Developing your financial plan from your strategic vision is a critical step in moving toward your dream.
Financial plans can be as rudimentary or as complex as you desire, but no one gets too far without some form of plan. A sound financial plan is vital for any size of business – from small startups to large corporations. It’s like a compelling novel, telling the story about your company, where you have been and where you expect to go.
Just as each story is unique, each business has different needs and therefore financial plans will vary from one to the next. However, every plan should contain three elements:
- Historical Analysis
- One-Year Plan
- Long Term Projections
The one-year plan and long term projections should be directly linked to the company’s strategy or business plan. In addition, a financial plan should include an analytical narrative – your analysis of what the numbers tell you, the assumptions that underlie your projections, and how they support your business plan.
Your financial plan establishes a benchmark by which to measure your financial performance and lets you know when you are getting off track. With that information in hand, you can take action before serious financial deterioration occurs. Let’s take a closer look at each element.
To conduct the historical analysis, gather financial data for the past three to five years from the balance sheet, income statement, cash flow statement and selected financial ratios. One of the best formats for gathering and interpreting this kind of financial data is the trailing 12-month chart because it allows you to see trends over time.
Comparisons to industry peers and best in class companies can help identify improvements areas. Once you have created and studied the information, you will be able to identify opportunities that will drive your plan.
The one-year plan involves converting your business plan into financial information for the next 12 months. This process will help identify conflicts or missing pieces from your plan. For example, an increase in sales normally drives increases to inventory, receivables and financing. If these areas aren’t planned for with the expected revenue increase, your company could find itself short of cash and unable to meet the sales goals.
- Project the income statement. First, develop a sales forecast and determine your expected gross margin percentage. Then estimate operating expenses and use all three figures to determine your projected profit (or loss).
- Project the balance sheet. Understanding how the business plan will impact your balance sheet is critical to executing the plan. Significant changes to your asset base or to your asset returns will impact your borrowing needs and shareholder returns. The relationship between your current asset returns and the returns on your new investments help to identify how effective your investment strategy is.
- Project cash flows. Using the information in steps one and two, project how these numbers will impact your cash flow, paying special attention to how much new debt or equity you will need to inject into the business and when.
- Project key financial statement ratios. The key ratios differ for every company but should include ratios that measure:
Where your ratios are weak relative to your comparison group, rethink what is driving the ratio for your business. This is a great way to improve your business plan.
A common supplement to the one-year plan is the rolling forecast. It updates the next 12 month’s performance on an ongoing (normally monthly) basis. This discipline prevents the one-year plan from getting stale and alerts management to internal issues or external market changes that may need addressing. The rolling forecast keeps the spirit of the one-year plan vibrant.
Long Term Projections
This tool is for looking further into the future and helping the leaders understand the resources and effort that will be required to achieve the company’s long term objectives. These financial figures identify what it will take in terms of staffing, capital expenditures and other investments to reach your goals. Growth, new product lines, geographic expansion and acquisitions require resources you may not currently have. A good financial plan will help you understand the value of these resources and help you determine their return.
Long-term projections allow you to grow the business without running out of cash. They are similar to the One-Year plan but rather than forecasting each month the forecast is done by quarter or annually depending on the planning needs of the business.
It’s important to remember that there is no ‘one-plan-fits-all’ financial plan. There are a variety of options and the tenure of the plan will be dependent upon the nature of the business. For example, a small start-up business might find a long term plan of 3 years too long and a potash mine or a water utility company will require 25-year plans. Whether you’re beginning a new chapter or are well into an epic, a sound financial plan will project a future worth reading.