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The importance of financial planning for small businesses

The owners of a coffee shop creating a financial plan for their business.
Lyle Solomon Guest Author
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The most crucial component of any business is a solid financial strategy. It serves as a short-term and long-term reminder of what you’re aiming for and a guide for getting there. It lays out the potential costs and looks for ways to address them. A financial plan is so crucial that without one, investors, banks, and creditors won’t even meet with you to discuss your small business.

Why is it crucial to have a financial plan for a business?

Most readers know that financial planning is crucial to business success. The financial plan is the blueprint for your company’s operations for the upcoming month, year, or longer.

The plan will assess your business environment, goals, the resources you need to reach these goals, and the budgets for your team and resources. It also points out any risks you might face. While it’s impossible to predict how events will unfold, this practice will help you be ready for whatever comes your way.

What does a financial plan include?

A financial plan includes the basic requirements for starting your own business, the investments you’ll need to make, and how you’ll finance them. That way, you can see if it’s worth pursuing your business idea.

Issues to consider when creating your business plan:

  • How much money do you hope to make?
  • How profitable do you anticipate your company to be?
  • If you have multiple debts, how will you pay them off?
  • Should you consider consolidating your multiple debts to pay them off quickly or go for a settlement plan?
  • How much money do you need and do you have enough to get by each month?

Your business plan’s success hinges on how well you answer these questions.

Here’s a checklist of the main components you need to include in your business’s financial plan.

Sale projection

It would be best if you had a rough estimate of your sales revenue at the end of each month, quarter, and year. You can learn a lot about your company and your sales cycles by looking for trends, and this knowledge will be invaluable as you develop your marketing and expansion plans.

If you run a business that experiences cyclical ups and downs as a result of seasonal changes or the economy, it’s important to be aware of these cycles and prepare accordingly. You can take steps to increase sales during your traditionally slow months, to make your company more resilient.

Expense plan

The term full expense plan refers to a comprehensive financial strategy that accounts for ongoing, foreseeable, and associated expenses.

Ongoing expenses include rent, utilities, and salaries because they are paid consistently. Foreseeable business expenses include conferences, advertising, and the office Christmas party. A comprehensive list of everyday costs will help you determine which are essential and which can be reduced or eliminated.

Associated expenses include the estimated cost of acquiring and training new hires, store openings, and delivery expansions. A realistic understanding of the costs involved in expanding your business is essential for keeping costs in check and ensuring its continued success.

Knowing how much money you’ll need to cover future expenses is helpful, as is knowing how much money you’ll need to reach various growth goals.

Future expenses can be reliably predicted, such as increases in tax rates, minimum wage, or the need for repairs. A portion of your budget should also be set aside in case of future unforeseen expenses, such as fixing your company after a natural or man-made disaster. Your business can prepare for future expenses by reducing budgets, increasing sales, or getting financial help when needed.

Balance sheet

Your company’s net worth is based on the assets and liabilities listed on its balance sheet. Keeping tabs on both will guarantee that your company is making the most of its resources.

In addition to failing to account for outstanding bills adequately, small businesses often undervalued assets like machinery, property, or inventory. Financial positions, also called balance sheet statements, provide a more comprehensive analysis of your company’s health than income and cash flow statements. The profit and loss statement details the company’s financial performance over a given time period, while the balance sheet details the company’s financial position as of a specific date.

Cash flow projection

Cash flow projections should be made monthly, quarterly, and annually, just like expense projections. By making a cash flow forecast for the entire year, you can prepare for any potential financial difficulties in advance. In addition, it can aid in the early detection of cash flow issues before they significantly impact your company.

A cash flow projection can help you plan for potential growth or investments by clearly showing what money is intended to be left over at the end of every month. You can use your savings from one month to cover your expenses the following month, making for a more efficient budget.

Profitability or break-even analysis

Here, we look at your fixed expenses and how they compare to the revenue you bring from selling more of your product. This is crucial to calculating the potential costs and profits of expanding or growing your business’ output. Your break-even analysis will be more precise and helpful if you fully flesh out your expenses as described above.

The best method for establishing prices is the break-even analysis. A break-even assessment can help you determine how many units you’ll need to sell at different prices to break even. Aim for a price that leaves some room between your revenue and your costs to keep your business viable in the market.

Overview of operations

Creating a comprehensive plan for your company’s daily functions is essential for smooth operations. You can make better decisions for your company’s growth and efficiency if you thoroughly understand the roles necessary to run your business. This can be at different output volumes, each employee’s output or work capacity, and the costs associated with each phase of your supply chain.

With the company growing, it is important to keep payroll and supply chain costs within your budget. A well-thought-out plan for operations can also help determine if you have room to improve your supply chain or processes through automation, cutting-edge technology, or excellent suppliers.

What are the benefits of having a financial plan?

There are many possible benefits to having a financial plan, but here are some of the most important ones:

Budgets and money management

Short-term budgets can be more easily broken down if you have a long-term financial strategy in place for your company. As a result of monthly or seasonal fluctuations in revenue, many businesses experience both cash surpluses and shortages.

The owner considers these cycles a way to control expenses when creating the company’s financial plan. It can be advantageous when revenue is anticipated to be low. Poor cash management can lead to problems like the inability to pay employees.

The business owner can rest easy knowing that their well-thought-out financial plan will always leave a safe cash buffer. A substantial cash cushion allows a company to respond quickly to unexpected opportunities, such as a drop in inventory prices from a regular supplier.

Focusing on the future

Amid business crises, it’s easy to lose perspective. A business owner who is too focused on the present may not take the time to plan for the company’s long-term success.

The financial plan’s focus on the future helps the business owner see what investments are needed to sustain growth and stay competitive. As the company strives for long-term prosperity, it can refer to the financial plan as a guide.

Because of the sheer volume of choices a business owner must make every month, it can be challenging to determine which decisions led to success or which ideas and strategies failed.

Setting goals that can be measured and compared to how well they were met throughout the year is an integral part of making a financial plan. For instance, the proprietor can check to see if the anticipated sales increase resulted from a rise in advertising spending. Based on how sales of certain products are going, the owner can better decide how to spend marketing money.

Setting expenditure priorities

A small business’s growth and success depend on saving and investing money. Business financial planning helps owners prioritize spending on activities that boost growth and profitability now over those that can’t wait until more funds are available. Even well established companies weigh the pros and cons of each investment to decide which to make first.

Keeping track of progress

Small business owners work hard and face many challenges, especially in the beginning. It can be difficult to tell if a company is progressing or faltering. Seeing actual results that exceed expectations is a huge morale booster for a small business owner.

A chart showing a steady increase in monthly revenue or cash balance is a great way to stay motivated. Like student financial planning, a well-planned business financial plan can give one the confidence that their business is on track to meet its goals.

Bottom line

Now that you know why a financial plan is vital for a business, you should make sure you have a solid one in place. Small business financial management is a must if you want to see your company flourish and expand.

Planning one’s finances has both overt and covert significance. You can run a successful business and beat the competition by taking efficiency measurements and avoiding common pitfalls that plague small companies.

Lyle Solomon is a Principal Attorney at the Oak View Law Group in California. He is a graduate of the University of the Pacific’s McGeorge School of Law in Sacramento.

*This blog post is intended for informational purposes only and is not intended as financial advice.
**Melio does not provide legal, tax or accounting advice, and you should consult with a professional advisor before making any financial decisions.