The Financial Plan: Start-Up Costs, Financial Statements
Good financial planning is one of the best ways to be successful. Quality numbers in reasonable detail make the financial plan work. You need to know the amount of money needed to start your business, including funds for equipment, operating expenses, working capital and bank reserves at the beginning. Incorporate this information into your business plan.
Since you are committing your life savings and your future income, you should spend a great deal of time developing all the numbers, preferably with the help of an accountant. The entire study, or the feasibility study, should be done with an open mind. If this study reflects a break-even point that is difficult to attain, then perhaps you should not proceed.
There are three financial statements -- the Balance Sheet, the Income Statement, and the Cash Flow Statement -- which must be prepared before starting your business. These "Pro Forma" statements will present a financial picture of your business in the future based on estimates and research. Once you have prepared them, they will serve as supporting documents when applying for financial assistance and will serve as tools for evaluating the financial progress of your business.
A balance sheet is a detailed statement of the condition or financial health of a company on a specific date. Balance sheets show the dollar amount of assets (what the business owns) and liabilities (what a business owes) in relation to net worth or owners' equity (what the owner, principals or stockholders own). Your balance sheet should be developed for the start date of each year.
The income statement is a detailed computation of the money a business makes or loses over a specific time period. Sales or service income is offset against expenses -- operating and production costs. You will most often see year-end statements reflecting income and expenses for a particular calendar year. Seasonal businesses may select a different 12 months.
In the case of a new business, there is no financial history on which to base estimates, consequently projections will be clouded with uncertainty. However, while the financial plan will explore a less-than-certain future, attention to detail can make this section far better than guesswork.
First, the financial section must conform to the details presented in the remainder of the business plan. If the marketing section presents an elaborate and expensive advertising campaign, this should be reflected in the projected income statement. If a seasonal pattern has been indicated in a sales analysis, projected cash flow should incorporate the same pattern.
Second, it is important to review your financial plan periodically, and when appropriate, revise projections. If a financial plan is to be effective as a planning tool and as a document used to raise funds, its content must be current.
Third, it is advisable to calculate more than one financial scenario. For example, one based on a conservative set of assumptions and another reflecting the business' full potential allows for a better understanding of the company's anticipated performance.
Fourth, the quality of research is directly reflected in the accuracy of projections. When making projections you will make certain assumptions which must be realistic and based on documented activities.
The financial plan is the least flexible part of a business plan in terms of format. While actual numbers will vary, every plan should contain similar statements or schedules presented in a conventional manner. There should be enough information in these statistics to reveal to an investor or lender that the entrepreneur understands his particular business. Any borrowing depends on the reasonableness of the results as seen by a loan officer.
If you do not know how to set up these financial statements, consult an accountant.
Start-Up Costs
Decide how much cash is needed to start your business before you search for funds. The following guidelines will help you do that. Estimated costs will vary depending on the type of business you have. Make informed guesses based on, and supported by, your market research.
Fixtures and equipment (Costs for storage shelves, cash register, window display fixtures, machinery, tools, etc.)
Installation of fixtures and equipment (Get a contractor's estimate.)
Starting inventory (You'll have to pay for most goods up front.)
Utility deposits (Call companies to find out what they require.)
Telephone equipment and installation
Legal, accounting, and other professional fees (Consult your lawyer, et al.)
Licenses and permits
Insurance (You will need to pay some part of the premium in advance.)
Advertising and promotion for the opening (Develop an estimate.)
Cash Reserve (Special purchases or unexpected expenses.)
Other (Add any other anticipated costs.)
TOTAL
Next, estimate your regular monthly expenses. For each category, you should have enough cash in reserve to pay expenses until your incoming cash can cover them. Depending on your industry, this may be 3 to 24 months' worth of expenses.
Cash Draw of Owner
All other salaries, wages and fringes
Rent
Advertising
Supplies (inventory)
Telephone, facsimile services
Other utilities
Insurance
Taxes, including Social Security
Interest
Maintenance
Legal and professional fees
Miscellaneous
Contingency Fund (5-10 percent)
TOTAL
Add your start-up costs and your monthly expense estimates together, and that is the minimum amount of cash you will need to get started and operate until break-even.
Balance Sheet
The company's opening Balance Sheet -- the balance sheet that is anticipated at the start of the business -- is relatively simple to prepare because it only reflects the amount of capital to be raised for the start-up. Specifically, it presents how the capital is to be spent (the assets that will be acquired) and how this capital will be raised (sources and equity). This Balance Sheet formula is the basic foundation of all accounting:
ASSETS = LIABILITIES + OWNERS' EQUITY
Assets: Cash, land, accounts receivable, equipment, inventory and other tangibles.
Liabilities: Amounts that your business owes as debt, such as accounts payable, notes payable, salaries and other debts.
Owners' Equity: These are claims that the owner has on assets and the business (personal investments, capital, revenues, etc.).
For new companies, a balance sheet reflecting the financial position of the company at its beginning -- and projected year-end balance sheets for at least two years should be included in your business plan.
Income (Profit and Loss) Statement
The purpose of the INCOME STATEMENT is to capture the performance of a prospective venture in summary form. By having a preview of future operations, the owner-manager can compare the year's expected profits or loss against the profit goals and objectives established for the business. This projection is generally divided into sales, cost of goods or services, expenses, and the resulting profit or loss.
The accounting formula for the Income Statement is:
REVENUES - EXPENSES = NET INCOME
Revenues: Money earned by services or sales.
Expenses: The cost of operating the business (rent, utilities, salaries, insurance, inventory, etc.)
Net Income: Difference between revenues and expenses; the purpose of the business.
The most important element in all of the projections, and the one that requires the greatest degree of support, is the anticipated sales volume. The credibility of this forecast is so important that an entire section of your marketing plan may be devoted to its support. Your projected sales figure must come from and be supported by your market research.
The second important assumption pertains to cost of goods sold and gross profit. This depends jointly on the cost of production and pricing policy. It is not sufficient to use a percentage of sales for these numbers. It is dangerous to use any ratios or data that are published for your type of business in that they reflect the numbers of companies that have been in business for years. Each line item should be costed out.
Income statements should be projected to reflect performances, monthly for year one, quarterly for year two and annually for additional years.
In formulating your Income and Cash Flow statements, the set of assumptions on which projections are based should be clearly and concisely presented. Numbers without these assumptions will have little meaning. You should consider using footnotes or a list of assumptions to relate line by line rationales of each dollar amount you project.
Cash Flow Projections
Profits and cash are not the same thing. Early in the company's lifetime, cash position will be more critical than profitability, because it more directly reflects the company's viability. In order to project the firm's future cash requirements, it is necessary to complete a separate schedule specifically designed for the purpose.
In a cash business, there is little difference. However, if you purchase a product and then hold it, process it and ship it, the significant difference comes in waiting 60-90 days for the payment.
The Cash Flow Projections provide a systematic method of recording estimates of cash actually flowing into and out of the business. This concept is similar to that of the checkbook. You make an entry when cash is deposited or cash is paid out. They should be monthly, quarterly and yearly as a companion to the income statements.
A few adjustments can transform an income statement into a cash flow statement:
With respect to sales, an income statement reflects revenues when earned, i.e., product is shipped and invoiced. A cash flow statement reflects the receipt of the cash.
With respect to expenses, an income statement reflects expenses when they are incurred, while a cash flow statement reflects the actual payment of these expenses. Some expenses may be paid immediately while others may be paid over a period of time.
An income statement reflects depreciation, because depreciation is an expense. However, since depreciation does not represent a cash obligation, it is not included in the cash flow statement.
As is the case with an income statement, a monthly cash flow, if prepared carefully, can represent the basis for an operating budget and goals against which you manage and evaluate actual performance.
The cash position at the end of each month should be adequate to meet the cash requirements for the following month. If there is too little cash due to over-estimated sales, additional funds will have to be injected or cash paid out reduced.
It is important to note that entrepreneurs are often optimists. They have a tendency to assess a project's future in an overly optimistic light. It is suggested that several levels of projections, based on different assumptions, be presented.
Other Financials
Other financial projections might also be helpful. For example, a break-even analysis will demonstrate the level of sales required to break even at a given scale of operation. Talk to your accountant for guidance. Accountants (from bookkeeper to CPA) perform periodic services called compiling, reviewing and auditing. Compiling is properly summarizing your loose financial records into balance sheets and operating statements. Reviewing reflects some analysis of the results. Auditing requires a much more detailed review of the entire accounting system. The right accountant for a new business is one who will provide as much guidance as possible and will timely and properly file your governments reports. The regularity that you receive reports, such as monthly or quarterly operating results, is a decision for you to make in light of the month to month changes in your business and the quoted fees of the accountant.
Tax Reports
The proprietor will report business income on Schedule "C" with its 1040 form. The partnership uses 1065 with its 1040 forms and corporations use 1020 or 1020S. In the first full year of business, it is important to keep current with your taxes by using quarterly payments through 1040E and 1040SE. All forms and instructions are in master books at public libraries. For simplicity in paying bills, consider "one-write" check systems at office supply stores. For handling deductions and for writing checks for employee wages, consider "payroll services" listed in the yellow pages.
