Financial plan: definition and purpose

The financial plan is a forward-looking projection of the company’s income and expenses, which is evaluated using a profit and loss statement (income statement), a cash flow statement (liquidity forecast), and a projected balance sheet (use and origin of funds).

The financial plan thus provides not only investors or banks, but primarily the founders and managers with important information about the success of the company and the capital available within the company. In addition, it enables an analysis of options for action by considering the influence of various income and cost developments or different financing scenarios (e.g., with or without an investor) on business development.

The financial plan is often prepared on a monthly basis over a period of three years, including an annual balance sheet. Every financial plan should be able to answer the following questions:

Question 1: What sales are expected in the future and why?

Sales planning involves estimating how many products or services can be sold, delivered, or provided per month.

The potential sales volume depends on how many customers are interested in the product and willing to pay the asking price. The business model with its value proposition and pricing strategy play a key role here.

Every delivery of a product or service incurs costs, which brings us to the next question:

Question 2: What investment and operating costs are expected?

Every business activity incurs costs. These costs can generally be divided into capital expenditures (CapEx) and operating expenditures (OpEx), the sum of which equals total expenditures (TOTEX).

Capital expenditure (CapEx)

Investment costs are one-time investments in fixed assets. Depending on the industry, these may include machinery, real estate (for production or administration), or operating and office equipment.

When starting a business, start-up and development costs must also be taken into account. (For clarification: R&D expenses are treated differently in accounting than investments in machinery and equipment).

Operating expenses (OpEx)

Operating expenses are all costs incurred by the operational activities of the company. These primarily include:

• Product-specific costs: Costs for raw materials, consumables, and supplies; manufacturing or procurement costs for products; energy costs; maintenance costs for machinery
• Costs of goods delivery (shipping & logistics)
• Personnel costs, including entrepreneur’s salary
• Administrative costs
• Costs of premises
• Marketing & sales costs and customer service costs
• Financing costs, i.e., interest costs of financing or similar
• Other costs, such as consulting and insurance

The amount and timing of the listed costs should be planned as realistically and honestly as possible. Since many of the costs are very industry-specific, planning can be challenging due to a lack of information or personal experience. In this case, you can refer to similar industries or seek the support of experts in drawing up the financial plan.

Question 3: How profitable are the company and its products?

Profitability is one of the most important aspects of a company and therefore central to financial planning. Only companies that are profitable in the long term, i.e., that at least cover their costs, are viable.

A company’s profitability is assessed using the P&L statement. The P&L statement compares the income and expenses (i.e., the answers from the last two sections) for a given period, thereby revealing the nature, origin, and amount of the financial success.

According to the cost of sales method, the income statement is structured as follows:

Revenue
-Cost of sales (including depreciation)
= Gross profit
-Distribution costs
- General administrative costs
= Operating profit (EBIT)
+ Depreciation
= EBITDA
- Depreciation
- Interest and similar expenses
= Profit from ordinary activities (EBT)

The structure of the income statement shows that various cost groups are deducted from sales revenue in order to determine profitability at different levels. For example, gross profit indicates how much money remains from sales revenue after manufacturing costs have been paid to cover other costs.

The financial plan provides further important information regarding profitability:

• Break-even point: How high must sales be in order to generate a surplus after various costs have been deducted? Based on monthly sales and cost planning, it is possible to estimate when the break-even point will be reached, i.e., when the company’s revenues exceed its total costs.
• Profitability of individual products: The financial plan should include an evaluation of profitability at the product level in order to enable decisions to be made about product strategy. The aim is to identify loss-making products as early as possible so that they can either be modified or discontinued.
• The level of profitability and the break-even point are important parameters for any financing discussions: with banks, investors, or funding agencies.

Question 4: When will how much money be needed?

Alongside profitability planning, liquidity planning is one of the two central components of any financial plan, because even the highest profitability is useless if there is no money in the account.

Liquidity planning does not show the impact of income and expenses on profit or loss, but rather the respective timing and amount of payments. In addition, capital inflows from investors or loans and capital outflows from withdrawals by shareholders or loan repayments are recorded (important: these payments do not affect profit or loss and are therefore not shown in the income statement). In this way, the cash balance, i.e., the company’s liquidity, is forecast for each month.

Additional important information regarding liquidity can be found in the financial plan:

• Peak capital requirements from investments or large orders, which may need to be offset by external capital providers (banks and investors)
• Payment bottlenecks arising from goods deliveries, which can be avoided by negotiating payment terms or through purchase or sales financing
• Total capital requirements until the company generates positive cash flow – important information for every investor

In professionally designed financial plans, the profit and loss statement and the liquidity plan are supplemented by a projected balance sheet; in this case, we refer to integrated financial planning. This not only verifies the mathematical accuracy of the P&L and liquidity planning, but also records the development of the individual balance sheet items, i.e., the use and origin of the financial resources. Of particular importance here are the development of equity in relation to debt capital, the development of inventories, working capital, and fixed assets.

Question 5: What assumptions underlie the financial planning?

Once the three components—profit and loss statement, liquidity plan, and projected balance sheet—have been created, the integrated financial planning process is quite extensive. In order to maintain an overview and communicate the assumptions, it is important to summarize the key planning premises and present the underlying planning assumptions in a comprehensible manner.

Summarizing planning premises and assumptions is important for communicating with investors and lenders. It stands to reason that every investor will ask the question: “How did you arrive at these values?”

A good understanding of your own planning assumptions enables you to develop planning scenarios. Popular scenarios include worst-case, base-case, and best-case scenarios, or scenarios that take into account the specific challenges of the business model.

Financial plan – too complicated? We are here to assist you!

Let’s be honest: financial planning is not the favorite topic of most founders! Instead, they put off creating a plan, ignore the necessity, and forget to update it. There are many reasons for this:

• Lack of knowledge and experience in creating a financial plan
• No time for this topic, as product development and operational tasks already fill up the day.
• Uncertainty or lack of knowledge regarding individual planning assumptions, as real empirical values are usually lacking.

At Startup-CFO, financial planning is one of our main areas of focus. We are happy to support founders and managers in creating financial plans that can serve as a basis for corporate management/controlling and for financing discussions with banks. You can find our ‘as a service’ offerings here.