5 Steps for Effective Financial Planning and Management

With so much on their plates, it’s easy for small business owners to get “lost in the weeds” of immediate financial matters, like moving inventory, making payroll, and paying bills.

But for a business to grow, it also needs a financial plan for the future. Comprehensive financial planning sets forth bigger, long-term business goals that stay in place amid the fluctuations of day-to-day operations.

When properly managed, a three- or five-year financial plan can keep cash flowing and chart a business’ path forward.

A financial plan is not set in stone, but it shouldn’t be constantly tweaked either. Rather, set a timeline – perhaps based on certain sales milestones or set time periods – to revisit, reassess, and, if necessary, readjust the plan.

Create Your Financial Plan

Mapping out a financial plan may seem time-consuming, but it’s a critical step for growth – and that’s exactly what many small businesses see for themselves this year.

According to a 2021 Federal Reserve survey of over 10,000 small businesses, 59% expect to see revenue increases in 2022. While no one can predict external market conditions several years out with absolute certainty, financial planning can set you in the right direction.

Here's how to create a financial plan for your small business.

1. Choose your approach.

Before creating a financial plan, you need a strategy.

Generally speaking, there are two approaches to financial planning: bottom up and top down. Larger and more diverse companies tend to take a bottom-up approach, starting with detailed information about specific product and services lines – such as orders placed, order value, sales projections, and operating expenses – to help predict revenue for the entire company.

For smaller businesses that offer fewer products or services, a top-down approach is often the way to go. This begins with a broad picture of the company’s financials as a whole, as well as high-level market data, to help predict revenue for the business and individual products and services.

2. Include the essentials.

Financial planning is only as sound as the information it’s built on. Every financial plan includes three major financial statements: an income statement, a cash-flow statement, and a balance sheet, all of which would be of particular interest to potential investors and lenders.

• Income statement. Sometimes called a profit-and-loss (P&L) statement, an income statement presents a company’s net profit – its “bottom line.” It lists all revenues and expenses over a set period, typically a year divided into quarters. A positive bottom line on an income statement indicates a profit; a negative bottom line shows a loss.  
• Cash-flow statement and projection. A cash-flow statement contains the amount of cash that came in and went out of the business during a period of time, including the beginning and ending balances. A cash-flow projection is a hypothetical model for future cash flow, often based on data from previous cash-flow statements, combined with assumptions about future activity. A positive cash flow shows an increase in liquid assets, whereas a negative cash flow shows more spending than intake during the specified period.
• Balance sheet. A balance sheet contains the company’s assets (what it owns), liabilities (what it owes), and equity (what it’s worth). If the sum of liabilities and equity is equal to assets, then the balance sheet has earned its name. If not, an error likely occurred somewhere along the lines – perhaps data pulled from the wrong dates or a simple typo, like transposed numbers – that needs to be corrected.

More often than not, a financial plan will also include:

• Financial ratios. These are key performance indicators (KPIs) pulled from financial data that demonstrate how well a company is performing in different areas of the business. The KPIs you choose will depend on the type of business you run, but some overall important ratios to include are working capital, debt-to-equity, gross margins, and return on investment (ROI).
• Personnel plan. A personnel plan is a snapshot of current employees, their roles, and potential positions that may be created in the future. This plan can be as detailed as needed; many include costs like compensation and benefits, as well as what the employee/role brings to the company to justify their cost.  
• Break-even analysis. The break-even point is when a business’ total revenue or volume of activity covers its total costs – to the penny – without a profit or loss. It is determined by a financial calculation known as a break-even analysis, which typically occurs when a business is considering taking on new costs.
• Forecasted sales. This is an estimate of future revenue and costs of goods and services to be sold during a specific period of time. Sales forecasts take into account a business’ historical sales data as well as greater industry and economic trends to help it plan for myriad financial scenarios.   

3. Set goals and create a path to reach them.

Let’s use revenue as an example. Say your goal is to increase revenue by 50% next year. One way to accomplish this goal is to introduce a new product to the market. This may require a larger investment in product research and development, hiring more people, and leasing additional equipment. How will you pay for all of those new expenses? Cash reserves? Or should you explore external financing, like a new line of credit or loan? The more details you can map out, the better you’ll be able to tell whether your goals are realistic and how to reach them. 

4. Consider contingencies.

Some financial planners advise businesses to create multiple financial plans: optimistic, realistic, and contingency. Others may suggest creating scenarios with a margin of, say, +/- 10% to leave room for variables. Those are all valuable exercises, though keep in mind that too many options can also muddy the path forward – the opposite of what you’re trying to accomplish. Sometimes simpler is better.    

5. Manage the financial plan.

A financial plan is not set in stone, but it shouldn’t be constantly tweaked either. Instead, set a timeline – perhaps based on certain sales milestones or set time periods – to revisit, reassess, and, if necessary, readjust the plan you have in place. For example, you may need to periodically update KPIs and sales forecasts as your business grows.

At a minimum, examine your financial plan at the end of every fiscal year and then extend the plan by another 12 months. This rolling plan keeps a business continually focused on the coming years and guides the business forward.

The Takeaway

A well-thought-out financial plan can help small businesses grow and reach their full potential. The financial planning process documents a business’ financial goals for the next three to five years, supported by crucial internal financial data, such as an income statement, cash-flow report, and balance sheet. A sound financial plan also typically includes specific KPIs to measure whether the plan is working or adjustments need to be made. It's also often helpful for lenders or investors who are deciding whether to extend credit or invest in a business.  

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