If you're creating a business plan, it's important to plan out how you're going to finance your business.
This is known as creating 'financial projections'.
Financial projections are important to both new and established businesses. They can help you:
- measure your performance
- plan how you'll finance any developments you want to make
Creating financial projections
Financial projections are normally made up of:
- profit and loss accounts
- a balance sheet
- a cash flow statement
They also usually have information about any assumptions you've made when creating these.
Profit and loss accounts
Profit and loss accounts show your sales and costs.
They breakdown how your:
- sales and costs are made up
- net profit or loss is calculated
Your 'net profit' or 'net loss' is the value of your sales minus the value of your costs.
Some business will also include details of 'depreciation'.
Depreciation is an accounting technique that lets businesses spread the cost of an asset over its useful life.
A balance sheet shows the value of your business 'assets' and 'liabilities' at a point in time. For example, the end of the financial year. Business 'assets' include:
- the cash you have
- any money you're owed
- money you owe to people
- unpaid tax bills
A balance sheet shows the 'net worth' of your business. Net worth is the value of your assets minus the value of your liabilities.
Cash flow statement
A cash flow statement shows:
- cash you expect to receive
- what you think you'll pay out
It will show information about anything you spend cash on to run your business, such as:
A cash flow statement shows how you expect your 'net cash' or 'net deficit' to accumulate over a period of time.
Your 'net cash' or 'net deficit' is the value of the cash you expect to be paid minus the value of the cash you expect to pay out.
When creating your profit and loss accounts, balance sheet or cash flow statement you should:
- make sure they balance
- use the same format for each so they look consistent
- use basic arithmetic and formulas
- show monthly breakdowns for the next 3 years
If you're starting a business, your profit and loss accounts, balance sheet and cash flow statement will be your best estimates.
When creating financial projections you'll need to make assumptions about:
- sales volumes – how much you think you'll sell and when
- overheads – running costs for your business, for example wages, rent, utility bills, interest and loan repayments
- direct costs – how much it costs to make each item
- gross margins – the difference between your selling price and cost of your product or service (direct costs)
You might also need to make assumptions for:
- capital expenditure – what you'll spend to create or deliver your business
- prices – how much you'll sell it for and the terms you'll sell it for
- what funding you expect to get and when
- any tax you'll have to pay
- the rate of inflation
You'll also need to consider any wider economic or competitive issues that could impact your business.
Examples could include a rise in unemployment or a change in consumer trends.
Testing your projections
It's important you test your financial projections to make sure they work.
You can test your financial projections by thinking of best or worst case scenarios (for example, if you have lots of sales, or no sales at all).
This can help you to better understand the key parts of your business that can impact on everything else. It can also help you understand the parts of your business you need to focus on (for example, hiring more staff to reach a sales target).
This is often called 'sensitivity' or 'scenario' analysis.
If your business is looking for funding, this type of analysis shows potential funders that you understand what factors could affect your business.