The importance of financial planning for small businesses

There are several things a business can go without. Some businesses don’t have offices, while others don’t even have employees besides the business owner.

The only thing you need to start and run a business is money, and in all our years of partnering with small businesses, we’ve found that financial planning is the best way to keep the wheels greased.

A financial plan is more than just a document with estimates and projections. It’s one of the most important business planning tools available to you. Most small businesses are a lousy quarter away from shutting their doors for good – something diligent financial planning can prevent.

Here’s why running your business without a financial plan is equivalent to driving with one eye open.

What is a financial plan?

Basically, a financial plan is the financial section of your business plan. But not all businesses start with a formal business plan anymore unless the founder hopes to secure funding. So, let’s recap for the uninitiated.

A financial plan is a document that uses current accounting data and educated conjecture to project the financial performance of your business for a period (usually a month or a quarter, sometimes a year). It comprises three essential financial statements: the income statement, balance sheet and cash flow statement.

The income statement is also known as the profit and loss statement, and it outlines precisely that – what your business gained and lost. It includes the cost of sales, the cost to produce goods, operational expenses and revenue. After adding and subtracting those amounts, you should have a figure that represents your profit or loss for that period, also known as your gross profit margin.

The balance sheet is a way of determining your business’s equity or how much the business is worth to its shareholders using the following formula:

Equity = assets – liabilities

An asset is anything of value that the business owns, such as property, equipment, raw materials, inventory, patents, royalties and intellectual property. Liabilities include everything the business owes, including rent, salaries and loans. Working out the difference between these two amounts helps you determine your equity.

A cash flow statement is like a snapshot showing how much cash or cash equivalents a business has in hand during a period. It’s a record of all transactions from a business’s operational, investment and financing activities. The simplest way for small businesses to calculate their cash flow is using the direct method, where all payments and receipts are simply tallied up. For bigger businesses, there’s the indirect method which uses non-cash transactions to adjust the net income.

5 ways a financial plan improves your business

Now that you understand what a financial plan is let’s explore how it adds value to your business and promotes financial health.

Set clear goals

Goal setting is the crux of any financial plan. What is your small business expected to accomplish within the next month or quarter? A financial plan helps you use your current financial performance to make realistic predictions.

Measure progress

There’s no practical way to know if your business is moving forward or backwards without a financial plan. You might confuse high sales volume with good business, but you could be neglecting the negative effect that liabilities and expenses have on your revenue.

Spot trends

Once you’ve gone through several financial plans, you can review them to see if any patterns stick out. Having your finger on the pulse of trends in your business’s finances will help you make the most of periods when business is expected to boom and prepare yourself for dips in sales.

Separate business and personal goals

Small business owners tend to get the business and personal goals confused, especially without proper financial planning. You need to have strict boundaries between what you’re hoping to achieve personally (homeownership, family planning and retirement) and what you want for your business in the short and long term. Crucially, you need to protect your personal goals from the risks associated with running a business, and a financial plan helps you do that.

Keep stakeholders in the loop

Preparing regular, accurate and comprehensive financial plans is an excellent way to build confidence from your stakeholders. Investors want to know how the business is performing and whether or not their share or the equity is growing in value. Detailed financial plans are also essential for recruiting more investors and seeking further funding.

Need a little help? Let’s talk

If all of that seems Greek to you, maybe financial planning isn’t your strong suit. That’s why you have Rae & Associates ready to do it all for you. We specialise in all parts of financial management for small businesses including financial plans. We assist owners with professional plans to help them get starting capital and growth capital or to simply keep a watchful eye on their finances, and we can do the same for you. Get in touch with R&A for sound and qualified small business advice.