In a previous article I introduced you to the three key financial statements that we build into all Pivotal180 financial modeling courses, as one should never develop a forward-looking model for any business without these three financial statements. We now look at the need for business and financial plans for a new business and the benefits of a financial model in this context.
So, you want to start a new business. You have a great idea and are confident it is going to be a success, but where to begin?
In order to start a new business, you need to understand the key drivers of your business and the market in which you will be competing. Make no mistake – starting a business is a huge commitment. Do not fail to appreciate the significant amount of time, resources, and energy that is required to start and grow a business.
There is a myriad of factors to consider and tasks to undertake. Here are just a few:
- Ensure you have a strategy plan and vision
- Understand regulatory and legal requirements you must satisfy
- Secure sufficient cash
- Bring in the right people,
- Build a great website
- Choose your partners wisely
- Know your competitors and your market
- Know your customer and provide exceptional service
- Plan your operations
- Invest in legal counsel with experience in startups and in a good accounting system
Before you even start you will need a business plan!
A business plan states the strategy, goals, objectives and timeline of a business or business idea. A short, clear summary of the business idea is often essential when presenting to external parties. By articulating the strategy for starting or growing your business, you are more likely to convince others of the validity of those business goals and secure and the resources needed to achieve them. Lenders and investors will almost always require some form of business plan before they release any funding, and the business plan can also be used to align goals internally, plan for the year and monitor the progress of your business.
A business plan includes:
- An executive summary with a company description
- Description of products and services
- Market analysis
- Strategy and Implementation plan
- Organizational chart and management team
- Marketing plan
- Financial plan and projections
Many a startup fails by simply running out of cash. A crucial task in starting a business is therefore to both secure capitals, understand exactly where it is coming from, establish a detailed, month-by-month budget, and review the budget regularly.
I think by now you can see it is not simple to start a successful business.
Whilst acknowledging all of the above, I want to focus on the financial planning side of the business plan, and specifically on the benefits of creating a financial model that accurately represents your business and uses the best practices of financial modelling.
In order to create a good business plan for our business, we need to have a realistic financial plan that forecasts for a period of one to three years.
In preparing the financial plan, you will need to consider many factors and develop a base case for your initial forecast. Some of the key considerations include:
- Upfront set-up costs: These are the costs that you will need immediately or very soon after opening the business. They typically include registrations and licenses, legal fees, rent and utilities, equipment, and software. These costs will determine the starting working capital needed for day-to-day operations.
- Sales and Margins: This process involves forecasting the sales over the first 12 months. You will develop sales targets, pricing, COGS and expected profit margins. This process requires researching the size of your market, the future potential, competitors, and your target market.
- Profit and Loss: Determine and forecast your other operating expenses such as rent, payroll, IT, marketing, and other fixed and variable overheads. Will the business be profitable?
- Cash-flow: Unfortunately, a business that makes a profit can still run out of cash. For example, you may have high revenue in the first few months but only receive payment for these sales a month or two later. You may have upfront capital costs that depreciate over a few years. Completing a cash-flow statement shows whether you can expect to have sufficient cash to run your business or if you need to source additional funding.
- Balance Sheet: List all your expected assets and liabilities after your first 12 months to create a financial snapshot of your business. This is an effective way to evaluate the financial health of your business and, importantly, understand your “break-even” point.
- Analyze your predictions: Stress test your base case forecasts and examine the following questions:
- What is the minimum sales figure needed to cover costs? This analysis is useful for judging whether your business idea is feasible.
- Are your assumptions realistic?
- Have you built in some contingency?
- How much cash do I need to start my business?
- Have you considered how to run sensitivities and scenarios?
A financial plan allows you to quantify your business assumptions, define specific benchmarks, plan for worst- and best-case scenarios, and measure your company’s success.
BUT what is the best way to create a financial plan? Here at Pivotal180, we strongly believe building a financial model for your business provides unparalleled value in financial planning.
A financial model provides a financial plan and is a flexible tool for start-up founders to forecast the company’s financial and operational activities. It will include assumptions and calculations of revenue COGS, operating expenses, inventory, capital expenditure, depreciation, financing through debt & equity, and a valuation.
A financial model is a framework that businesses use to predict likely financial outcomes based on a set of defined goals and financial data. The beauty of preparing a best practice financial model is allows you to stress test by changing your prices, costs, and sales. Financial models also give you the capability to understand key drivers of the business and important relationships between different variables and assumptions through building sensitivities and scenarios. The tools available in a financial model provide a clear and transparent demonstration of the value and risks of your business, which are critical to understand not only for founders, but also lenders or investors from whom you may seek funding.
I will explore the benefits of a financial model in my next article. These benefits also form the basis of our next online course which focuses on financial modeling for business plans.