inventory, utilities, supplies, hiring, marketing and advertising, and office maintenance. Once you total your fixed and variable expenses, you’ll have a good idea of how much you spend each month.
It’s also helpful to create a third section that lists start-up costs, or the money you spent to get your business running, like permits, registration fees, rent deposits, set-up fees for utilities or IT, and any down payments on buildings or equipment.
2. Income statement
An income statement, also known as a profit and loss statement, breaks down your revenue, cost of goods sold (COGS), and expenses to show how profitable your business is. In your first year of business, it’s smart to create an income statement every month to ensure you’re on track with your goals. Once you’re more established, however, you can limit your statements to once a quarter.
You can use this formula to calculate your net income, Cofield suggested:
Net income = Sales/Revenue – COGS – expenses and taxes
“This will be your projected bottom line,” he explained.
Your COGS should tally up any costs associated with making the products or providing the services your business offers, including inventory. Your overall inventory expenses will include direct costs, like the cost of materials and packaging, as well as indirect costs, like the cost of storage or temporary labor.
To calculate COGS, use this formula:
COGS = Starting inventory costs + additional inventory costs – ending inventory
For example, say your business’ inventory costs at the start of the year add up to $200,000. You make $500,000 worth of additional inventory purchases throughout the year and finish with $100,000 worth of inventory at the end of the year. Following the formula, your COGS would be $600,000.
Plugging this number into the net income formula, along with your total expenses, can help you with small business financial planning as you see exactly where you’re spending money, as well as what changes you can make to increase your earning potential.
3. Balance sheet
A balance sheet in a financial plan is a summary of your business’ assets and liabilities at the end of a certain period, like the fiscal year. Assets refer to anything your business owns of financial value, including cash, accounts receivable, equipment, or property. Current assets are assets you expect to liquidate in the next 12 months.
Liabilities, on the other hand, refer to forms of debt, like loan payments, accounts payable, income taxes, or salaries payable. Current liabilities are liabilities your business needs to pay in the next 12 months. The difference between your total assets and total liabilities shows how much equity your business has.
4. Break-even analysis
Cofield said it’s smart to include a break-even analysis as you write a business financial plan. Your break-even point is the “amount of products or services you need to sell each year to break even on your total costs,” he said. In other words, it’s the point at which your revenue covers your operating expenses. Figuring out your break-even point can help you see whether or not you’re pricing your products right, as well as how much you need to sell to actually profit.
Use this formula to calculate your break-even point for your financial plan:
Break-even point = Fixed expenses / (Price per unit x variable cost per unit)
As an example, let’s say your phone case business has $50,000 of fixed costs, which include rent, payroll, and taxes. It costs your business $8 in raw materials, packaging, and shipping to make each phone case, and each case sells for $12. Using the formula, that means your company would have to make and sell 520 phone cases to break even with your fixed costs. To make a decent profit, though, and account for variable costs, you’d need to produce and sell much more than that.
5. Cash flow statement and projection
Cash flow, which refers to the money coming in and out of your business, is a good indication of your business’ financial health. If your business has a few years worth of financial documents, start by creating a cash flow statement, which is a record of how much cash flow your business has had in the past.
Putting together a statement is as simple as tallying all your various forms of cash revenue and cash disbursements (like payroll, rent, utilities, and vendor payments), then calculating the difference between the two. Positive cash flow may mean you can afford to spend more money in certain areas, while negative cash flow may mean there are areas you should cut costs.
Next, you’ll want to write a cash projection, which is an estimation of your business’ future cash disbursements and cash revenue. If your business doesn’t have cash flow history to draw from, this is where you’ll start. You can use the same format: cash flow = cash revenue – cash disbursements.
Be sure to take into account factors like inventory shipment time and product seasonality. For example, if you typically have to double inventory for your floral business to meet the demand for Valentine’s Day, you’ll know you have less cash to work with around that time.
Include sections in your financial plan for analysis
It’s helpful to include brief analyses of each section of your financial plan, especially if you want to apply for financing.
“In a business financial plan, you should always include why you are implementing any specific strategy,” said Creger, “so you can look back and remember why you chose one path over another.” For example, if your IT expenses were unusually high one year, you should write in your analysis that you chose to invest more money in new equipment to help reduce tech issues and cut down on IT repair costs.
These sections of your financial plan don’t need to be lengthy — a brief paragraph that includes trends and important notes should suffice. Having this explanatory information, Creger said, can come in handy if you want to make changes to your business. “If you know why you did something in the past, you only need to evaluate if the ‘why’ is still relevant,” he said. If it’s not, you can adjust your methods, he explained.
Update your financial plan regularly
“The key to a good financial plan is to revisit and modify often,” said Cofield. He recommended reviewing your financial plan at least once a quarter to make updates. Not only does this give you better insight into your business, he explained, it also helps make your projections more accurate.
Developing a financial plan is crucial to building a successful business. Periodically examining your business’ finances puts your company’s practices into perspective, showing you what’s working and what’s not.