Purpose of a Financial Plan
When we gave an overview about writing a business plan, we had said that there could be several reasons behind writing a business plan. Besides serving the purpose of being a documented blueprint of your thoughts on running the business, one of the most common purposes behind a business plan relates to the funding needs. Your business plan is the only document through which you can communicate the proposed road map laid out by you to potential investors and other funding agencies about your business.
Why do you need potential investors or funding agencies, and who are these possible targets? Any business is funded by a combination of the promoter’s equity, equity contributions from other ‘owners, retained earnings pumped back into the business, Grants received, and various types of Loans - long-term and short-term loans. As you grow, (or in some cases, while starting up a new business itself), you quite often need additional funds over and above what the original promoters and internal generation from the business can sustain. In such cases, the additional funding needs can be met by:
- Private equity investors
- Venture Capital Partners
- IPO (for large public equity funding)
- Banks and financial institutions for long-term loans as well as short-term working capital needs
- Private lenders etc…
All these potential investors, and funding agencies, are interested in knowing all the components of your business plan - the marketing strategies yo propose to use, the operational plans, your human resources strategies etc… Besides all these, from a funding point of view, they are most interested in your bottom lines - as reflected in the crucial business financial plan, since that is the real indicator of the health of your business. We will now see what is needed to prepare the financial plan for your business.
How To Prepare Projected Profit & Loss Statement and Balance Sheet
The two main components of the Business Financial Plan that we will discuss here are:
- Profit and Loss Projections - usually for a three-year period or a five-year period
- Projected Balance Sheet for the same period
Given below are specimen formats for the two statements
The primary sources for these statements are the Marketing Plan and the Manpower and Capital Expenditure Plan drawn up as explained in the Parts 2 and 3 of this series. You will notice that the Sales figure as well as all Sales and Marketing expenses are derived from the Marketing Plan. Th cost of Sales is the sum of all direct expenses related to the sale of products and services. When you deduct Cost of Sales from the Sales figures, you get the Gross Profit.
After Gross Profit, all expenses derived from the Manpower Plan and expenses from Capital Expenditure Plan for the equipments leased are listed. The equipments purchased as per the Capital Expenditure Plan will get into the Assets part of the Balance Sheet. Depreciation is computed for each class of assets. Now, the Finance charges appearing in the Profit & Loss Projections will be a balancing figure, since this will depend upon the amount of Loans you need for funding the business. This balance between the additional funds required and the resultant finance charges will go through a process of iterative steps.
In the projected Balance Sheet, the equity components are the figures indicating the funds brought in by the promoters and other equity partners. The Fixed Assets are derived from the Capital Expenditure Plan. Under current assets and current liabilities, you will find the Receivable and the Payable amounts, which come in because of the credit periods given to the customers, and the credit period you enjoy with your suppliers. Otherwise the formats are self-explanatory.
An important point you will notice is, for most startups the projected net profits in the initial periods will generally be in the red (losses), because of the high startup costs. This is perfectly acceptable, so long as the venture starts generating profits from the second or third year. Hence usually, potential investors and funding agencies look at the projections for three to five years at a glance. These two statements give a clear picture of the profitability and financial health of the firm reasonably well.
In the concluding part of this series, we will understand how to prepare another important component of the Business Financial Plan - the Cash Flow Projections, and also understand how these projections are compared with benchmark numbers for the industry using financial ratios.
This post is part of the series: Writing a Business Plan: Step by Step
This series will walk the reader through the steps involved in writing a detailed business plan. The guides have been written using the natural intuitive thinking approach, so that the entrepreneur realizes the structure behind the written plan, and appreciates its value.
- Writing a Business Plan - Simplified
- Business Model and Marketing Plan Components of a Business Plan
- Manpower and Capital Expenditure Components of a Business Plan
- Writing a Business Plan (Part 4): Projected Profit and Loss Statement and Balance Sheet
- Writing a Business Plan (Part 5): Cash Flow Projections and Ratio Analysis