A financial business plan consists of three financial statements; a balance sheet, an income statement, and statement of cash flows. Each one evaluates the company from a unique perspective. When combined, they present the overall position, profitability, and health of a company.
Preparing a Balance Sheet
The first financial statement you should prepare for your business is a balance sheet. By far the easiest of the three to prepare, a balance sheet is a picture of your company’s value at a particular period in time. Balance sheets are split up into two sections; assets vs liabilities and owner’s equity. Assets are tangible or intangible things that a company owns that produce value; liabilities are debt, and owner’s equity is the owner’s interest in the company (the total amount of money the owner is contributing to the company). The balance sheet reflects the equation Assets = Liabilities + Owner’s Equity (Total Assets = Total Liabilities + Total Owner’s Equity or A = L + E). The reason a company’s assets are equal to the combined total of liabilities and owner’s equity is because liabilities and owner’s equity are the two sources from which assets are produced. Think about it; if you buy a laptop with your own money, you’re contributing your own money to the company, which means you’re using owner’s equity to create an asset (cash, check, etc.) and pay for the laptop. If you use a credit card, you’re using your creditor’s money to create an asset (credit card funds or credit) to pay for the laptop. However, when you use a credit card, you’re now indebted to your creditor (you owe your creditor money). To prepare a balance sheet, first, you have to organize your document (or spreadsheet) into three sections; one for Assets, one for Liabilities, and one for Owner’s Equity. Then, all you have to do is put each resource in the correct section. You’re just starting off so you really don’t have many resources. If you’re contributing any money to the business, those moneys will represent an asset and your interest in the company (owner’s equity). If you open up a business credit card, the credit card’s spending limit will represent an asset (credit) and a liability (because you now owe your creditor every time you use the credit card). Always remember, Total Assets have to be equal to Total Liabilities and Total Owner’s equity combined. If you would like more information on how to prepare a balance sheet, click on this link.
Preparing an Income Statement
The second financial statement you should prepare is an income statement. An income statement shows how profitable a company was over a specific period of time. By subtracting total expenses from total revenue to reveal the net income, a company can see just how much money it made in a particular month, quarter or year. Even though it may sound pretty simple, preparing an income statement is a little tricky, especially for startups. Sense you’re just starting off, you probably haven’t made any money yet, which means all the figures in your income statement will be projections (estimated revenue vs estimated expenses). Projecting revenue and expenses is one of the most difficult things to do in the business world, why? Because there’s no exact science for doing it. Every business and business expert has a unique way of projecting revenue and expenses, but unfortunately, most revenue and expense projections are highly inaccurate. The approach I’m going to show you, however, gives you the best chance to correctly forecast the profitability of your company. Preparing an income statement is mere addition and subtraction once you’ve projected your revenue (sales) and expenses (cost), therefore, I’ll keep the focus on preparing projections. Here are detailed steps for projecting revenue and expenses.
- Estimate the Number of Customers You’ll Have
The first thing to do when projecting revenue and expenses is to determine how many customers you think you’ll have within a given time frame. If you’re unsure of the time frame, use a month so you won’t become overwhelmed; then multiply your figure by 12 to get the full-year figures. Remember, if you add a sales employee or team into the equation, those are more expenses you’ll have to account for (payroll, sales training, sales software, etc.)
- Estimate your Expenses
The next step is to estimate your expenses; the cost of items and services you’ll need to run your company. This includes fixed and variable cost. Since you’re just starting off (and probably working out of your home), the only fixed costs you’ll probably have are an internet bill and whatever marketing tools you’re using (which usually cost a fixed amount per month). A good example of a variable cost is the cost-of-goods-sold (COGS), which changes from month to month. If you’re in the tech industry, cost-of-goods-sold may be the cost associated with serving a single subscriber. The goal is to try to think of every cost associated with running your company. Salaries (in-house and outsourced), COGS (materials, supplies, and packaging), advertising, accounting software, and any other cost you can think of.
- Estimate your Revenue
Now it’s time to project your revenue, or sales. In order to do that, you first have to set a price for your product. When it comes to setting a price, do market research FIRST! Find out what your competitors are charging; find out how much your potential customers are WILLING to pay for your product. You can’t set a price that’s too expensive or too cheap; your price has to be based on how valuable your product is to the public. You want to generate growth, so make sure your price is high enough to create a profit margin that will allow your company to grow, financially. When it comes to forecasting sales, take it month by month. BE REALISTIC. Projecting revenue is all about creating attainable expectations. If your sales levels are too optimistic, you’ll put yourself in a hole and have to dig your way out. You’ll create a budget based on inflated, unrealistic sales levels and probably overspend in areas you shouldn’t.
*If you would like more information on how to project revenues and expenses, click on this link*
After you project revenue and expenses, you simply subtract total expenses from total revenue to get your net income (profits) for that time frame. If you would like more information on how to prepare an income statement, click on this link.
Preparing a Statement of Cash Flows
The final financial statement to prepare is the statement of cash flows. This is by far the hardest one to prepare, but don’t worry, I’ll walk you through it. A statement of cash flows shows a company’s financial health. For example, a company can have $100,000 in sales and revenue, but if it’s all in accounts receivables, the company has no cash; how will it pay its operating expenses? That is an unhealthy company. Preparing a statement of cash flows is difficult because it’s hard to predict how many customers will pay you immediately and how many will procrastinate. If you’re selling inexpensive goods, then you might not have this problem (because your customers probably pay you in cash, immediately), however, if you’re selling expensive products and services and you bill your customers after the service is rendered, then you should pay close attention to what I’m about to say. There’s a trick to solving this problem. If you decided to charge your customers a percentage of the price upfront (like 25%), you would be able to more accurately forecast your cash flows. In fact, all you would have to do is look at your revenue projections and subtract 25% of the price from the total price for every unit you sell. Then, you would at least have a starting point for your statement of cash flows. Now, let’s walk through the process of preparing a statement of cash flows.
- Determine beginning cash balance
This is easy. You’re just starting off, so your company’s beginning cash balance is the amount of cash it had on hand when you first started the company.
- Determine the amount of cash generated from sales
This is the hard part. Like I said earlier, it’s hard to predict whether a customer will pay you immediately or procrastinate. However, if you use the trick I showed you, you’ll at least have a good starting point. If this number is positive, it will raise your overall cash balance.
- Determine the amount of cash spent on investments
Cash spent on investments is cash used to purchase equipment or supplies for the company. A laptop is a good example of cash spent on an investment. If this number is positive, it will decrease your overall cash balance.
- Determine the amount of cash raised through financing
Cash raised through financing is cash invested in the company by investors. Any cash you receive from an outside source (even a loan) is cash invested in the company. If this number is positive, it will raise your overall cash balance.
- Determine ending cash balance
You’re finished calculating everything! All you have to do now is compile the data and record your ending cash balance.
If you would like more information on how to prepare a statement of cash flows, click on this link.
I know this was a long article, but look at the silver lining; you now know how to prepare every financial statement that you’ll need to set your business up for success. You now know the steps in preparing a financial plan for your business. I did my part, now the rest is up to you. Remember, a business is NOTHING without a financial plan. If you have any questions, leave it in the “comments” section below. Good Luck!
-Mike, creator of EntrepreLoser