Business Plan : 6 Financial Plan

raisingcapitol“Money is the lifeblood of business.” This truism points out the importance of the financial statements section of the business plan. The financial statements (or the “financial plan”) is one of the most closely scrutinized sections of any business plan. Investors have been known to go from the executive summary straight to the financial statements to judge the merit of a business plan. Your business plan must address the financial issues of cash flow, start-up capital and, of course, profit.

However, this is not an accounting or finance tutorial. Furthermore, if you are a business student it is likely you have taken, or are taking, an accounting course. We don’t propose to duplicate all that content here. Therefore, some knowledge of accounting principles and financial statements is assumed. The purpose of this lesson is to describe the fundamental requirements for a financial plan in an e-business plan and outline the financial statements that are required, without defining every accounting term that is used.

What is a Financial Plan?

The previous sections of the business plan define what the business intends to produce and how it will do so. The financial plan estimates the monetary resources and flows that will be required to carry out the business plan. The financial plan also indicates when and by how much the business intends to be profitable. Finally the financial statements tell a lot about the entrepreneur in terms of business commitment and financial wherewithal to make the business a profitable success.

In addition to the financial statements, a financial plan includes a list of assumptions upon which the financial statements are based. Clearly stating your financial assumptions serves two purposes: it allows investors to know what is behind the numbers and it helps you to know the financial impact when the basis of your assumptions changes.

Assumptions are most important in “soft numbers” such as projected sales and interest rate projections. “Hard numbers” such as rent, computers, and Web site hosting costs can be estimated with some certainty after a reasonable amount of research. The trick to creating realistic, credible financial statements is to make reasonable and conservative projections of the soft numbers and to understand the assumptions upon which they are based.

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A financial plan should also contain a set of key financial ratios. Financial numbers aren’t always enough to convince an investor that the business is a viable firm. Investors will want to compare your financial projections with those from other companies that have succeeded or failed. However, companies differ in size and it is difficult to make comparisons when one company is small and the other is large.

To solve this problem investors use financial ratios. When you divide one number by another, the resulting ratio or percentage makes it easier to compare similar businesses of different sizes. An accounting or finance textbook will provide a comprehensive list of ratios, but a few of the most important in assessing business plans are:

  • Debt-to-equity ratio: long-term liabilities / owner’s equity
  • Net profit margin: net profit / gross revenue on sales
  • Return on investment: net profit / total assets
  • Return on equity: net profit / equity

Credibility can be added to your financial ratios if you provide the potential investor with comparative data from successful companies in the industry in which the business will compete. Financial data services such as Standard and Poor’s, FISonline, and Dun & Bradstreet publish this data. A limited amount of free data may be available on-line, more detailed data are published in reports found in most university libraries or purchased from the firm.

The Financial Statements

The financial statements section begins with a start-up budget that details expected investment before the business starts to operate (i.e., before the first sale is made). Next, a series of financial statements — income and expense statement, balance sheet, cash flow statement — that project the financial future of the company for the first 3-5 years after start-up are presented.

Start-up budget:

If the business is a new one, you will need to prepare a budget that defines the expenses required to start the business, before it can begin to generate revenue through sales. For almost every business this includes items such as office furnishings, legal fees, product development, manufacturing equipment, and vehicles. For an e-business, a start-up budget will also include computers, software, Web site development costs, and provision of Internet service.

Income and expense statement:

An income and expense statement is an accounting term for what most people call a budget. The I&E statement includes income items such as revenue from sales and interest income. It also includes all anticipated expense items, usually grouped into logical categories such as cost of goods sold, administration expenses, interest, and taxes. The statement concludes with various profit figures — operating profit, profit before taxes, and net profit.

The income and expense statement shows these figures over a period of time, annually in most business plans (e.g., income and expenses for the period January – December 2003) and projected several years into the future (e.g., 2003-2005 for a three-year projection).

Balance sheet:

The balance sheet is a statement of the business’s assets (what it owns), liabilities (what it owes), and owner’s equity (what it is worth).

Whereas the income and expense statement shows financial results for a period of time (e.g., year ending 31 December 2003), the balance sheet is a snapshot of financial results at a single moment in time (e.g., as of 31 December 2003). In established businesses, a current balance sheet usually presents previous year data too, for comparison purposes.

Cash flow statement:

Even if the income and expense statement shows profits and the balance sheet shows positive owner’s equity, you may still not have a viable business. Why not? Because a business needs cash on hand in order to pay bills. The purpose of the cash flow statement is to monitor changes in the cash position of a business over a period of time.

The top portion of the cash flow statement records cash coming in (inflow) and the bottom portion records expenses for cash going out (outflow). The categories are similar to those that appear in the income and expense statement, but the numbers are more “honest” because income is recorded only when it is deposited and expenses are recorded when the check (or e-payment) is made.

The “bottom line” here is the ending cash balance. If this number is negative for two consecutive periods, warning bells are likely to go off in the investor’s mind.