Financial Planning
Goals:
Key Terms:
Financial Planning – Picture yourself as a business owner. One of the constant problems you face is the need to have adequate financial resources to operate the business. Financial questions never go away. Even the most successful businesses are continually active in financial planning.
Beginning a Business – The moment a decision is made to start a business, financial planning
begins. How much money will be needed to start the business? Where will that financing come
from? How will adequate funds be obtained to operate the business for months or years until
the business becomes profitable?
Many new businesses fail due to poor financial planning. Experts in business finance should be
consulted to help the new business with its financial planning. The business owner needs to
know the importance of financial planning and must develop financial management skills.
Ongoing Operations – Finances are a key part of the operations of all businesses. Every business
activity costs money. Without careful planning and management, those costs can grow to a level
where the business cannot cover the expenses. All income that a business receives over a period
of time is called revenue. Businesses also have expenses. Expenses are the costs of operating a
business. Every business is guided by the basic financial equation.
Revenue – Expenses = Profit or Loss
If revenue is greater than expenses, the business will make a profit. If expenses exceed revenue,
the business will suffer a loss.
The difference between revenue and expenses determines whether a business makes a profit or
loss. If a company’s annual revenue is $2 million and expenses were $1.5 million, did the
business make a profit of suffer a loss?
All managers are responsible for the costs of the part of the business they manage. Each
employee should also be concerned about those costs. The profitability of the business is
directly related to the number of employees and the wages the business can pay. Managers and
employees should find ways to increase sales and income through better products and services
and higher customer satisfaction.
Ongoing operations require that employees be paid, supplies and materials ordered and
buildings maintained. Equipment must be repaired and technology updated. Each decision
related to ongoing operations requires careful attention to costs.
Business Expansion – Successful businesses expand to be able to serve more customers, reach
unserved markets, and sell new products. Expansion costs money. The hope is that the income
generated by the expansion will be far greater than the cost. A more profitable business is the
result.
Business expansion calls for research to develop new products and locate new markets. New
factories and equipment may be needed to produce the products. Additional employees may
need to be hired and trained. Marketing activities will be planned and implemented to distribute
and promote products. Each time business expansion is anticipated, careful planning must be
completed. The planning must anticipate the costs associated with expansion, and the expected
revenue that will result from the new plans. Id the planning is not correct and the expansion
results in heavy losses rather than profits, the previously successful business may fail.
Developing Business Budgets – A budget provides detailed plans for the financial needs of individuals, families and businesses. A business budget has two main purposes:
The business must be able to identify and predict the amount of each source of income and each type of expense. In addition, the business will need to determine when each expense must be paid ad when income will be received. For the business to succeed, enough revenue must be available to pay all expenses.
Sources of Budget Information - to develop an effective budget, information to predict income
and expenses is needed. If a business has operated for several years, identifying sources of
income and types of expenses will not be difficult. The main source of information is the
financial records of the company. Budgeting is much harder for a new business when no
financial records exist to serve as a guide. Other sources of information must be used.
The Small Business Administration (SBA) provides many planning tools for new businesses.
Among those tools are guides to developing a budget and financial information to help the new
business owner predict income and expenses. Another source of information is private
businesses that collect and publish financial information on similar businesses. Examples of
those companies are Dunn & Bradstreet, Value Line, and Standard & Poor’s. Some information is
also available from business magazines and newspapers including Fortune, Forbes, and The Wall
Street Journal.
Professional organizations, such as the National Association of Independent Business and the
National Retail Merchants Association offer resources to help with financial planning. A new
franchise will typically receive assistance with financial planning from the franchisor. This help
might include a complete beginning budget. A bank or financial institution where the new
business has established accounts is another source of financial planning. Franchisors and
financial institutions want to see businesses succeed, so they typically require careful financial
planning.
Budget Preparation – The most important step in financial planning is developing a budget.
You can compare the use of a budget with the use of a road map when you are traveling to
unfamiliar places. Without the map, you will have little idea where you are going when you
travel. If you make a wrong turn, you will have difficulty knowing your mistake. It will be hard to
get back on the correct road without a map. In the same way, a budget identifies where a
business is going. It allows the owner to determine if the business is making progress toward its
final destination. By regularly comparing the business’s financial performance to the budget, the
owner can determine if the budget goals are being meet. If not, the owner can make corrections
before financial problems occur.
A business budget has the same basic goals as a personal or family budget developed to manage
the household finances. The goals are to determine the sources and amounts of income, to
identify the types of expenses and predict their costs, to determine how the income will be
distributed to cover those expenses and to reward investors if there is a profit.
The budgeting process involves four fundamental steps:
1. Prepare a list of each type of income and expense that will be a part of the budget
2. Gather accurate information from business records and other information sources
for each type income and expense
3. Create the budget by calculating each type of income, expense, and the amount of
net income or loss.
4. Explain the budget to people who need financial information to make decisions
The person responsible for preparing business budgets need several skills. Budgeting requires an
understanding of financial information, computer skills, mathematical abilities, and effective
communication skills. New small business owners often seek the help of an accountant or a
banker when preparing a budget for the first time. Small and medium sized businesses may hire
an accounting firm to maintain financial records and help with budget development. Larger
businesses employ accountants and other financial planning experts to maintain the business’s
financial records.
Types of Budgets – A large business will have many specialized budgets. Each manager will be responsible for one or more budgets in his or her area of operations. For every business, three particular budgets are essential.
The start-up budget plans income and expenses from the beginning of a new business
expansion until it becomes profitable. Most start ups require thousands or even hundreds of
thousands of dollars in order to open. Buildings and equipment must be purchased or leased.
Inventory, supplies, and materials are needed. New employees will be hired or existing
employees retrained. Expenses for utilities, licenses, advertising, and transportation will be
incurred before the company can sell it new products and services. Sources of financing for
these expenditures must be identified from either inside the company or from outside financial
sources. The amount of start-up expenses must be predicted correctly so that ample start-up
financing is available until new activities produce adequate income.
The operating budget describes the financial plan for ongoing operations of the business for a
specific period. The operating budget is usually planned for three months, six months or a year.
Each department and division of a large business will also develop and follow its own budget.
When planning an operating budget, income and expenses are reviewed. Planners look for
possible changes that could increase or decrease income and expenses. Then the budget for the
next period is prepared. It is used to manage the operations of the company for the period
covered by the budget.
A cash budget is an estimate of the actual money received and paid out for a specific period. A
cash budget anticipates that cash will come into a business and that cash will be paid out during
each week or month of operation. If a new business is losing money, it still must have adequate
cash on hand to pay current expenses. Even profitable companies may have times when
adequate cash is not available due to high expenses or a delay in receiving payments from
customers.
A cash budget will determine if a business has adequate financial resources on hand to pay bills
as they become due or if they will need to borrow money. It will also show when there is so
much cash on hand that some of it can be invested. Investing cash on hand provides another
source of business income.
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