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Supercharge Your Start-up With a Strong Financial Plan
A business plan is nothing without a strong financial plan. It’s how you know if you can – or will – make a profit. Which, let’s be honest, is what makes this entrepreneurial hustle all worth it.
Financial planning is one of the biggest factors that can make or break a start-up business. That’s why it’s essential to get your numbers right. We know this can be a daunting task for many entrepreneurs, particularly if you’re new to budgeting and forecasting. We’ve built this beginner’s guide to give you a good understanding of each part of a comprehensive Financial Plan, so you can fast-track your path to profitability.
What is a Financial Plan?
Simply put, a financial plan includes financial projections that allow you, as a business owner, to budget for the year ahead.
This ensures that your costs do not outweigh your revenue.
It’s a working document that functions as a working budget. In other words, it helps you plan for the year ahead.
Each month, you can then track if you’re behind or ahead in projected turnover and profits. You’ll also be able to see if your costs are higher than projected, an issue many start-ups run into.
The good news is that if this does happen, you will have the tools and information you need to decide if you must increase sales or adjust your business model to reach your targets.
However, without a roadmap to follow, it’s much harder to hit your turnover goals and ensure you make a profit.
A financial plan is essentially an ‘educated guess’ that:
- Projects revenues and expenses for a certain period of time
- Describes the operational activities and costs related to your business
- Includes a profit and loss statement, a balance sheet, and projected cash flow
Best of all, the process of creating – and then following – a financial plan stress-tests your numbers and your assumptions, radically increasing your chances of succeeding in your entrepreneurial venture. The financial plan of an established business will include financial statements, balance sheets, and other financial information. A new business (without a trading history) should include targets for the first one to three years, including projected costs and sales, as well as any potential investments that the business may attract.
Why financial planning is so important for your business
1. Financial plans increase your chances of success
There are two reasons that all business owners need a financial plan:
- The act of planning helps you to determine your projected revenues and expenses, ensuring your business is cash flow positive and makes a profit.
- Once you launch your business, your plan will become a working document you can revisit on a monthly basis.
2. Impress investors with your financial plan
Financial plans are really important if you want to approach investors and banks:
- Venture capitalists, angel investors, alternative funders and banks, require you to be able to prove that your business is on a growth path.
- Investors need to see that their contribution will deliver a good return on investment.
- Banks and other lenders need to see that your projected cash flows show the ability to repay loans.
6 Benefits of a financial plan
- For start-ups, a financial plan can show if or when your business will start making a profit.
- Once the business is operational, your financial plan will guide your day-to-day spending decisions.
- The plan includes an Expense Budget that lists all the costs that your business will face.
- It also includes a Forecast to predict how much revenue your business will generate, and when that revenue will come.
- Financial planning keeps you on top of your cash flow – more specifically, it helps you to keep cash flowing into your business. Cash flow challenges occur when expenses outpace revenue forecasts. Poor cash flow is often the result of overspending or not sticking to your budget.
- Maintaining an up-to-date financial plan is essential to evaluate the overall financial health of your business, and to detect cash flow problems early on so that you can address them quickly and effectively.
Bring your financial plan to life
The process of sitting down and using past figures to establish patterns, cut costs and understand cash-flows and margins is invaluable to you as a business owner.
Update your plan as you go
Unfortunately, many business owners go through the process of creating a business plan and a financial plan, and then they put it on a shelf and never look at it again. Great entrepreneurs will tell you that you need to do the opposite – once you create your financial plan, you need to check it regularly.
Your financial plan is the ideal tool for effectively and profitably managing your business.
To master your financial plan like a boss, block out one day a month where you fill in your actual numbers in the profit and loss statement and compare them to your projections. Now you know how your business is doing, and if any changes are necessary.
Not only will this help you to revise future projections, but you will immediately notice if your cash flow is under pressure, may be under pressure in the future, or if costs are not balanced by your revenue.
Cash in on your cash flow
One of the biggest reasons that businesses fail in their first three years is cash flow. Unfortunately, start-ups end up in a situation where their expenses exceed their cash, resulting in a cash flow problem. It’s possible to have a profit on paper, but insufficient cash in the bank to pay creditors.
Great entrepreneurial hustlers are all about how much money they have in the bank. Take a page from their book to ensure your start-up succeeds.
“Make sure you always get paid. Don’t carry on doing work if your clients don’t pay and chase your invoices. I’ll climb in my car and drive 600 kilometres to fetch my money. That’s my business we’re talking about.”
– Tim Hogins, founder of GOG, a group of lifestyle and adventure parks
Poor cash flow happens for a number of different reasons:
- Inadequate credit control: Providing payment credit terms to customers with a poor credit score
- Increasing debtor days: Allowing delayed payment terms to 45, 60 or 90-days
- Incurring bad debts: Customers who fail to pay you
- Late invoicing and other poor accounting practices
- Failing to budget for capital or exceptional expenditures.
All of these risks can be mitigated by a financial plan, particularly if you revisit the plan – and your numbers – on a monthly basis.
Master common financial terms
- Revenue, also called Sales, is the money that comes into the business
- Cost of Sale or Cost of Goods Sold (COGS) refers to the expense of creating the goods or services that you sell. A services business will have a Cost of Sale, but not a COGS
- Gross Margin is your revenue or sales minus your Cost of Sale or COGS
- Note: All of these figures do not include local income taxes or value-added taxes, which you will need to factor in.
What’s in a Financial Plan?
1. Your Sales Forecasting: Revenue
What is a Sales Forecast?
- Sales forecasting is the process of estimating your business’s future sales
- It’s difficult to make the best decisions for your business in the short- and long-term if you don’t know how you’ll be making money
- You also need to understand how much you need to spend in order to offer your product or service to the market (including salaries, office rentals etc)
- Sales forecasts are based on past sales data, industry-wide comparisons and economic trends
- If you’re a new business that can’t draw from your own past sales data, you will need to research your market and customer buying trends carefully in order to accurately forecast potential sales
- Your sales forecast should be consistent with the sales number you use in your profit and loss statement
How do I create a Sales Forecast?
To begin your sales forecast, create a spreadsheet that will project your monthly sales over the course of three years.
If you haven’t launched your business yet and cannot draw from past sales, then ask these three questions:
- How many customers do I anticipate?
- How much will I charge them?
- How often will I charge them?
Create different lines of sales for each product line or division in the business, and columns for each month of the first year, and months or quarters for the second and third years.
Include the following:
- Unit sales
- Multiple units x price = sales
- Unit costs
- Units x unit costs = cost of sales
Anticipating projected sales is one of the reasons why experts strongly recommend launching a business in an industry you know and understand. It’s difficult to anticipate how customers will react to your solution if you aren’t already familiar with their specific needs and challenges.
Calculating Your Gross Margins
Cost of sales is an important element in your sales forecast because it allows you to calculate your gross margin.
The formula is as follows:
Gross Margin = Sales - Cost of Sales
When you compare this number to different industry standards, you can get a sense of whether your cost of sales is too high, and your Gross Margin therefore too low.
Gross Margin is an important figure because it tells you how much money you have left each month after you have paid for the fixed and variable costs of your production or services.
Once you have your Gross Margin, you will know what you have left to cover general administration costs and what you can invest in your brand’s growth through marketing, branding, capital expenditure etc.
Mistakes to avoid when creating a sales forecast
- Don’t ignore your costs. It’s important to forecast sales, but your ultimate goal is to determine your Gross Margin. This means your cost of sales is as important as your sales or revenue figure. Examine each sale from the perspective of how many costs were involved. Include the salesperson’s time and salary, overheads, and the materials and equipment used to secure the deal and deliver the product or service.
- Don’t forecast based on your gut or assumptions. While there is some guesswork involved in forecasting (and none of us can see into the future), you want to be as accurate as possible. Draw on past sales (if you are an already-established business), survey your customers and prospects and investigate your industry.
The ‘Lean Start-Up’ approach to business planning recommends that entrepreneurs with new business ideas get into the market as quickly as possible. This helps you to build forecasts based on real customer feedback and early sales, rather than on guesswork alone.
- Don’t ignore external factors. There are many external factors that impact sales. Make sure you have thought of them and how these risks can be avoided. Don’t fall into the trap of being highly optimistic about your sales and then find that the reality is far less than you thought it would be – and yet your costs are too high based on extremely positive projections. Being positive and optimistic are great entrepreneurial traits, but you want to be realistic as well.
2. Your Expense Budget: Costs
What is an Expense Budget?
- An Expense Budget is the tool that helps you to determine your Cost of Sales
- It lists Fixed Costs and Variable Costs and helps you to ensure that you are spending as little as possible to operate without sacrificing on quality, your capacity to deliver a service or product, and your ability to gain a maximum profit for your business.
The difference between Fixed and Variable costs
Start by differentiating between your Fixed Costs and your Variable Costs. If you are a start-up, you will also want to separate your start-up expenses and your operating expenses.
- Start-up expenses include business registration fees, starting inventory, rental deposits, down payments on a property or equipment, utility set up fees and office set up costs.
- Operating expenses on the other hand are the costs of keeping your business running and are generally monthly expenses. They include salaries, rent, telecoms expenses, utilities, any raw materials you might require, storage, distribution, marketing, office supplies and maintenance.
- Operating costs are made up of Fixed Costs and Variable Costs. Fixed Operating Costs are costs that don’t vary based on the amount of product you make or services you sell. These include rent and salaries.
- Variable Operating Costs are costs that change according to how much product you make or services you sell. These include sales commissions, raw materials and utility expenses like electricity. You also have fixed and variable administration costs, for example, rent is fixed but stationery and printing expenses might vary based on purchases in a month.
- Fixed Administration Costs should always be covered first, as these will be incurred regardless of whether or not you make a sale. You need to know what revenue is required to cover these to ensure you break even.
How do I create an Expense Budget?
An Expense Budget is also known as an Expense Forecast, or Projected Expenses. When you combine your Expense Budget with your Sales Forecasts, you have what you need to project your business’s profit and loss.
There are three common types of spending in a business:
- Operating costs, such as salaries, rent, utilities, marketing and telecoms. These are monthly expenses and tend to be Fixed Costs.
- Direct costs, also known as Cost of Sale or Cost of Goods Sold (COGS) in manufacturing. These are included in your Sales Forecast and include any expenses that are directly related to producing an item. These tend to be Variable Costs, as they are impacted by how many units you manufacture and deliver or sell.
- Repaying debts and purchasing assets. These affect your cash flow and your balance sheet, but not your profits. Profits are what you have left after paying your bills (both fixed and variable).
Here’s how you determine your Expense Budget:
To get started, first list all the expenses associated with running your office:
- These are operational or operating expenses, and include salaries, rent, telecoms, utility bills and so on
- They are bills you will incur whether or not you make a single sale
- They are fixed and don’t fluctuate based on the strength or weakness of your revenue in a given month.
List each item separately, and then add them all up to get an operational cost.
Next, list your variable costs, such as:
- Equipment purchases
- Printing business cards
- Raw material purchases
List each item separately, and then add them all up.
Determining Your ‘Cost of Sales’ or ‘Cost of Goods Sold’
- Once you understand your Fixed and Variable costs, you need to determine your Cost of Sale, or Cost of Goods Sale (COGS):
- First, list your fixed costs (labour, rental of a manufacturing space, electricity for your production plant) that are directly related to manufacturing your goods. These do not include office overheads etc, which you would incur even if you didn’t manufacture a single item.
- Next, list your variable costs (maintenance, raw materials).
- The key here is that these costs are directly affected by your sales. For example, if you produce 200 widgets, your costs will be different to 1 000 widgets.
- Most variable costs are direct costs that belong in your sales forecast and directly impact your Cost of Sale or COGS.
- If you carry the cost regardless of whether you make a sale, it should not be included here.
- To determine cost of sale, use this formula:
- COGS = Beginning Inventory + Purchases during the period - Ending Inventory
- Your COGS per unit must be lower than the revenue it generates, or you will be running at a loss.
- Once you have your Cost of Sale, you can now determine whether your product is priced correctly, and if your Sale Forecast will cover your costs and give the business a profitable return.
- The rule of thumb is to aim to make double that figure to ensure you have some wriggle room, and the business is able to generate a profit.
3. Your Cash Flow Statement
What is a Cash Flow Statement?
- A Cash Flow Statement shows the physical amounts moving in and out of your business
- It is also factors in forecasting, using assumptions from your sales forecasts, expenses and balance sheet items
- A Cash Flow Statement shows the amount of cash your business brought in, how much you paid out and what your cash balance was at the end of the month
Cash is the life-blood of businesses, making this a critical financial document for you.
Why is a Cash Flow Statement so important for my business?
If you are launching a new business, it’s critical to compile a Cash Flow Projection that shows your expected cash flow month-by-month for the first year of operations.
Unfortunately, many start-ups focus on making profits and signing large deals, but forget that without cash flow, the business can’t pay its bills. For every large corporate customer that will ask for 60- or 90-days, you need customers who will pay upfront or on 30-days. Your Cash Flow Statement will help you plan this.
One of the harsher realities of business is that how much profit you are projected to make each month is meaningless if you don’t have cash flowing into your bank account. Profits on paper do not pay salaries, overheads or suppliers. If you want to build a successful business, cash in hand is critical.
- Your Cash-Flow Statement is a tool to realistically determine which customers will pay upfront, and which will be on 30-day terms, 60 days, 90 days and so on.
- It’s essential that you are as realistic as possible. You don’t want to be surprised if you only collect on 70% of invoices in your first 30 days, when you were counting on 100%.
- Track your invoices against your Cash Flow Statement as well to ensure every customer has been invoiced on time.
Your Cash Flow Statement is also the area of your business that lenders and investors will want to review before considering giving you a loan or funding, as it’s a good indicator of the health of your business.
4. Your Income Statement / Profit & Loss Statement
What is a Projected Income Statement?
- A Projected Income Statement is based on your Sales Forecast, Expense Budget, and Cash Flow Statement
- It’s an educated guess that is essential if you want to determine whether or not your business can make money
- This means that your Projected Income Statement is a way to plan your Profit and Loss Statement before the financial year begins
- Because your Profit and Loss Statement (or P&L) can only be finalised at the end of your business’s financial year, an Income Projection is important to determine whether the business will make a profit or a loss, and if something needs to be addressed early on in the financial year to ensure a profit is achievable.
How to calculate Gross Margin and Net Profit
- Gross Margin is a business’s net sales revenue minus its cost of goods sold (COGS). The gross margin represents the amount of sales revenue that your business holds after all the direct costs associated with producing your goods or services have been paid. All businesses have costs and debt obligations they need to service. The higher the gross margin your business enjoys, the higher the percentage of each rand of a sale you retain after costs are covered.
- Net Profit illustrates the percentage of revenue collected by your business that translates into profit. In other words, the Net Profit margin is the ratio of net profits to revenues after your cost of sales has already been subtracted. Net Profit is what a business is left with after additional expenses, taxes and interest have been deducted as well.
The formulas are simple:
- Gross margin = Sales - Cost of sales
- Net profit = Gross margin - Expenses, interest and taxes
5. Your Balance Sheet: Assets and Liabilities
What are Assets and Liabilities?
- A Balance Sheet tracks your Assets and Liabilities (not included in your Profits and Loss Statement)
- Assets and Liabilities figures are used to project the net worth of your business at the end of your financial year
- Assets are anything of value like land, buildings and equipment – assets that provide future economic benefits to the business
- Liabilities are outstanding debts; they are your business’s obligations
- In successful businesses, assets outweigh liabilities
- If liabilities outweigh assets, the business is probably in trouble, and the overall value of the business will be low.
- A good way to gauge the health of your business – and the value of your equity – is through your Balance Sheet.
How your Balance Sheet tracks Assets and Liabilities
Your Balance Sheet essentially tracks your Assets, Liabilities and Equity.
If you have taken a bond on a property, for example, this will appear under Assets and Liabilities. The interest on the loan is in your Profit and Loss Statement, but the principle repayments are on your Balance Sheet.
It’s called a Balance Sheet because the equation needs to balance out: Assets = Liabilities + Equity
The total of your liabilities plus your total equity always equals the total of your assets.
- Assets: Accounts receivable (your sales), money in the bank (cash flow) and inventory (product on hand to sell)
- Liabilities: Accounts payable (money you owe), credit card balances, loan repayments
- Equity: Owner’s equity, investor shares, retained earnings and stock proceeds.
How do I create a Balance Sheet?
- Because a Balance Sheet is essentially an equation that balances out, assets go on one side of the sheet, and liabilities on the other.
- The difference between these two numbers is your equity in the business (ie. What you as the owner would walk away with if you sold all your business’s assets and paid off all its debts).
6. Your Break-even Analysis
What is a Break-even Analysis?
- For start-ups, your Break-even Analysis helps you to determine when you can expect your business to start covering all its expenses and generating a profit
- To do this, you need to determine exactly how much you need to sell in order to generate a specific level of profitability
- It’s an important step in understanding whether you have a good business idea: Can you realistically generate sufficient sales revenue to cover your costs?
Why is my Break-even Figure important?
Having a clear understanding of your Break-even Point (BEP) allows you to set your prices appropriately so that you can forecast when (and if) your business will become profitable.
How do I determine my Break-even Figure?
The Break-even formula is the following:
Break-even Point = Fixed Costs / (Unit Selling Price – Variable Costs)
- Fixed Costs: These are costs that must be paid every month, whether or not any sales take place (includes rent)
- Unit Selling Price: What you sell each product or service for
- Variable Costs: Semi-variable costs that go up or down depending on the activity of your business (includes raw materials).
What Your Break-even Analysis Means For Your Business
Your Break-even Analysis provides you with valuable information on how many sales you need to make in order to cover all of your business’s costs. For example, if your calculation shows that you need to sell 600 units, you then need to determine whether or not this is possible.
- If selling 600 units does not seem possible, you have a number of options:
- You could cut costs
- You might ramp up your sales efforts
- You could target an additional market or perhaps add a new, more profitable unit line
- If you do none of the above, you’re unfortunately unlikely to reach BEP or make a profit, which will impact the sustainability of your business.
- Finally, it’s important to understand that a Break-even Analysis is not a predictor of demand – understanding that you need to sell 600 units does not mean that your target market wants to buy 600 units.
- If you go to market with the wrong product or at the wrong price, you may never hit your BEP – which is the reason for this important tool in the first place.