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Financial planning for small business is crucial: but where do you start?

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Most people would agree that financial planning is even more critical for small companies because one mistake can be exceptionally costly. The survival rates regarding start-up businesses do not make great reading. A recent study from indicates that 90% of start-ups fail. One reason for this is because they run out of funds. With that in mind, let’s take a look at why financial planning is so critical for small companies, as well as providing some helpful advice.

Why is financial planning important for small businesses?

Small businesses tend to have smaller budgets. One wrong move for a small business can lead to disaster. Not only is this because big businesses have bigger budgets but it is also because they have diversified too. Therefore, if one of their products or services fails, their other revenue streams protect them from financial ruin. Most small companies do not have this luxury.

Planning financially allows small companies to manage their cash effectively and make better decisions, i.e. whether to buy a generator as a back-up or go for generator hire as and when needed to protect the continuity of your business. It can be easy for businesses to become too focused on short-term goals – this is especially the case for small companies. However, finance planning considers both short and long-term goals. You can also use data to easily spot trends that can help you to run your business more effectively and make better financial planning decisions. Furthermore, you can measure progress and prioritise expenditure effectively.

Financial planning tips for small business

Before you do anything, you need to establish how much money you have available to you, your incomings, your fixed and variable costs, and anything else that impacts your financial standing. You can’t put together an effective plan without doing this first. Moreover, your financial position is something that needs to be constantly addressed. Changes occur regularly in business, and one small change could have a big impact on the overall picture.

Another important part of financial planning is meeting all of your tax deadlines. Failure to do this can be extremely costly. You also must chase debts. Unfortunately, not everyone is going to pay you on time. Follow up your debts with a first reminder letter and then a final demands letter. Another part of financial planning and management is inventory management.

Too much stock can be extremely costly, and running out means opportunities missed and money lost. Furthermore, finding the right kind of funding is important. From overdrafts to loans, the choices are endless. You need to make sure the one you select is right for your business specifically. Don’t rush into decisions like this because they have a long-term impact on the success of your business.

Financial planning: components

If financing is required, the bank and / or investors will request financial planning. The basis for the decision is normally the liquidity planning (for 3-5 years on a monthly basis) and the profitability calculation (for 3-5 years on an annual basis). Often the investors also want to see the complete financial planning, which consists of the following 5 components:

# 1 Sales planning

The starting point of financial planning is sales. The main thing is to create a realistic and comprehensible sales plan. For example, comparisons with the previous year’s or current values ​​are helpful. Factors such as capacity limits and possible seasonality should also be taken into account when planning sales.

# 2 Cost planning

Cost planning follows sales planning. The cost side consists of various line items. The most important are variable costs (i.e. costs that are directly dependent on sales), personnel costs, marketing expenses and operating costs.

#3 Plan P&L

The plan profit and loss account (P&L) is automatically created in a good financial plan based on the entries made. It shows when you start working profitably (break-even point) and how high the annual profit or loss is. The associated profitability calculation also shows how high margins and profitability are.

# 4 Investment plan

The investment plan shows when which investment is made and how it is written off. Possible disinvestments (e.g. the sale of a machine) are also taken into account in the investment plan.

#5 Liquidity plan

All assumptions made flow together in liquidity planning. It shows how the monthly account balance changes and when, if necessary, the account slips into the red. Based on the liquidity plan, the entire future capital requirement can be derived, which of course also has to be financed.

# 6 Financing plan

The financing plan lists all financing: own funds, private loans from Family & Friends, subsidies, long-term and short-term bank loans. The respective financings are also taken into account in the liquidity plan.

Six common mistakes

Numerous financial plans, especially from founders, but also from self-employed and small companies, contain these common erros

# 1 Unrealistic sales planning

In the sales planning, relevant factors such as capacity limits (a restaurant with 10 tables will probably not be able to serve more than 20-25 guests during the lunch break) or seasonality (sales are often lower during the summer vacation season) are usually not or only insufficiently taken into account. Incidentally, a continuously increasing turnover is almost never realistic!

In the case of start-ups, there is often an overly optimistic sales plan. In practice, especially with start-ups, a start-up period is usually required. It is not uncommon for the sales forecast in the first month to be achieved after 6 months – this of course also has a negative effect on liquidity planning.

# 2 Net or gross?

It is not uncommon for net and gross values ​​to be mixed up in financial planning, or, in some cases, for sales tax to be completely forgotten. When making financial planning, make sure that you calculate both net (e.g. relevant for the income statement) and gross values ​​(important for liquidity planning).

# 3 Pay attention to payment terms!

Payment terms are often not taken into account in financial planning. In liquidity planning in particular, it makes a difference whether you receive the money from your customer immediately after the service has been provided or the invoice has been issued, or not until 60 days afterwards. In addition, many founders and self-employed people do not include payment defaults and payment reductions (such as discounts or cash discounts) in their financial planning. However, all three factors can have a significant impact on liquidity planning and thus on capital requirements.

# 4 Don’t forget about your own wages

Your own wages should also be taken into account in a comprehensive financial plan. In the case of freelancers, sole proprietorships and partnerships, the entrepreneur’s wages are made through private withdrawals. In the case of corporations, the founders are usually employed and receive a regular wage (with or without social security contributions, depending on the size of the shares). One last point on the subject of personnel: Please remember that you also take non-wage costs into account in your financial planning if you have employees.

# 5 Oops – did you think about taxes too?

The subject of taxes is certainly not a pleasant one – but you should not be missing in a complete financial plan. Almost all self-employed persons and companies have to deal with the advance registration of sales tax and advance payments for income tax. With the exception of freelancers, the subject of trade tax is also relevant. If you have a corporation, you also have to pay corporate income tax and solos.

# 6 For start-ups: no buffer, capital requirements too low

Over 70% of small business founders underestimate their own capital requirements – on average, founders need more than twice as much capital as originally planned. Sales are overly optimistic, while often not all costs are taken into account in financial planning. This can quickly lead to a financial problem or even bankruptcy due to a lack of liquidity. It is therefore advisable to proceed a little more conservatively when planning sales and to allow for a buffer. The size of this buffer depends in particular on the business model. In practice, experienced consultants usually set a buffer of 6 months for the fixed costs (i.e. operating costs + personnel costs + possibly additional costs for marketing etc.).

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