What is a Financial Plan?

A financial plan is the translation of a (new) business plan into financial data, which helps determine if an idea is economically sustainable. It also helps you pitch investors, anticipate growth and prevent cashflow shortages.

The financial plan is part of the overall business plan and contains three major components— a profit & loss forecast, cash flow forecast and balance sheet forecast. These forecast statements are made for 3 to 5 years and are usually created using detailed forecast specifications, such as revenue, personnel, investment and/or financing specifications.

Why is a Financial Plan important?

A good financial plan can help you better understand how to allocate resources. It shows which choices will impact revenue and which occasions will lead to cash shortages.

A financial plan is required when approaching investors. It shows how a business manages expenses and generates revenue. It shows where it stands and how much it needs from sales and financing to meet its financial benchmarks.

Components of a Financial Plan

Whether a business is a start-up, scale-up or established, the financial plan should include three main components:

Profit & Loss forecast (P&L): Also known as income statement, it shows the expected profit or loss over a specific period. It lists the following:
Revenue streams, usually in the form of sales;
Direct costs and direct labor, also known as cost of sale or cost of goods (how much does it costs to produce the goods or services);
Gross profit: revenue minus direct costs;
Gross profit margin: gross profit as a percentage of revenue. A measure of how efficient the production of the product(s) or service(s) is;
Operating expenses, also known as overhead or indirect costs, such as (indirect) personnel, rent, utilities, depreciation and interest;
Net income: revenue minus all costs, the 'bottom line';
Net income margin: net income as a percentage of revenue. A measure of how profitable the total business is;

Cash Flow forecast: This is the most critical part of the plan. It shows how much cash is on hand. Understanding how much cash is coming in and when, shows the difference between profit and cash position. The forecast should display how much cash is available at specific points in time, where it’s going and where it will come from. It consists of three key components:

Cash flow from operating activities: involves all operational business activities, including sales, buying and selling inventory and supplies as well as paying salaries;
Cash flow from investing activities: involves equipment purchases or capital expenditures (CapEx);
Cash flow from financing activities: involves raising money from equity or debt or repaying that equity or debt.

Balance Sheet forecast: Basically a balance sheet shows what a business owns and how it is financed. It is therefore a snapshot of the business' financial state of affairs on a specific moment. What it owns (assets) appears on the debit side. The funding (shareholder equity and liabilities) is on the credit side. Both sides should balance out to zero.

Assets: grouped in fixed material assets (e.g. property, land, equipment), fixed immaterial assets (e.g. branding, patents, goodwill), fixed financial assets (e.g. loans to shareholdings, franchise entrance fees or rental deposits paid) and current assets (e.g. cash, bank deposits, goods, inventory, debtors). Current assets can be converted into cash within one year;
Shareholder equity: funds from the business' shareholders and profit generated by the business;
Liabilities: everything the business owes to debt suppliers (banks) and creditors (trade suppliers, tax authorities)

These three main components, in turn, are created using forecast specifications:

Revenue or sales forecast: How much will the business sell in a specific period? A sales forecast needs to be an ongoing part of any planning process since it helps predict cash flow and the business' overall health;

Personnel forecast: A business needs the right people to meet goals and retain a healthy cash flow. A personnel forecast plans positions and shows whether they should be full-time, part-time, or work on a contractual basis. It looks at compensations levels, including benefits, and forecasts those costs. By looking at growth and costs a business can see if the potential benefits that come with a new employee justify the expense;

Investment forecast: Which long-lasting assets does a business need to purchase and when? Property, construction, transportation, IT, equipment or furniture? Their useful life determines their depreciation cost. Does the business need to pay goodwill, a franchise fee or a rental-deposit? Does the business need a starting inventory or working capital? An investment forecast lists all major purchases or capex.

Financing forecast: Lists the business' existing and required future financing sources. It shows financing type (equity share series, secured/unsecured/convertible debt etc.), duration, repayment schedule, interest rates and costs. It calculates de business' Runway (number of months left with positive cash balance) given the listed financing sources.

How to create a Financial Plan for your business?

Create a (strategic) business plan. Easier said than done, however there are plenty services that help you create a plan online or using templates. As long as you know what your business' basics are:

What is your business model (how will you make money)? Will you sell products, services, subscription based services or something else?
What are your strategic goals and timeline?
What does your business need to achieve these goals?

Create forecast specifications: Revenue forecast, Personnel, and Investment forecasts. You will need them below. Create 3- to 5-year forecasts, specified per month and year. Do not account for V.A.T.

Create a Profit & Loss forecast.
Plug in your revenue forecast;
Determine your cost of sales: given your business model, what are the costs driven by the number of products or services you sell? The difference between revenue and cost of sales gives you the Gross profit;
Subtract the Personnel costs and your other expenses needed to achieve your goals. From your Investment forecast, take the depreciation costs and subtract them too. This gives you the Operating profit or EBIT (earnings before interest and tax);
Leave a space for the interest expense which will be calculated in the Finance forecast later on. Subtracting this interest expense gives Profit before tax or EBT.
Subtracting the corporate tax rate from any profits (taking into account tax losses carried forward) gives Net profit or the 'Bottom line'.

Create a Cash Flow forecast. Creating this forecast follows a similar path as your Profit & Loss forecast. Except this time you include only the items that have a cash-effect. This means you include VAT and exclude depreciation.

Cash flow from operating activities: similar to the operating revenues and costs in your Profit & Loss forecast, except for the timing of the cash flows;
Cash flow from investing activities: includes the assets purchased;
Cash flow from financing activities: leave this line open as it will be calculated in the Financing forecast later on;
You can now calculate your cash position at the beginning and end of each period, indicating, in case of negative cash positions, the financing needed in that period;
Create a Financing forecast: you can play around with financing sources to find out which sources, terms and conditions suit your financing needs. Enter the result in the ‘Cash flow from financing activities’ line of the Cash Flow forecast, including any interest costs payable.

Create a Balance Sheet forecast. Now this is where it gets tricky when you're not really into financial accounting. All forecasts that you created so far come together in the balance sheet. Without diving too much into details, here's what you do:
For each month, group your assets as detailed above, taking into account the monthly depreciation;
For fixed assets, plug numbers from your investment forecast;
Current assets come from your cash flow forecast;
Shareholder equity funds originate from your Financing forecast, while profit generated by the business cumulates from your Profit & Loss forecast;
Long term debt minus repayments originates from your Financing forecast, while short term debt (creditors) usually come from the cash flow forecast;
The trickiest part: both sides of the balance sheet should equal out to zero, every month! Since all your forecasts are connected, this could take some time and frustration.

Create financial ratios and charts. Ratios and charts are excellent ways for investors to learn about your business' performance at a glance.

Create a scenario analysis. In a scenario analysis, you create 3 versions of your plan: a base case, a best case and a worst case scenario. It is an indication for yourself and investors of your business' sensitivity to changes in your business drivers:
Base case scenario: your original forecast;
Best case scenario: what are the best possible, though realistic, variable values;
Worst case scenario: what are the worst possible, though realistic, variable values;

Integrate your Financial Plan in your (Strategic) Business Plan. Although most of it can be added as an appendix, you should consider:
Consistency: your story should fit your numbers and vice versa;
Readability: people don't like scrolling back and forth in documents. Inserting small tables and charts in the relevant parts of your story allows for easy reading and interpretation of your text.

Automate your financial business planning

Creating spreadsheets can get the job done when your business is pretty straightforward and/or you're really into finance. However, it's easy to get overwhelmed.

Financial business planning services may be worth the expense because they offer automated capabilities. Using cloud-based financial planning tools like Financial Business Plan Generator can help you automatically translate information into financials without the need for financial or spreadsheet skills.

Whether you're looking to secure funding or just monitor your business growth, understanding and creating a financial plan is crucial. Once you have an overview of your business’ finances, you can make strategic decisions to ensure its longevity.