American sports personality Stephen A Smith said, “If you are in the world of business, that means you are in the business of making money.” As a business, one of the key indicators of success is making money for your stakeholders and employees. Financial planning holds an organization in good stead even during times of crisis.
You might have great business planning skills, but if it doesn’t include a doable financial plan, you have little hope of winning the confidence of investors. A business also doubles your chances of success as it keeps you focused on priorities.
Financial Planning: An Overview
Financial planning refers to an organization’s financial health and how it can be leveraged to plan for short-term and long-term goals.
A financial plan is part of finance management of an organization. Setting goals and staying on track is easier when you have a financial plan that aligns with your business goals. It can also reveal opportunities that businesses might otherwise overlook.
Business financial planning allows a company to sensibly allocate resources to various functions.
Business financials gives you an insight into your company’s financial health and helps you develop a realistic strategy for the future. It allows you to gauge how far you have come, where you are bleeding money, and how to troubleshoot problem areas. Financial planning also serves as an early warning system, helping you make predictions about the future, forecasting income, and expenditure.
Apart from making you attractive to investors, it also helps you set realistic goals for your business. You are better prepared for growth and crisis, as you are familiar with your business financials.
Why is it important to have financial plan for your business?
Without a financial plan in place, you will have a heard time assessing the performance of your company.
Almost 50% of businesses fail in the first five years. For businesses that do not have a business plan, 25% of them will die within two years of startup.
A detailed financial plan is an art and a skill that takes time to master and is fundamental to growth. Business planning is a non-negotiable part of strategizing for success. A Palo Alto Software survey found that entrepreneurs who had completed a business plan for their venture were more than twice as likely to successfully grow their business as those who had no plan or an incomplete financial plan.
Financial planning also boots stakeholder confidence and support sound money habits that make it easier to manage income. Building wealth becomes second nature when you are equipped with a sound financial plan.
Ideally, business owners must engage in a yearly financial planning exercise that maps out short-term and long-term goals for the company. Chinese philosopher Confucius said, “A man who does not plan long ahead will find trouble at his door.”
Five Important Steps to Creating a Foolproof Financial Plan for Your Business
Chalking out a financial plan for your business will help you pinpoint the best timing for projects, cash flow needs, avert crisis, and convince financiers to lend you money. Financial business planning must include budgetary allocations for immediate and long-term needs.
1. Review Your Company’s Strategy
A business strategy is the first plan of action that outlines a business’ vision and goals, and guides its decision-making process. Before getting started on financial planning for a business, executives must familiarize themselves with the organization’s strategy.
This will help you understand what the company plans to focus on in the coming year and allocate budgets accordingly. Some questions that can be asked while reviewing your business plan are:
- What is affecting the company’s cash flow?
- How much financing is needed for the next year?
- What are the regular expenses vs expected future expenses?
- How will liabilities affect cash flow in case of a crisis?
These factors will help you come up with a clearer picture on what kind of a financial plan is required to meet business goals in the coming year.
2. Study the Balance Sheet
To get a clear idea on where you stand in terms of finances, you must review the balance sheet. It is essential to understand the company’s past and plan the future. A balance sheet also shows you past strategies and how it affected your company. It is rich in data and facts.
A balance sheet lets you review the assets and liabilities under your organization. In simple terms assets are what your company owns while liabilities include anything that your company owes.
Assets provide future benefits while liabilities drain spending power. A thorough understanding of assets and liabilities will help you plan what can be leveraged in the future.
The formula to calculate shareholder equity is:
Shareholder Equity = Assets – Liabilities
Organizations must focus on growing their assets to have a steady cash flow from various sources as it is necessary to fight off unprecedented crises. Studying the balance sheet before financial planning ensures that you are well-versed with what you have and what you stand to lose.
3. Personnel Costs
In case the company plans to expand its footprint in the coming year, it is essential to plan for added FTE costs. FTE stands for Full-Time Equivalent, a tool used to forecast the costs of a project or forecasting employee hours and salaries.
For most companies, wage and salary costs itself account for almost 70% of employer costs. Personnel costs include cash compensation, training costs, travel allowances, severance packages, payroll taxes, incentive programs, office and computing supplies, and other expenses if any.
It is also important to study whether you have the right amount of people to meet business goals. In case of new projects, a comprehensive study helps you understand whether you need to on-board more employees and if they should be full-time, part-time, or work on a contractual basis.
Personnel planning helps you monitor if you are on track to meet business goals or if some adjustments are needed.
4. Break-even Analysis
A break-even analysis is the tipping point in financial planning. It shows us the point at which total cost and total revenue is equal and what kind of situations will push a business to reach it.
A break-even analysis is a major milestone before a business moves into profitability. It also tells you whether you might need to borrow money to keep the business afloat or if the endeavor is a lost cause.
It calculates the company’s break-even point (BEP) and is an internal calculation that is sometimes shared with investors and regulators. Mature businesses conduct this exercise even to evaluate risks before making major decisions regarding product changes.
Although a major part of business planning, a break-even analysis is conducted whenever a business plans for additional costs. The ideal break-even window is between six to 18 months. In case it exceeds the 18-month mark, it indicates that the risk factor is extremely high.
Cash-flow statements, which record all cash flow from operations, investment, and financing activities, are an important part of break-even analysis.
Often, lenders ask companies to share their break-even analysis to calculate the company’s eligibility for a loan. When what-ifs and different market conditions complicate matters, a break-even analysis provides business owners with a simplified decision-making process.
5. Income Projections
Business owners must continue to look ahead to make substantial progress. Short-term and long-term income projections guide companies on how to monitor their financial activity.
A sales forecast is the first step towards income projections. Sales are affected by market conditions, global concerns, and supply-chain challenges. Taking these variables into account while drawing up a sales forecast gives you an approximate idea on where you stand with regards to income.
Well-researched, data-driven income projections help you onboard the right investors and chart a course for greater profitability. In today’s competitive marketplace, income projections are essential to understand how much money your company can make in a year, broken down month by month.
Benefits of Financial Planning for Businesses
The benefits of financial planning far outweigh the stress induced while preparing one. A financial analysis shows you whether your business is viable or in the red. Schwab’s 2018 Modern Wealth Index found that having a written financial plan can lead to better “daily money behaviors.”
Plan for contingencies
What would you do if your financial health deteriorated suddenly? When you have engaged in financial planning, you have a step-by-step guide on how to deal with crisis situations. You also know what can be done in such cases to keep the business afloat.
It is crucial for risk management and helps you prepare ahead of time for man-made and natural calamities that can derail business plans.
Monitor goals
In any business, it is important to periodically review goal-setting. Throughout the course of the year, you can match your actual results with your financial planner to see where you stand, and adjust course accordingly.
Regularly checking in helps prevent catastrophes as you spot potential trouble much earlier.
Expert Intervention
A financial planner also indicates when a business is going under and needs expert guidance. Business financials are treasure troves of data on the health of the organization.
When things are not going to plan, it highlights the need for a fresh pair of eyes and expert advice. Businesses can reach out to consultants to course-correct when their strategies fail to give expected results.
In a study conducted by the Financial Bank of Chicago, it was discovered that there is a direct correlation between financial management and financial health of small businesses. The financial plan helps guide the day-to-day decision making of the business and keep a tight-rein on expenditure during lean periods.
According to the research, “The Power of Planning: Proven Benefits That Transform Consumer Financial Outcomes,” Americans with a written plan save more across all income levels. Improving a company’s financial management is key to achieving profitability.
