Understanding the Fundamentals
Strategic business planning has many dimensions associated with it, and the financial planning process is one among them. It can be defined as the financial side of business planning that deals with one critical factor needed for the functioning of a business, viz.,capital. Nevertheless, it should not be confused with a normal business plan for the simple fact that while a business plan has a longer time horizon and is more fixed in nature, the financial plans are drawn on an annual basis. It is an instrument that compares a series of variables such as sales, profits, costs, etc., with a pre-drawn plan. In cryptic terms a business financial planning process is a performance exercise of the financials of any business. It deals with sourcing of funds and directing their allocation to differing competing needs; the outcomes are normally decided by the quantum of profits and/or losses incurred. It also provides an idea of the financial health of the business on an annual basis and, to that extent, can be compared to that of a master health checkup.
What it Constitutes:
A business plan from a financial process contains two elements, viz., an operational plan and a financial plan discussing how the operations are going to be financed. Both of them are normally merged into a single financial plan document in which budget occupies a central position. It is central to the financial process basically because with it a business can make reasoned decisions by having control of various financial variables.
Stages in Plans and Projections
A business financial planning process would typically follow the steps described below:
- A 12-month profit and loss projection.
- A 4-year profit and loss projection.
- A cash flow statement.
- A breakdown analysis.
- A projected balance sheet.
All the above in turn would cover at least the following:
- Costs and prices.
- Cash flow monitoring.
- Record keeping.
- Setting up financial reserves and contingency plans.
- Availability of long term or emergency finance.
A 12-month P&L projection would state the major assumptions on which the company has relied to estimate the income and expenses; but these assumptions should not be born out of air and would have some basis from historical performances. In this the sales projections would be indicated by making an annual sales forecast.
A 4-year projection of the financials of the company is something similar to a perspective plan in that it does not look at the present but extends the company’s horizon to a future date; this would be beneficial when the company is looking at raising venture capital. Subject to other things being equal, it can be said in general that while the 12-month projection would be useful for working capital (cash-credit) facility, the 4-year projection would be useful for raising term finances.
Projected cash flows represent your cash accruals from sales, immediate or within a reasonable time, and the outflow that goes toward recurring expenses. It would in the process give you an idea of the adequacy of working capital and also plan the methods to your financing the shortfalls that may arise out of delayed receipts or unanticipated increase in the costs. A cash flow statement is critically different from a profit and loss statement in one respect: It never takes into account depreciation.
A break-even analysis would take into account your sales, fixed and variable costs, and the ultimate picture as to whether you would be incurring profits or losses. It gives a warning signal should there be a likelihood of losses or motivates you to work harder if prospects of making surpluses are brighter.
A projected balance sheet sums up all the above and would take into account any historical changes that have taken place between the previous actual one and the present projected one due to changes in the business environment. For calculation purposes what you need to note is that while the fixed costs are expressed in dollar terms, the variable costs would be given as a percentage of total sales.
It may thus be concluded that in essence financial planning can be reduced to a set of spreadsheets/QuickBooks that furnishes you the financial future of your company and in the process improves your insight into the inner financial working of your company.
Image Credit: Business Plan - https://commons.wikimedia.org/wiki/File:Business_plan.png