Preparing The Business Plan – Financial Planning & Analysis

One of the most difficult tasks for the founders of any new business is finding the capital necessary to get the business up and running.  Before abandoning the financial security of their current positions, entrepreneurs need to carefully review the capital requirements for the proposed business, their own personal financial position, and the sources of financing for the new business.  The issues in this area are challenging for technology-driven companies that will operate in a risky and uncertain environment and the founders should exercise caution when creating budgets and projections.  While the founders obviously prefer to keep their investment in professional services manageable until the business is up and running, input from experienced accountants and financial consultants can be extremely valuable.  The goal is to establish a practical and useful financial reporting system, including the ability to generate GAAP-based income statements, balance sheets and statements of cash flows, and procedures that will allow monitoring of the financial aspects of departmental activities and major inter-department projects.  All forecasts and projections should be supported by key assumptions and should be rigorously and regularly tested through sensitivity analysis.

1.         Costs and Expenses

Financial planning and analysis begins with the projected costs and expenses associated with launching and operating the proposed business.  Every business is different and the budget items will depend on the type and number of products and services, the functions to be performed by the company, and the location and scope of the company’s business activities.  For example, among other things, the founders may need to consider:

  • Manufacturing and inventory costs, including the purchase or licensing of equipment or intangible assets;
  • Employment costs, such as wages and payroll taxes;
  • Facility costs, including payments for use of buildings and furniture; and
  • Overhead costs, including payments to legal and accounting professionals.

New businesses must also attempt to conserve financial resources when selecting office and manufacturing space and the equipment required for operations.  In most cases, the company should take advantage of rental and leasing opportunities to conserve cash and retain flexibility before making significant long-term investments in facilities and capital assets.  This can be particularly important in situations where the technology underlying the business activities of the company is rapidly changing or unstable.  Also, while the founders should certainly attempt to make accurate estimates of demand and unrelated capacity requirements, it often takes some period of time to identify realistic resource requirements.  Other issues that may have an initial impact on financial reserves include improvements to facilities and security deposits.

Once the business is launched, the founders need to consider the ongoing costs and expenses that will be incurred in order to operate the business.  The company may incur expenses in building up an acceptable level of inventory and may also need to absorb finance charges if customers are not able or unwilling to pay on a timely basis.  If expansion of business activities is contemplated, consideration must be given to projected costs of new facilities and equipment and hiring new employees.  The need to comply with financial reporting requirements and simply monitor the financial performance of the business means that cash and human resources must be invested in setting up and maintain a recordkeeping and reporting system.

2.         Cash Flow

It is often said that “cash is king!”  The life blood of any business is its ability to collect cash and pay bills as well as pay its managers and employees.  Far too often, young businesses do not have enough operating capital to meet their current needs.  Consequently, they may be forced to sell out to a stronger competitor, sell a portion of the company to investors at an undesirable price, or close the doors and put the company out of business.  None of these alternatives are typically what the founders intended when starting the business.

The ability to forecast cash resources and uses is an art and is by no means a well-defined science.  No one has a crystal ball and any cash forecast that is prepared by the management of a company or an outside consultant can be no more than a guess as to when the customers will pay and when the business will pay its obligations.  Hopefully, the more effort that is put into cash forecasting the better will be the educated guess and the more accurate the resulting picture of the future operations of the business.

Cash flow projections can be very slow, time consuming and tedious to undertake.  It is often very tempting for the founders to hire someone else to prepare the projections for them.  There are a variety of individuals who can help, but the critical factor is that they only help.  The managers of the business are the only individuals truly qualified to develop cash flow projections. Certainly a trained professional can offer guidance and ask pointed questions to be sure that consideration is being given to all of the necessary and sometimes hidden costs of operating a business.  However, the more effort put into developing cash flow projections the more accurate they will be.  This exercise may also help pinpoint potential cash savings which had not otherwise been considered.

One of the most significant factors to be considered in cash flow analysis is the volume of sales that will be generated for the period for which the forecast is being made.  The sales forecast must be as fine-tuned as possible.  In many cases, sales forecasts are based on assumptions, often unrealistic, regarding the size of the market for the company’s products or services and the market share that the company will be able to capture.  While these measures and targets can provide a good starting point for preparing the forecasts, reference should be made to actual experiences of similar businesses in comparable markets.  Moreover, the forecasts should take into account other factors that might impact the level of sales at any point in time, such as new distribution arrangements, expansion of product lines, seasonality, and the state of the economy.

New businesses selling technology-based products and services may find it is difficult to estimate the average sales price for its products during the product launch period.  While some reference can be made to comparable products, actual customer use and satisfaction will ultimately determine the sales price, as will the future impact of competition.  Another factor to consider is the need for the company to offer discounts on products and services in order to create incentives for customers to use their products and services during the launch period.  If discounts are planned in advance, they actually can be budgeted as a marketing expense.  If, on the other hand, discounts are offered in response to market reactions after the projections have been finalized, they will reduce the projected sales revenues during this period.

Once a reasonable level of sales has been determined and the founders are comfortable with their forecasts, consideration must be given to converting sales into cash that can be used for the business.  One of the most common problems for new businesses is their inability to promptly collect amounts due from customers.  The forecasts should include realistic assumptions about collection of receivables, including the average amount of time between the date that a sale is booked for accounting purposes and the date that the income is collected.  Also, the founders must not assume that all receivables will actually be collected and create reserves for returns and discounts that may be necessary in order to build customer trust and loyalty.

3.         Working Capital

It is the fortunate, and rare, business that can match its expenses and income from operations from the first day.  Instead, it is far more likely the founders will not to obtain some amount of working capital to continue operations until the business is profitable.  The amount of capital will depend on the shortfall from operations identified by the projection of income and expenses, as well as the need to fund long-term investments that are not likely to reap returns within the specific planning period.

Working capital comes in a wide variety of forms and from a myriad of different sources.  Obviously, the founders themselves can make capital available to the company from their personal resources.  Commercial lenders can provide short-term capital that simply bridges the gap between the accrual of a sale and actual payment.  Investors may provide financing to fund the initial product launch and investment in the development of new products and penetration of other markets.  Capital may be in the form of equity, which generally is permanent and need not be repaid within a fixed period, or debt, which must be repaid on or before a specified date along with interest and other charges as agreed with the lender.  While equity instruments tend to reduce the day-to-day costs of working capital, they do dilute the ownership interest of the founders in the ultimate appreciation in the value of the business.  Moreover, equity investors seek some voice in the management of the business.

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