The most frequent recommendation made in counseling for those who desire to start a new business is you need a business plan. Although people flinch when they hear the words Business Plan it really does serve a critical purpose. The purpose of the business plan, first and foremost, is to test the feasibility of a business idea. If the final conclusion is that the plan does not look like it will lead to a success, it is better not to proceed. This will save a great deal of grief and financial resources (cash), or, the business model must be reasonably reworked to make the chances for success better. If the plan looks good, it becomes a tool for obtaining financing and is the roadmap for future actions.
Business plans consist of two sections: the narrative section and financial statement section. The narrative part is easier since data comes from your own knowledge or easily researched information. The financial statements are more difficult, especially for a non-financial person. Most often this is the type of person involved in a startup. The necessary financial statements are:
- balance sheets,
- income and expense statements, and
- cash flow statements.
The data needed for the statements can be determined by careful, educated assumptions. Expenses are more easily projected than income as they can be easily determined. Planning income is more difficult. It should be established by “mining” marketing data from a variety of data collection sources. Key to these assumptions is to not be overly optimistic about sales and to ensure that enough cash will be on hand during the early months of operations.
The balance sheet is a snapshot of one moment in time of the financial condition or, when starting up, planned needs of the business. The statement is made up of three parts: assets on one side, liabilities on the other side, balanced by the computed difference of the first two, which reflects owners’ equity or value.
The purpose of balance sheet:
- indicates capital need of the business,
- the allocation of resources in the business,
- how much capital or seed money you put up, and
- what has to be financed.
Income and Expense Statement
Most businesses operate on the accrual basis which means completed transactions are recorded real-time as they are incurred. The income and expense statement is made up as follows:
- Sales or revenue less cost of sales = Gross profit,
- Gross profit less administrative and other expenses = Net profits (before taxes)
This statement can be generated in three scenarios: worst, expected, and best. Also the break even point can be determined by finding the set of numbers that lead to zero profit, which means you broke even. These are all important decision-making tools. For third party presentations only, the most reasonable and defensible statement is used. This usually means using the expected financial information.
The purpose of the income and expense statement; to determine the feasibility of a business idea, that is, will it be profitable enough to pursue?
Cash Flow Statement
This statement is similar to income and expense statements, except that it reflects and follows cash. It starts with beginning available cash. Add to this cash received over the measured period, less cash expended during the same time frame to arrive at ending cash. This statement concerns itself not with the timing of transactions, whether income or expense, but rather when cash is received or expended. Having enough cash to meet your bills, pay your employees and purchase more goods to sell is clearly a key requirement to stay in business. Not enough cash flow and the business goes under.
The purpose of the cash flow statement; it reflects your cash position at all times and your ability to meet your commitments on a timely basis, especially loan repayments.
Financial statements can be very technical. In your preliminary studies, use of available computer accounting software or available Excel spread sheet templates (SCORE Template Gallery) should indicate to the user whether to proceed to the next level in starting a business. If indications from these planning steps suggest continuing with the business idea, retaining an accountant may be needed to confirm your conclusions or to add a professional element to the appropriate array of financial statements for the purpose of presenting them to funding sources . The catch 22 is that most start-up businesses have limited budgets for professional services, but in many cases such services are needed to help achieve success.
One option is to work with your SCORE counselors to help you understand these financial reports. Certainly, if you wind up in business, it is mandatory to know and use these reports to manage your business. The time to recognize this is before you spend your retirement on your life’s dream.