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.
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:
Profit and loss statement
Cash flow statement
Balance sheet
Sales forecast
Personnel plan
Business ratios and break-even analysis
Even if you’re in the very beginning stages, these financial statements can still work for you.
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.
- 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.
- 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.
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.
