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.
"This is what will tell you whether the business will be viable or whether you are wasting your time and/or money," says Linda Pinson, author of Automate Your Business Plan for Windows® (Out of Your Mind 2008) and Anatomy of a Business Plan (Out of Your Mind 2008), who runs a publishing and software business Out of Your Mind and Into the Marketplace. "In many instances, it will tell you that you should not be going into this business."
The following pages will cover what the financial section of a business plan is, what it should include, and how you should use it to not only win financing but to better manage 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 an historical view. Business planning or forecasting is a forward-looking view, starting today and going forward into the future.
"You don't do financials in a business plan the same way you calculate the details in your accounting reports," says Tim Berry, president and founder of Palo Alto Software, who blogs at bplans.com and is writing a book, The Plan-As-You-Go Business Plan. "It's not tax reporting, it's an elaborate educated guess."
What this means, says Berry, is that you summarize and aggregate more than you might with accounting, which deals more in detail. "You don't have to imagine all future asset purchases with hypothetical dates and hypothetical depreciation schedules to estimate future depreciation," he says. "You can just guess based on past results. And you don't spend a lot of time on minute details in a financial forecast that depends on an educated guess for sales."
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 that you understand how you project that 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. "There is a tremendous problem with the hockey-stick forecast" that projects growth as steady until it shoots up like the end of a hockey stick, Berry says. "They really aren't credible." Berry, who acts as an angel investor with the Willamette Angel Conference, says that while a startling growth trajectory is something that would-be investors would love to see, it's most often not a believable growth forecast. "Everyone wants to get involved in the next Google or Twitter, but every plan seems to have this hockey stick forecast. Sales are going along flat but six months from now there is a huge turn and everything gets amazing, assuming they get the investors' money," Berry says.
The way you come up a credible financial section for your business plan is to demonstrate that it's realistic. One way, Berry says, is to break the figures into components, by sales channel or target market segment, and provide realistic estimates for sales and revenues. "It's not exactly data because you're still guessing the future. But if you break the guess into component guesses and look at each one individuals, it somehow feels better," Berry says. "Nobody wins by overly optimistic or overly pessimistic forecasts."
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.
How to Write the Financial Section of a Business Plan: How to Use the Financial Section
One of the biggest mistakes business people make is to look at their business plan, and particularly the financial section, only once a year. "I like to quote former President Dwight D. Eisenhower," says Berry. "'The plan is useless but planning is essential.' What people do wrong is focus on the plan and figure once the plan is done it's forgotten. It's really a shame because they could have used it as a tool for managing the company." In fact, Berry recommends that business executives sit down with the business plan once a month and fill in the actual numbers in the profit and loss statement and compare those numbers with projections. And then use those comparisons to revise projections in the future.
Pinson also recommends that you undertake a financial statement analysis to develop a study of relationships and comparisons of items in your financial statements, comparative financial statements over time, and even comparing your statements to those of other businesses. Part of this is a ratio analysis. She recommends that you do some homework and find out some of the prevailing ratios used in your industry for liquidity analysis, profitability analysis, and debt and compare those standard ratios with your own.
"This is all for your own benefit. That's what financial statements are for. You should be utilizing your financial statements to measure your business against what you did in prior years or to measure your business against another business like yours," she says.
If you are using your business plan to attract investment or get a loan, you may also include a business financial history as part of the financial section. This is a summary of your business from start to the present. Sometimes a bank might have a section like this on a loan application. If you are seeking a loan, you may need to add supplementary documents to the financial section, such as the owner's financial statements, listing assets and liabilities.
All of the various calculations you need to assemble the financial section of a business plan are a good reason to look for business planning software, so you can have this on your computer and make sure you get this right. Software programs also let you use some of your projections in the financial section to create pie charts or bar graphs that you can use elsewhere in your business plan to highlight your financials, your sales history, or your projected income over three years.
"It's a pretty well-known fact that if you are going to seek equity investment from venture capitalists or angel investors," Pinson says, "they do like visuals."
Making It All Add Up: The Financial Section of a Business Plan
One of the major benefits of creating a business plan is that it forces entrepreneurs to confront their company's finances squarely.
You can avoid some of the most common mistakes by following this list of dos and don'ts.
Making Your Financials Add Up
No business plan is complete until it contains a set of financial projections that are not only inspiring but also logical and defensible.
How many years should my financial projections cover for a new business?
Some guidelines on what to include for a new business.
More than 100 free sample business plans plus articles, tips, and tools for developing your plan.
Planning, Startups, Stories: Basic Business Numbers
An online video in author Tim Berry's blog, outlining what you really need to know about basic business numbers.
Out of Your Mind and Into the Marketplace
Linda Pinson's business selling books and software for business planning.
Palo Alto Software
Business planning tools and information from the maker of the Business Plan Pro software.
U.S. Small Business Administration
Government-sponsored website for writing a business plan for small and mid-sized businesses.
Financial Statement Section of a Business Plan for Start-Ups
A guide to writing the financial section of a business plan developed by SCORE of NE Massachusetts.