Many, many business owners go to work each week with uncertainty about how things are going. They’re not sure how much cash is in the account, or when more will be coming or going. They’re not sure when or how to pay themselves. They may not even know whether they can make payroll.
This is where financial planning for businesses comes into play. A sound financial plan for your business will give you clarity surrounding the current state of your company & it’s future vision, and the steps needed to connect the two. It will provide a framework for handling cash, managing taxes, and describe exactly what financial commitments will be made along the way.
In this post we’ll cover a simple financial planning framework for businesses that everyone can use.
Assess Your Current State
Any form of planning begins with a realistic understanding of where you’re starting from. For businesses this means your financial statements. Ideally you have bank accounts dedicated to business activities only, and bookkeeping software like Quickbooks that tracks all business related transactions. Once each months’ transactions are categorized and reconciled, you should be able to produce accurate financial statements at will. There are three you need to be familiar with:
The balance sheet is a snapshot of your business’s assets and liabilities at a certain moment in time. Its where the business lists receivables, cash, equipment, and other assets as well as debts, prepaid fees, and other liabilities. Balance sheets have a grand equation you’ll need to remember: assets = liabilities plus owner’s equity. The more assets & fewer liabilities a business has, the larger the value of owners’ equity. You’ll want to use the most current balance sheet when devising a financial plan for your business.
Whereas balance sheets explain assets, liabilities and equity at a moment in time, income statements express performance over longer periods. Income statements may be expressed monthly, quarterly, annually, or even longer. All income statements look similar. Income is shown on the top with expenses listed underneath. Profit is shown at the bottom, which is the difference between total revenues and total expenses. Financial planning is most effective when viewed over long time periods, since it smoothes out anomalies in income or unexpected expenses. For this reason, you will probably want to use an income statement that shows the most recent completed fiscal year.
Statement of Cash Flow
You’ve heard it before: cash is king. Even though your income statement might show incredible profitability, it doesn’t mean a whole lot if you don’t have enough cash to make payroll. Businesses accepting deferred payments, or those extending credit can sometimes run short of cash. Which is why it’s essential to have a good feel for what’s coming into your business and what’s going out. The statement of cash flow gives you an accurate view of these flows, and an expectation of what’s coming down the pipe.
Explore Your Future Vision
Once you have a good feel for where your business stands, it’s time to explore where you want to take it. Vision is a subjective topic and means different things to different people. Your vision might be building out a new product or service. Another’s might be based on a certain number of clients or employees, or personal income and compensation. Whatever your motivating factors are, it’s time to crystallize your vision and objective over the next couple years.
In most cases, your vision and objective setting should go out no farther than three years. Most businesses set strategic targets over both one and three year intervals. And while we do want to keep our eye on the future and finger on changing trends & upcoming changes, planning farther out is usually fruitless. The business environment will change so much between now and then that any target more than three years away will be obsolete far before then.
Draw the Map
There are thousands of paths that will connect the dots between where your business stands today and where you want it to be one and three years down the road. The right path will incorporate the needs of you and other stakeholders, be congruent will the needs and nuances of your business, and have the maximum chance of succeeding.
A good financial plan for your business should consider the following:
- Your monthly expenses
- How many of your expenses are fixed vs. discretionary
- What will happen with the next $1,000 / $10,000 / $100,000 of cash
- How to handle idle cash in the business bank accounts
- How and when cash will be distributed from the business
- How you will handle taxes on business profits and your personal compensation
- The milestones for growth and new expenses
Tying Your Financial Plan Together
The secret to any personal or business financial plan is that it needs to be both descriptive and prescriptive. It should be descriptive in the sense that gathering the data and going through the exercise should shed light on where you are today and how far you are from your goals. It should also be prescriptive, and show you precisely how to get there.
After having done this for a while, I can tell you with certainty that the value of having a financial plan for your business is not in the document itself. It’s in the exercise of understanding where you are today, exploring where you want to take your business, and knowing what you need to do to get there. It’s a process. And if done successfully, you’ll come away from the exercise with clarity about your next steps and confidence that they’ll lead to the successes you’re seeking.