Financial Plan

A business plan is all conceptual until you start filling in the

numbers and terms. The sections about your marketing plan and
strategy are interesting to read, but they don't mean a thing if you
can't justify your business with good figures on the bottom line.
You do this in a distinct section of your business plan for financial
forecasts and statements.
The financial section of a business plan is one of the most essential
components of the plan, as you will need it if you have any hope of
winning over investors or obtaining a bank loan. Even if you don't
need financing, you should compile a financial forecast in order to
simply be successful in steering your business.
How to Write the Financial Section of a Business
Plan: The Purpose of the Financial Section
Let's start by explaining what the financial section of a business
plan is not.
Realize that the financial section is not the same as accounting.
Many people get confused about this because the financial projections that
you include--profit and loss, balance sheet, and cash flow--look similar to
accounting statements your business generates. But accounting looks
back in time, starting today and taking a historical view. Business planning
or forecasting is a forward-looking view, starting today and going into the
future.
The purpose of the financial section of a business plan is two-fold. You're
going to need it if you are seeking investment from venture capitalists,
angel investors, or even smart family members. They are going to want to
see numbers that say your business will grow--and quickly--and that
there is an exit strategy for them on the horizon, during which they can
make a profit. Any bank or lender will also ask to see these numbers as
well to make sure you can repay your loan.
But the most important reason to compile this financial forecast is for
your own benefit, so you understand how you project your business will
do. "This is an ongoing, living document. It should be a guide to running
your business," Pinson says. "And at any particular time you feel you need
funding or financing, then you are prepared to go with your documents."
If there is a rule of thumb when filling in the numbers in the
financial section of your business plan, it's this: Be realistic.
How to Write the Financial Section of a Business
Plan: The Components of a Financial Section
A financial forecast isn't necessarily compiled in sequence. And you
most likely won't present it in the final document in the same
sequence you compile the figures and documents. Berry says that
it's typical to start in one place and jump back and forth. For
example, what you see in the cash-flow plan might mean going back
to change estimates for sales and expenses. Still, he says that it's
easier to explain in sequence, as long as you understand that you
don't start at step one and go to step six without looking back--a
lot--in between.
Start with a sales forecast. Set up a spreadsheet projecting your sales
over the course of three years. Set up different sections for different
lines of sales and columns for every month for the first year and either on
a monthly or quarterly basis for the second and third years. "Ideally you
want to project in spreadsheet blocks that include one block for unit
sales, one block for pricing, a third block that multiplies units times price
to calculate sales, a fourth block that has unit costs, and a fifth that
multiplies units times unit cost to calculate cost of sales (also called
COGS or direct costs)," Berry says. "Why do you want cost of sales in a
sales forecast? Because you want to calculate gross margin. Gross
margin is sales less cost of sales, and it's a useful number for comparing
with different standard industry ratios." If it's a new product or a new line
of business, you have to make an educated guess. The best way to do
that, Berry says, is to look at past results.
Create an expenses budget. You're going to need to understand how
much it's going to cost you to actually make the sales you have forecast.
Berry likes to differentiate between fixed costs (i.e., rent and payroll) and
variable costs (i.e., most advertising and promotional expenses), because
it's a good thing for a business to know. "Lower fixed costs mean less risk,
which might be theoretical in business schools but are very concrete
when you have rent and payroll checks to sign," Berry says. "Most of your
variable costs are in those direct costs that belong in your sales forecast,
but there are also some variable expenses, like ads and rebates and
such." Once again, this is a forecast, not accounting, and you're going to
have to estimate things like interest and taxes. Berry recommends you go
with simple math. He says multiply estimated profits times your best-
guess tax percentage rate to estimate taxes. And then multiply your
estimated debts balance times an estimated interest rate to estimate
interest.
Develop a cash-flow statement. This is the statement that shows
physical dollars moving in and out of the business. "Cash flow is king,"
Pinson says. You base this partly on your sales forecasts, balance sheet
items, and other assumptions. If you are operating an existing business,
you should have historical documents, such as profit and loss statements
and balance sheets from years past to base these forecasts on. If you are
starting a new business and do not have these historical financial
statements, you start by projecting a cash-flow statement broken down
into 12 months. Pinson says that it's important to understand when
compiling this cash-flow projection that you need to choose a realistic
ratio for how many of your invoices will be paid in cash, 30 days, 60 days,
90 days and so on. You don't want to be surprised that you only collect 80
percent of your invoices in the first 30 days when you are counting on
100 percent to pay your expenses, she says. Some business planning
software programs will have these formulas built in to help you make
these projections.
Income projections. This is your pro forma profit and loss
statement, detailing forecasts for your business for the coming
three years. Use the numbers that you put in your sales forecast,
expense projections, and cash flow statement. "Sales, lest cost of
sales, is gross margin," Berry says. "Gross margin, less expenses,
interest, and taxes, is net profit."
Deal with assets and liabilities. You also need a projected balance sheet.
You have to deal with assets and liabilities that aren't in the profits and
loss statement and project the net worth of your business at the end of
the fiscal year. Some of those are obvious and affect you at only the
beginning, like startup assets. A lot are not obvious. "Interest is in the
profit and loss, but repayment of principle isn't," Berry says. "Taking out a
loan, giving out a loan, and inventory show up only in assets--until you
pay for them." So the way to compile this is to start with assets, and
estimate what you'll have on hand, month by month for cash, accounts
receivable (money owed to you), inventory if you have it, and substantial
assets like land, buildings, and equipment. Then figure out what you have
as liabilities--meaning debts. That's money you owe because you haven't
paid bills (which is called accounts payable) and the debts you have
because of outstanding loans.
Breakeven analysis. The breakeven point, Pinson says, is when your
business's expenses match your sales or service volume. The three-
year income projection will enable you to undertake this analysis.
"If your business is viable, at a certain period of time your overall
revenue will exceed your overall expenses, including interest." This
is an important analysis for potential investors, who want to know
that they are investing in a fast-growing business with an exit
strategy.
The financial section of the business plan should consist of three
types of standard financial statements:
Cash flow statement
Income statement (sometimes referred to as profit/loss statement)
Balance sheet
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.
1. 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 incurred 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.).
A typical profit and loss statement should include:
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
aren’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
2. 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.
Why you should use accrual accounting for cash flow
For the best sense of how your business operates, you should consider switching to accrual
accounting if you aren’t using it already.
Here’s why: Let’s say you operate a summer camp business. You might receive payment from a
camper in March, several months before camp actually starts in July—using the accrual method,
you wouldn’t recognize the revenue until you’ve performed the service, so both the revenue and
the expenses for the camp would be accounted for in the month of July.
With the cash method, you would have recognized the revenue back in March, but all of the
expenses in July, which would have made it look like you were profitable in all of the months
leading up to the camp, but unprofitable during the month that camp actually took place.
Cash accounting can get a little unwieldy when it comes time to evaluate how profitable an event
or product was, and can make it harder to really understand the ins and outs of your business
operations. For the best look at how your business works, accrual accounting is the way to go.
The cash flow statement is one of the three main financial statements
(along with the income statement and balance sheet) that shows the
financial position and health of a business.
The cash flow statement shows actual cash inflows and outflows of a
business over a specified period of time, usually a month or a quarter.
The statement then compares cash received to cash spending to
determine if a business is cash flow negative or positive. The cash flow
statement also often shows how much cash a business has on hand at
the end of a given period of time.
A cash flow positive business is receiving more cash than it is spending.
Likewise, a cash flow negative business is spending more cash than it is
receiving.
The Two Types of Cash Flow Statements
There are two different types of cash flow statements that a business may produce: An indirect cash flow
statement and a direct cash flow statement.
Indirect cash flow statement
The indirect method starts with Net Income from the Profit and Loss statement and then makes additions and
subtractions from that number to arrive at cash flow.
The indirect cash flow statement is more popular because it can be easily created from reports produced by
accounting software. That said, it can be more difficult to use for cash flow forecasting.
For more details on the indirect method of cash flow forecasting, read The Indirect Cash Flow Method: How to
Use It and Why It Matters. Also, read our guide that explains every row of an indirect cash flow forecast.
Direct cash flow statement
The direct method simply totals up cash received and cash spent and then compares the two numbers to
arrive at a cash flow number.
For more details and explanations about the direct cash flow statement, read our guide on forecasting cash
flow that explains the direct method in detail.
How to Use a Cash Flow Statement
While the Income Statement (also known as the Profit & Loss Statement) usually gets all the attention, the cash flow
statement is arguably the more important financial statement to review when you’re looking at a business’s books.
The cash flow statement shows if a business is bringing in cash or losing cash over time. With cash being the lifeblood of
business, knowing if cash is moving into the business or out of the business is critical.
You can use the cash flow statement to calculate cash runway – the amount of time that a business can stay in operation if it
continues to lose money at its current pace. Learn more about cash runway.
How the cash flow statement works with the Income Statement and Balance Sheet
Along with the income statement and balance sheet, the cash flow statement is one of the three critical financial statements
that you can use to evaluate a business’s performance.
The income statement records booked sales and expenses and calculate profits. It’s important to know if a business is
profitable, but you then turn to the cash flow statement to see how this activity impacts cash.
The income statement does not reflect cash received and spent. This is because customers often take time to pay after they
receive an invoice and businesses also don’t pay all their bills right away. Learn more about the difference between cash and
profits.
The balance sheet connects to the cash flow statement in that it also records the amount of cash a business has on hand. In
addition to this key metric, the balance sheet lists a business’s assets and liabilities. Learn more about how to read and
understand a balance sheet.
3. Balance sheet
Your balance sheet is a snapshot of your business’s financial position—at a particular moment in time, how are you doing?
How much cash do you have in the bank, how much do your customers owe you, and how much do you owe your vendors?
The balance sheet is standardized, and consists of three types of accounts:
Assets: Your accounts receivable, money in the bank, inventory, etc.
Liabilities: Your accounts payable, credit card balances, loan repayments, etc.
Equity: For most small businesses, this is just the owner’s equity, but it could include investors’ shares, retained earnings,
stock proceeds, etc.
It’s called a balance sheet because it’s an equation that needs to balance out:
Assets = Liabilities + Equity
The total of your liabilities plus your total equity always equals the total of your assets.
At the end of the accounting year, your total profit or loss adds to or subtracts from your retained earnings (a component of
your equity). That makes your retained earnings your business’s cumulative profit and loss since the business’s inception.
However, if you are a sole proprietor or other pass-through tax entity, “retained earnings” doesn’t really apply to you—your
retained earnings will always equal zero, as all profits and losses are passed through to the owners and not rolled over or
retained like they are in a corporation.
If you’d like more help creating your balance sheet, check out our free downloadable Balance Sheet Template.
The balance sheet provides a snapshot of the overall financial
condition of your company right now. It lists all of the company’s
assets, liabilities and owner’s equity in one simple document. By
subtracting liabilities from assets, you can determine your
company’s net worth at any given point in time.
Components of a balance sheet
Typically, a balance sheet is divided into three main parts:
1. Assets
Current assets are those that can be converted to cash within one year. They typically include cash, stocks, accounts
receivable, prepaid expenses, and inventory.
Fixed assets are tangible assets that are for long-term use, such as equipment, machinery, vehicles, land and buildings,
furniture and fixtures, and leasehold improvements. Many other assets don’t fit within either of these categories so most
balance sheets include an “other assets” category for these items—typically things like long-term investment property, life
insurance cash value, and compensation due from employees.
2. Liabilities
Current liabilities are business obligations due within one year.
These typically include short-term notes payable (including lines of credit), current maturities of long-term debt, accounts
payable, accrued payroll and other expenses, and taxes payable.
Long-term liabilities are business obligations that are due outside of one year, such as any bank debt or shareholder loans
with maturities longer than one year.
3. Owner’s equity
This is the sum of all shareholder money invested in the business and accumulated business profits. Owner’s equity includes
common stock, retained earnings, and paid-in-capital.
How to use the balance sheet
Your balance sheet can provide a wealth of useful information to help improve financial management. For example, you can determine your company’s net worth by
subtracting your balance sheet liabilities from your assets, as noted above.
Perhaps the most useful aspect of your balance sheet is its ability to alert you to upcoming cash flow shortages. After a highly profitable month or quarter, for example,
business owners sometimes get lulled into a sense of financial complacency if they don’t consider the impact of upcoming expenses on their cash flow.
There are two easy-to-figure ratios that can be computed from the balance sheet to help determine whether your company will have sufficient cash flow to meet current
financial obligations:
Current ratio
This measures liquidity to show whether your company has enough current (i.e., liquid) assets on hand to pay bills on-time and run operations effectively. It is expressed as
the number of times current assets exceed current liabilities.
The higher the current ratio, the better. A current ratio of 2:1 is generally considered acceptable for inventory-carrying businesses, although industry standards can vary
widely. The acceptable current ratio for a retail business, for example, is different from that of a manufacturer.
The formula:
Current Assets / Current Liabilities
Quick ratio
This ratio is similar to the current ratio but excludes inventory. A quick ratio of 1.5:1 is generally desirable for non-inventory-carrying businesses, but—just as with current
ratios—desirable quick ratios differ from industry to industry.
The formula:
Current Assets – Inventory / Current Liabilities
Knowing your industry’s standards is an important part of evaluating your business’s balance sheet effectively, which is one reason why we offer free sample industry
reports to small businesses. Using the balance sheet included in your industry’s report, you can calculate the current ratio and quick ratio that are desirable for your business
type, to get a better sense of how your own business’s ratios stack up.
Get familiar with your balance sheet
Most companies should update their balance once per quarter, or whenever
lenders ask for an updated balance sheet. Today’s accounting software
programs will create your balance sheet for you, but it’s up to you to enter
accurate information into the program to generate useful data to work from.
The balance sheet can be an extremely useful financial tool for businesses that
understand how to use it properly. If you’re not as familiar with your balance
sheet as you’d like to be, now might be a good time to learn more about the
workings of your balance sheet and how it can help improve financial
management.
Create your balance sheet easily by downloading our Balance Sheet Template,
and check out our article on The Key Elements of the Financial Plan for more
info on your business financials.
4. Sales forecast
The sales forecast is exactly what it sounds like: your projections, or forecast, of what you think you will sell in a given period.
Your sales forecast is an incredibly important part of your business plan, especially when lenders or investors are involved,
and should be an ongoing part of your business planning process.
Your sales forecast should be an ongoing part of your business planning process.
You should create a forecast that is consistent with the sales number you use in your profit and loss statement. In fact, in our
business planning software, LivePlan, the sales forecast auto-fills the profit and loss statement.
There isn’t a one-size-fits-all kind of sales forecast—every business will have different needs. How you segment and organize
your forecast depends on what kind of business you have and how thoroughly you want to track your sales.
Generally, you’ll want to break down your sales forecast into segments that are helpful to you for planning and marketing
purposes. If you own a restaurant, for example, you’d probably want to separate your forecasts for dinner and lunch sales; if
you own a gym, it might be helpful to differentiate between the membership types. If you want to get really specific, you might
even break your forecast down by product, with a separate line for every product you sell.
Along with each segment of forecasted sales, you’ll want to include that segment’s “cost of goods sold” (COGS). The
difference between your forecasted revenue and your forecasted COGS is your forecasted gross margin.
6. Business ratios and break-even analysis
Business ratios
If you have your profit and loss statement, your cash flow statement, and your balance sheet, you have all the
numbers you need to calculate the standard business ratios. These ratios aren’t necessary to include in a
business plan—especially for an internal plan—but knowing some key ratios is always a good idea.
You’d probably want some profitability ratios, like:
Gross margin
Return on sales
Return on assets
Return on investment
And you’d probably want some liquidity ratios, such as:
Debt-to-equity
Current ratio
Working capital
Of these, the most common ratios used by business owners and requested by bankers are probably gross
margin, return on investment (ROI), and debt-to-equity.
Break-even analysis
Your break-even analysis is a calculation of how much you will need to
sell in order to “break-even” i.e. cover all of your expenses.
In determining your break-even point, you’ll need to figure out the
contribution margin of what you’re selling. In the case of a restaurant,
the contribution margin will be the price of the meal less any associated
costs. For example, the customer pays $50 for the meal. The food costs
are $10 and the wages paid to prepare and serve the meal are $15. Your
contribution margin is $25 ($50 – $10 – $15 = $25).
Using this model you can determine how high your sales revenue needs
to be in order for you to break even. If your monthly fixed costs are
$5,000 and you average a 50 percent contribution margin (like in our
example with the restaurant), you’ll need to have sales of $10,000 in
order to break even.
Financial planning is 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.