The Financial Plan section is a critical component of the business plan. Having a thorough financial plan will help you determine how much money you will need to turn your idea into a business and serve as a budget once it’s launched. If you aren’t experienced with creating budgets or using spreadsheets, it will be important to have someone on your side who is – ideally an accountant or CPA, but, many communities offer free resources to help you review or prepare these with you. You can talk to a SCORE mentor with financial expertise, seek assistance at a local Small Business Development Center, or search on Meetup or Eventbrite for community events where entrepreneurs can learn how to structure their business financials. There are nine key parts to your financial plan. This week, I will cover the requirements and considerations that go into the first five sections. Next week, in “What’s In My Financial Plan? Part II”, I will dive into the remaining four areas.
The Financial Plan section should contain the following elements and should be no more than four pages, with additional details in the appendix if you want to include supporting statements and visuals:
The business model is how you intend to make money. How exactly you’re going to generate revenue and make a profit at some future point? Let the following questions guide you in describing your own business model:
Is it a business that will sell to other businesses (B2B) or directly to consumers (B2C)?
Is it a retail or service business with a storefront?
Is it a service business that’s home-based?
Is it an online retail business?
In terms of generating revenue, are you selling a product or service directly to customers? Are you charging a one-time or recurring fee? Selling memberships? Finding some other revenue-generating strategy? Provide a simple visual snapshot of your model, using an illustration or diagram to show how your business model works.
These are the basic assumptions that you’ll be making to support your estimated revenue and expense projections. Your list of assumptions should contain three categories:
Most of your cost assumptions should be pulled together from other sections of your business plan. Determine how many customers you’re going to get and the price they’re going to pay: That’s your basic calculation. For example, if you’re going to get 100 customers who are each going to pay $10 for the product, then your revenue will be $1,000. If it’s recurring, meaning that the customers pay this each month – for example, a subscription – then you will have $1,000 each month for as long as the customers continue to subscribe.
Your Key Financial Data section will be a set of spreadsheets that documents your financial picture along with assumptions (as outlined above). These should include the following three financial statements with five-year projections, broken down by month for the first year and annually for the subsequent four years:
Income Statement: Measures all your revenue sources set off against business expenses for a given time period.
Balance Sheet: Provides a snapshot of the business’s assets, liabilities, and owner’s equity at a given time (e.g., December 31, 2011).
Cash Flow: Like the income statement, measures financial activity over a period of time and is the most important. If you run out of cash, the business won’t be able to sustain itself, so you’ll need a good handle on your cash flow.
One of the most common tools used to determine the financial feasibility of starting a new business is to do a Break-Even Analysis. This analysis lets you determine what you need to sell, monthly or annually, to cover the costs of doing business – your break-even point.
The break-even point can be expressed in terms of unit sales or dollars and is extremely important for potential investors, as they can get a sense of how long the company will need to run on investment capital before it can sustain itself. Below is a simple calculation you can use to determine your break-even point (in units):
Break-even=Total Fixed Costs/Margin
Margin=Revenue per unit less Variable costs per unit
When you subtract the variable costs (costs that you pay only as each product is sold) of each unit from the price you charge per unit, you get the margin on each unit. Then divide the total fixed costs (costs that you have to cover even if you are not doing any business) by that margin, and you get the number of units you need to sell in order to break even.
For example: Fixed costs equal $1,000 to cover rent and electricity, the Revenue per unit is $15, and the variable costs are $5 (which are the costs of production).
Margin=$15 revenue-$5 variable costs
Fixed Costs= $1,000
Therefore, break-even=$1,000 fixed costs/$10 margin, or 100 units. So, in this example, you must sell 100 units at $15 to break even. Profit will be $0, but you will not be operating at a loss.
How much money are you going to need to start this business? Document how much you’ll need and how you’re going to use it to support the five-year income statement projections that you calculated.
Whether your number is $10,000 or $1,000,000, you’ll need to demonstrate why it’s the magic number to get going. List every expense projection to justify your numbers. Give your budget room if you predict changes in your market or factors that might affect your industry. For example, if you’re operating a business that depends on vans to transport goods. Based on economic trends, you’ll have to factor in increasing gas prices over the next five years.
Once you’ve figured out how much money you will need to finance your company, think about how you plan to structure that investment: as equity, debt, convertible debt? Which makes the most sense for your type of company? Refer back to my previous blog post that defines the differences between debt and equity funding.
Debt: Financing takes the form of loans that must be repaid over time, usually with interest. These can be obtained from friends, family, banks, or even the SBA (Small Business Association).
Equity: Financing takes the form of money obtained from investors in exchange for an ownership in the business. This can be obtained from friends, family, wealthy “angel” investors, or venture capital firms. The primary advantage of equity financing is that the business is not obligated to repay the money; rather, the investors hope to reclaim their investment out of future profits.
Convertible Debt: Financing is simply a loan that can be turned into equity, generally upon the occurrence of future financing, and can sometimes be a good solution for small businesses.
Whatever money you need and however you decide to structure the investment, take into consideration that getting capital is difficult, and sometimes “bootstrapping” is the primary option you’ll need to consider – which means that you’ll have to self-fund the business for a while, at least to get it going.