By Amy Fontinelle
The financial part of a business plan includes various financial statements that show where your company currently is financially, and where it intends to be. This information helps you determine how much financing your business needs and helps financiers determine whether lending you money or investing in your business is a prudent use of funds.
While the financial statements are helpful in and of themselves, the data they contain can also be used to calculate financial ratios such as gross profit margin, return on investment and return on owner's equity. Ratios provide helpful information about a company's liquidity, profitability, debt, operating performance, cash flow and investment valuation. (Learn more about financial ratios in our Financial Ratio Tutorial.)
Before you seek financing, ask yourself if your business is ready to take on new debt. Do you know exactly what you will use the money for? Can your business handle the cost and the risk of borrowing this money? What would the consequences be if you were to default?
Begin your financial plan with information on where your firm stands financially at the present time, and what its financial situation has looked like historically. Then lay out your financial targets, such as return on investment, sales per employee, profit margin and so on.
If your business plan is for the expansion of an existing business, your statements will be based on your business's existing financial data. If your business is new, your statements will be speculative, but you can make them realistic by basing them on the published financial statements of existing businesses similar to yours. (Our Financial Statements Tutorial will get you up to speed, if you're new to the subject.)
Your financial plan should include three key financial statements: the income statement, the balance sheet and the cash flow statement. Let's look at what each statement is and why you need it.
- Income Statement
The income statement summarizes your company's revenue and expenses. Revenues are your company's sales and/or other sources of income (for example, a car dealership might earn money from car sales, car leases and auto loans). Expenses include items such as the cost of goods sold, payroll, taxes and interest. The bottom line of the income statement shows the company's net income. Financiers want to know what kind of numbers your company is working with and whether your company is profitable. (To learn more, read Understanding The Income Statement.)
- Balance Sheet
The balance sheet shows your company's assets and liabilities. It's called a balance sheet because the assets must perfectly balance the liabilities. Within each category are numerous subcategories. For example, your assets will include things like cash, accounts receivable, inventory and equipment. Your liabilities will include things like accounts payable and loan balances. The balance sheet is important because it shows the company's financial position at a specific point in time, and compares what you own to what you owe. (For more information, see Reading The Balance Sheet.)
- Cash Flow Statement/Cash Budget
The cash flow statement shows the amounts of money you expect to be coming into and going out of your business in a given time frame. Topics you'll need to examine to predict cash flow include sales forecasts, cash receipts vs. credit receipts and the time frame for collecting accounts receivable. How much will these expenses be, and how often will you need to pay them? Will you have trade credit, and how long will you have to pay your suppliers? A realistic cash budget covering one year of operations and broken down into one-month intervals is an important short-term planning tool. You'll also need to prepare longer-term projections that go at least three years out, if not five. These are called "pro forma" statements, and they are based on your assumptions about how your business will perform.
Your financial statements should show both a long- and short-term vision for your business. In business plans, three-year and five-year projections are considered long term, and your plan will be expected to cover at least three years. Your projections should be neither overly optimistic best-case scenarios, nor overly cautious worst-case scenarios, but realistic in-between projections that you can support. Also, be aware that lenders may want your statements presented in a certain way. A bank, for example, may want to see monthly projections for the first year, quarterly projections for the second year and annual projections for the third year. In addition to financial statements for your company, if you are a new business, you may need to provide personal financial statements for each owner.
Preparing your financial plan shows how much money will you need. Perhaps this sounds obvious, but you really should know how much money you need from lenders or investors before you ask. If you can't ask for a specific amount of money, explain why you need that amount of money and show exactly how it will be used, any reasonable lender will be very hesitant to give it to you. Lenders and investors will also expect that you have invested your own money in the firm - this shows that you are committed to your idea and confident that your business will succeed. The amount of your own money the lender will expect you to have invested in the business compared to the amount you want to finance varies, but it usually ranges from 20-50%.
You must also determine what type of financing would be most suitable for your business. Banks offer several types of financing to businesses that do not present too much risk. Do you need a short-term working capital loan to increase your inventory? Do you want a transaction loan, where you receive all the money at once, or a line of credit, where you draw on funds as you need them? Do you need an intermediate-term loan to purchase larger assets such as real estate or equipment? Would you prefer revolving credit, which has a longer time frame than a line of credit and allows you to re-borrow funds that you have previously paid back?
Potential lenders will also want to know how and when you intend to repay the loan or line of credit, so you should put together a proposed repayment schedule and terms. They may not agree with you, but your proposal shows that you are considering the loan from the lender's perspective. Also describe what collateral is available to secure the loan, such as inventory, accounts receivable, real estate, vehicles or equipment. Be aware that lenders do not count the full value of your collateral, and each lender will count a different percentage.
Potential investors will want to know when their investment will pay off and how much of a return to expect. They will also want to see that you have an exit strategy to cash out on your investment.
When you put together your financial statements, make sure there are absolutely no typos or mistakes in your calculations. If you are inexperienced in preparing these statements, hire a professional to help you. Even if you and all of your business partners know exactly what you are doing, you may still want to hire an unbiased, outside professional to check your work and give you a second opinion on whether you are being realistic in your projections. You don't want to be blindsided by mistakes or problems in your financial statements when a potential lender or investor rejects your proposal.
Keep in mind that no one has to lend you any money or invest in your company, and when they are considering doing so, they will be comparing the risk and return of working with you to the risk and return they could get from other investments, such as bonds and stocks. (For further reading, see What You Need To Know About Financial Statements.)
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