Table of contents
What is Financial Planning?
Financial planning in business is the process of projecting the future financials of the company in different scenarios. Financial planning thus involves projecting future sales, revenues, costs, investments etc. It is an iterative process where you normally should end up with a complete set of financial projections/forecasts, that is, a Financial plan.
The Financial plan is an overview of your current business financials and financial projections into the future. It can be thought of as a road map of the financial expectations and goals for your business.
The Financial plan should at least contain:
- Sales forecast
- Income statement
- Balance sheet
- Cash flow statement
- It helps you determine if a new business idea may be viable.
- It is necessary to attract investors and financing.
- It helps existing businesses grow and thrive
- Financial planning helps you make better business decisions!
Financial planning and accounting
It is important to note that financial planning and the financial plan is not the same as accounting.
The financial plan include the same financial statements as the accounting does, that is, the Income statement, Cash flow statement, and the Balance sheet. But accounting looks back in time, and the financial plan looks into the future. That means, that you do not do the financial plan the same way as you do the accounting. Accounting is done following rather strict rules based on things that have occurred. Financial plans are more educated guessess. This also means that the financial plans are less detailed than the accounting.
Financial planning tools
In this blog I am using the Financial Planning tool BusinessPlanNumbers.com. In this solution you just have to input the expected sales and costs, and then all the financial projections/statements are automatically created. It also automatically calculates the cash/financing need, valuation etc. Using the tool saves you a lot of time, it is spreadsheet compatible, and it has really valuable reporting capabilities.
Even though it is getting more common to use online Financial planning tools, most financial planning are still being done in spreadsheets. It can take a lot of time to build a functional financial forecast in a spreadsheet, but it may in some cases allow you to make more detailed assumptions etc.
From Sales forecasts to Financial forecast
Financial forecasting is about converting actual sales forecasts, costs forecasts, investment plans, development plans etc. into a complete Financial forecast.
Example: A Startup business website (SaaS) that is going to sell licenses.
Chart 1) Licenses
The chart shows the expected/input development in sold licenses/subscribers. Number of licenses/users in the last period is 1 031.
Chart 2) Prices per licenses
The chart shows the expected/input price per licenses
Chart 3) Revenues
The chart shows the expected/calculated revenues.
Revenues = Licenses * Price per license
Revenues = 1 031 * 200 = $206 200
Chart 4) Revenues and Costs
The chart shows the expected/calculated revenues and the expected/calculated costs.
Costs should be split into variable and fixed costs.
Chart 5) Operating cash flow and Financing need
The automatically calculated Operating cash flow is the difference between Revenues and Costs in chart 4). The automatically calculated Financing need (the green columns) is the accumulated financing need - in order to finance the periods in which the Operating cash flow is expected to be negative.
From the chart we can see that the expected accumulated financing need reaches a maximum of about 135.000 in the middle of 2024. This means that, if this Startup wants enough cash/financing today in order to survive until being cash flow positive (middle of 2024), then this Startup should at least have cash/financing of more than 135.000.
Further below we will talk about including different scenarios in order to better understand the risk and uncertainties in these forecasts
Profitable business idea?
In the first phase of starting a completely new business, or make significant changes to an existing business, it is crucial to learn about the possible financial effects. This will help you understand if your business idea may be profitable, how profitable it may be, and you will learn about the possible financing need.
As an example, you can use the Financial Planning tool on BusinessPlanNumbers.com to find a sales volume and price of your product or service that gives you an expected sufficient profitability. You can then compare these minimum needed sales volumes and prices with what your expect that you can actually get in the market. If you expect that you can achieve a higher volume and/or higher prices in the market than the minimum needed - then this may be a viable business idea.
The next step in the financial part of the analysis will then be to do some scenario testing in order to learn about the risk and robustness of your idea, and then you must learn about the possible financing/investment need.
Step 1) Check the expected profitability of a business idea
First input your base case assumptions in order to get an overview of the possible profitability of your idea.
Example: Testing if the business idea may be sufficiently profitable, within a given time horizon and investment need
Assuming a case where the Entrepreneurs only want to try this Startup if they think it is relatively reasonable to assume a sufficient profitability after 3 years, and that the financing need is not too high. In this example we use Quarterly periods (3 months).
Base case assumptions
The below image from BusinessPlanNumbers.com shows the assumptions* and the calculated Revenues and Costs.
*Assumptions: Sales volume, Price per volume, Variable costs per volume, and Fixed costs.
Chart 1) Revenues and Costs: Base case
Chart 2) Net profit
The Net profit is expected to be about $4 000 in Q4 2024.
The business is expected to be profitable for the first time in Q4 2023.
The business is expected to be profitable for the first time in Q4 2023.
Chart 3) Operating cash flow and Financing need In this example the Operating cash flow is equal to the Net profit. The Financing need is estimated to be about $16 000.
Summary
Given the assumptions made, the expectations is that this possible business may:
- Be profitable for the first time in Q4 2023.
- Reach a profitability of $4 000 in Q4 2024
- Need a financing of about $16 000
Note: These are just some output chosen for this example. In other business cases there may be other/additional important variables to look at.
If the above summary indicates that this may be a good business idea, then the next step in the financial part of the analysis will then be to do some scenario testing in order to learn about the risk and robustness of your idea.
Step 2) Scenario testing
It is very important to test the financial outcomes in different alternative scenarios, and learn about the financial robustness of the business idea. That is, does the business idea still make financially sense even though some forecast assumptions worsens a bit, e.g. what if sales are lower, costs are higher etc.? Also learn about how the financial outcomes may be if some of the forecast assumptions are improved, e.g. what if sales are higher etc.?
It is also important to learn and create a plan of how to react if any of these alternative scenarios materializes.
This information is very important for both the Entrepreneurs directly and for investors/banks.
Expanding the above example to include scenario testing:
Example: Is it reasonable to assume sufficient profitability after 3 years, and how much financing is it reasonable to assume may be needed?
Chart 4) Revenues and Costs: Worse case
The image below shows the Revenues and Costs, and the assumptions made in the created/assumed Worse case. In this Worse case it is assumed that Sales volume only reaches 100 in Q4 2024 (as compared to 200 in the above Base case, Chart 1)
Chart 5) Revenues and Costs: Good case
The image below shows the Revenues and Costs, and the assumptions made in the created/assumed Good case. In this Good case it is assumed that Sales volume reaches 300 in Q4 2024 (as compared to 200 in the above Base case, Chart 1)
Scenario summary
Given the assumptions made in the different scenarios, the expectations are:
The last column 'Weighed' is the calculated weighed outcome of the 3 scenarios.
The Entrepreneurs can then look at the above estimated financial outcomes, and then make a better informed decision with regards to if they would like to do this Startup or not.
Investment need & Financing
Valuation Analysis?
IDEA: Can describe/show briefly, and refer to other blog, (and include in the URL report)?
c) Lucrative Startup - Negative oper CF - Investors
- Valuation analysis too?
- .. for this expected capital need, and time spent, we may create a business that can be worth X... ok?
BELOW - The advanced case ! ! ! nOT USE IT? ...
.png)
Example:
Projected cash flow in the assumed base case, and the projected cash flow in the assumed bad case.
