The Financial Planning Process Explained

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The Financial Planning Process Explained

financial planning process

The financial planning process

Are you wondering how to do the financial planning process right? Creating a financial plan for your business sounds complicated if you have never done one before, but it is really not that difficult with the right tools and guidance. You can have a professional financial plan done within a day.

What is a financial plan?

A financial plan is a forecast of the future financial performance of a business, meaning forecasted Profit and Loss Statement, Balance Sheet and a Cashflow Statement.

  • Profit and loss (P&L) statement , also known as an income statement, summarizes the revenues, costs, expenses, and profits/losses of a company during a specified period. These records provide information about a company’s ability to generate revenues, manage costs, and make profits.
  • Balance sheet informs us about a company’s assets, liabilities, and equity at a specific point in time. In other words, the balance sheet provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders.
  • Cash flow statement provides information about all cash inflows that a company receives from its operations and external investment sources. It also includes all cash outflows that pay for business activities and investments during a given period.

Why do you need a financial plan?

Businesses that plan grow 30% faster than those that don’t. But why? A financial plan used to better manage your business, raise funding, set goals, and guide strategic, operational and investment decisions. A well-done financial plan makes you think through every aspect of your business and find ways to improve it.

I will now go into detail explaining the financial planning process. If you rather watch than read, here is a video explaining it. 

The financial planning process

There are 4 steps in the financial planning process:

  1. Identify the purpose of your financial plan.
  2. Define the plan structure, assumptions and gather data.
  3. Build the financial model.
  4. Sense-check your financial plan.

Step 1: Identify the purpose of your financial plan.

The purpose for creating your plan will define the required complexity and detail for your plan. For example, if you need a plan to apply for a bank loan, you will need a simpler financial plan. You will need high level financial statement projections, sense checks against historical performance and with healthy ratios that banks care about. 

On the other hand, if you need a financial plan to raise VC funding, you will need a more detailed, high growth, driver-based financial model . It will need to be sense checked against industry benchmarks and clearly presented to tell a story of an excellent investment opportunity.

Step 2: Define the plan structure, assumptions and gather data

  • Financial model structure.
    • Define the revenues your business generates. This is the income from the different products or services your business sells.
    • Direct costs or cost of goods sold. These are the cost of the products and services you sell. If you sell bikes, these are your costs to purchase or manufacture the bikes.
    • Employees do you need to run the business.  Sales, marketing, manufacturing, R&D, office support, etc.
    • Operating expenses. Things like rent, utilities, insurance, sales and marketing budgets, travel, office supplies, repairs, accounting and legal, bank charges, etc.
    • Assets. These are the property, equipment, furniture, vehicles, intangible assets that you need to run your business.
    • Financing. What are the sources of financing your business? Equity investment from the founders or investors, bank loans, etc.
    • Taxes. Which taxes do you need to pay? VAT, Sales tax, GST, Income tax, etc.
  • Assumptions . How will you calculate the revenues, cost of goods sold, employee costs, operating expenses, taxes you identified when defining the financial model structure. Assumptions will include thing like number of units sold and prices for revenue calculations. Cost per unit for COGS. Number of employees needed per type of employee and their gross salaries, inflation rates, tax rates, capacity constraints, conversion rates, cost per lead, accounts payable and receivable days, inventory turnover, etc. Most of the assumptions should be operational metrics of your business so that you can establish a logical relationship between how your business operates and the expected financial result from those operations.
  • Gathering data . Once you defined the assumptions that you will use to calculate your revenues, costs, expenses, taxes, assets, financing needs, etc., you need to gather data in order to define the values of each assumption. How many units will you sell? At which price? How much will each unit cost you to procure? How much will you pay to each employee? How much will you pay for rent, utilities, office expenses? How much will it cost you to acquire a new customer?

    Always the best place to start with gathering data is your company historical performance. If you have historical data, you will have reliable basis for your assumptions of your future performance. You will then tweak your past performance data based on expected growth and initiatives that you plan to implement in the future.

It is more difficult for new companies to define the values of their assumptions because they do not have past performance data. So, for new companies, benchmarks from similar companies, also known as industry benchmarks, would be a good place to start and tweak those benchmarks based on your specific situation. If your assumptions are in line with industry benchmarks, it is fairly easy to defend them. If they defer significantly from industry benchmarks, you should have a good and logical explanation why this is the case.

Whether you use past company performance data, industry benchmarks or a combination of both, the values of your assumptions need to be logical and defendable. 

Step 3: Build the financial model

The financial model are all the formulas and calculations that calculate your Revenues, Cost of Goods Sold, Employee Costs, Operating expenses, Taxes, Assets and Financing Needs based on the assumptions. And then calculating the main outputs for the financial plan: Profit and Loss Statement, Balance Sheet and Cashflow Statement. 

This is by far the most difficult and time-consuming step in creating a financial plan. If you are not an expert in excel and financial planning, you might struggle with this step. Luckily, there are softwares like Modeliks that does these calculations for you, so you can have a professional financial plan even if you have never done one before in your life. What’s even more important, specialized financial planning software ensures that your calculations are correct, while building a financial plan in excel is very prone to errors. 

Step 4: Sense-check your financial plan outputs

You have come to the end. You defined your financial plan structure, gathered data from reliable sources and created your financial plan (i.e. your forecasted Profit and Loss, Balance Sheet and Cashflow Statement). Now you need to step back and see if your numbers make sense. Just one mistake in assumption can make your whole financial plan unrealistic and unreliable. 

To sense check your financial plan, make sure the following indicators make sense when you compare them to your past performance or industry benchmarks. 

  1. Revenue growth rate. How fast is your revenue growing year on year. 10% might be realistic for an established company, but 100% probably not. For a startup with low revenue base which is gaining traction 1000% growth in revenue might make sense. Make sure you can explain the revenue growth rate, whatever it is.
  2. Gross margin. This is Gross Profit divided by Revenue. For a restaurant 70% gross margin makes sense. For a supermarket, 25% is more realistic.
  3. EBITDA margin. Hotels can have a 60% EBITDA margin. Wholesale businesses, probably less than 15%.

Every business will have a few additional key numbers that you need to sense check. For SaaS businesses, sense-check customer acquisition costs and churn rates. Regarding hotels check occupancy rate assumptions and average room rates. For manufacturing businesses cost of materials, etc.  Sense-check the assumptions that have the highest impact on your business results for your type of business.

Final thoughts on the financial planning process

Financial planning can seem complex and scary if you have never done it before. But with the right tools , anyone can create a professional financial plan.

Whether you are a startup or an established and successful business, a financial plan will help you think through every aspect of your business and find ways to improve it. It will help manage your business better by setting clear targets for everyone in the company and tracking performance against those targets. It will help you make informed decisions and evaluate new initiatives. And it will help you raise funds, if you need them.  

If you need a financial plan, check out Modeliks , a financial planning a performance tracking software for SMEs and startups.

Author:
Blagoja Hamamdjiev , Founder and CEO of Modeliks , Entrepreneur, and business planning expert.

In the last 20 years, he helped everything from startups to multi-billion-dollar conglomerates plan, manage, fundraise, and grow.