Guessing is not an option. Preparing the financial section of a business plan is more than scribbling some pleasing numbers on a sheet of paper. The end result of every business plan is not how great the business start up will be or the tremendous skills to be employed in the business but the bottom line.
Having extraordinary skills and talent in a business area, being hardworking and determined, persistent, having great ideas and full of energy is a fantastic mix for a successful business career. But all those exquisite qualities mean nothing if the end result is not represented in the bottom line.
The financial section of the business plan is where all the operational items included in the rest of the business plan come together. There are three essential elements to a properly thought through and well constructed business plan. Those elements are a forecast profit and loss account stating the income and expenditure, a cash flow statement that determines the liquidity and a sensitivity analysis that indicates the risks and opportunities within the business plan.
The forecast profit and loss account should be prepared on a monthly basis for the first year with an annual projection for the second year. The first year of every new start up business can be difficult due to financing and funding growth from a standing start which is why the first financial year should be detailed.
The forecast profit and loss account is the financial calculation of all the sales, purchases, expenditure and prices contained within the other areas of the business plan. In addition full account should also be taken of the business administration costs. All the figures in the business plan income and expenditure account should be fully supported from the physical projections contained in the other sections and derived from those sections.
From the sales section multiply the sales volume of each product by the considered selling prices. Keep to a minimum sundry additional income that might be expected. The resultant financial calculation produces the expected monthly sales turnover.
Using the information in the production or operations section of the business plan and if included the purchasing section the sales volume should be evaluated at the expected purchase cost of the products and services. This produces a cost of sales figure which when deducted from the sales turnover provides a forecast gross profit figure each month.
The business plan should include notes and comments of all other main cost items including projections of staff requirements. Together with administration and overhead costs a monthly projection of the expected running costs of the business start up can be produced. The business running costs are an important area to forecast in detail as while sales prices and costs may be determined with some accuracy errors in the business running costs could cause a good business to fail.
The monthly forecast profit and loss account is complete by entering the sales turnover, deducting the cost of sales and the business running costs, overheads, to produce a net monthly profit. The bottom line may start in a monthly loss until volumes grow but should indicate a satisfactory profit. If a loss is indicated do not manipulate the numbers to show a profit which would be hiding the truth, instead go back to the sales and costs sections and consider what action is required to justifiably increase gross profit margins or reduce overhead costs.
Cash flow is often critical to a small business plan and a lack of capital or liquidity to carry out the ambitions and projections of the small business owner is a principal cause of small businesses going into liquidation before those business aspirations are achieved. The cash flow statement is based upon the volumes and prices included in the business plan and stated in such a way as to indicate the financial resources required.
Cash flow is different to the profit and loss account as the profit and loss account only states the different between sales sold and costs incurred. The cash flow statement takes account of both the profits made plus volume changes of purchases and stock, one off payments, financing debtor balances offset by creditor balances and shows how liquid and solvent a business is.
Producing cash flow statement tends to come within the province of accountants. A simple cash flow statement can be produced by starting with the net profit or loss each month, deducting the cost of stock which has not been sold yet including both raw materials and finished goods stock and also deducting any one off payments such as bills that have to be prepaid and the cost of paying for fixed asset purchases.
In addition when a new business starts up the amount owed to suppliers, creditors, is zero and the amount owed by customers, debtors, is zero. During the year these balances will change each month in proportion to the financial terms and conditions of the business and the movement of these balances need to be entered on the cash flow statement. An increase in debtors reduces the cash flow liquidity and an increase in creditors increases cash flow liquidity.
The third element of the financial section is an analysis of the whole business plan and the projections in what is called a sensitivity analysis. A technical accounting area for the majority of non accountants but nevertheless an important area as it is the financial sensitivity analysis that should indicate both the increased financial opportunities and the financial risks carried within the business plan.
All major areas within the business start up plan such as sales volume, sales prices, important cost elements and other factors that may have an impact on the business should be evaluated. For each item set an upper limit and lower limit based upon potential market conditions and risks.
Make a financial evaluate of each upper and lower limit for every item and determine the impact each would have on the profit and loss account and the cash flow statement. Also combine the financial effect of several factors to assess the impact of a combination of events on the small business. A lower sales volume may be uncomfortable for a small business but combined with lower sales prices and higher costs the risk could be severe.
The financial section of a business plan should be accurate and reflect the projected financial performance of the start up business. It is also important it is honest and evaluates the risks involved so that should any of those risks become reality urgent management action can be taken to limit the financial effect. In practice some of those risks will happen and being forewarned can be the difference between survival and failure with liquidity being the most dangerous risk of all.