Financial plan: what it is, how to do it and what it is for

 

The financial plan, or financial plan, is a document that contains the financial and economic planning of a business, organization or company.

In this practical guide, we will explain in detail the financial plan, what it is for and how to make an effective financial plan for your company.

What is the financial plan?

But in practice, what is the financial plan? First, it is a fundamental document for all companies and organizations. Whether a business has already started or is being launched, the financial plan illustrates the current financial situation. It makes it possible to predict the economic future with which to define the activities' strategies, objectives and commercial investments.

In financial projections for startup, the financial plan is essential to calculate the company's valuation and potential based on expected future earnings.

On the other hand, in companies that have already started up, the financial plan makes it possible to monitor the business's financial health. Therefore, it should be updated every six months or annually, depending on the frequency of the changes that have taken place.

What is the financial plan for?

Thanks to the financial plan, it is possible to define the current state and predict the financial future of the company: this means that the financial plan is used to plan the objectives to be achieved, implement the strategies to achieve them and track the progress towards the expected results.

In practice, the financial plan serves to:

• Illustrate the economic and financial situation of the company;
• Define the objectives to be achieved;
• Predict corporate profitability;
• Determine the amount of money needed to achieve the goals;
• Analyze growth projections;
• Implement new commercial strategies;
• Evaluate the profitability of new investments;
• Calculate the value of the company, organization or business.

What are the elements of the financial plan?

Now that we have seen the financial plan and what it is for, let's analyze what it is made up of.

The fundamental elements of a financial plan, those on which the actual financial plan is based, are essentially two:

• Cash flow forecast, or cash flow statement, which allows you to forecast all the cash inflows and outflows of the company;
• Forecasts of profits or losses, or forecast income statement, where the company's expected profits and expected losses are budgeted. In startups, these values ​​allow you to calculate the company's valuation, taking into account the expected future earnings.

In addition, a series of additional detailed information should also be included in the financial plan, including startup and management costs of the company, expenses for salaries, personnel contracts and loans, current balance sheet, future hiring plans and KPIs to monitor the performance.

1. How to make a financial plan
2. Define the objectives to be achieved
3. Create the financial statement
4. Estimate expected costs and expected revenues
5. Draw up the income statement
6. Predict investments
7. Final review and update
8. Define the objectives to be achieved

The first step in creating your company's financial plan is to define the objectives: once the goal has been established, it is easier to chart the route to reach it.

In this first phase, it is very important to set clear and realistic objectives by reasoning from an entrepreneurial point of view: your goal should not be to "Earn 1 million euros quickly", but rather "Reach 5,000 customers within 5 years".

Create the financial statement

Once the objectives have been established, it is possible to start with the practical drafting of the financial plan starting from the cash flow statement: it is a detailed report of the cash flows of the business; in practice, where and how much money goes out (goes out) and how many goes in (goes in) every month.

Several indicators make up the cash flow statement:

• FCFF (Free Cash Flow to the Firm): the ability to generate incoming cash flows;
• FCFE (Free cash flow to equity): the ability to generate cash flows to repay debts;
• Net Cashflow: the net financial balance at the end of a given period;
• Cumulated Cash Flow: The bank balance at the end of a given period.

Estimate expected costs and expected revenues

This crucial step allows you to estimate all the income and expenses of the business.

When calculating costs, it is important to consider fixed and variable costs while also trying to predict the impact of unexpected expenses and the costs associated with the sale and marketing of products, including marketing, product development and sales commissions.

Regarding the expected revenues, however, it is appropriate to calculate an estimate based on the selling price of the product or service using the TAM, SAM and SOM methods to evaluate the market demand:

• The total addressable market (TAM) is the total market demand for a product or service, calculated in annual revenue or unit sales, taking into account reaching 100% of the available market.
• The Serviceable available market (SAM) is the portion of TAM potentially served by a company's products or services.
• The Serviceable obtainable market (SOM), or market share, is the percentage of SAM realistically achieved by the company.

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Draw up the income statement

The income statement is an essential part of the financial statements and indicates the economic result of a given period under analysis. It is composed by:

• Production value: all revenues from the company's sales and economic activities;
• Production costs: all costs and expenses associated with the management and operations of the company, including salaries, sales costs and more;
• Financial income and expenses: for example, capital gains and losses deriving from the company's financial investments;
• Value adjustments of financial assets and liabilities include revaluations or write-downs of assets, investments or corporate capital.

Therefore, the income statement is used to calculate the profit or loss for the year of a specific period or commercial investment.

Predict investments

Another important element to include in the financial plan is the investment plan. Starting and managing a business requires continuous investment. Whether it is marketing campaigns to advertise a new product or expenses to modernize the tools necessary to carry out the operations, establishing an investment plan will allow you to have a clear vision and realistic of the expenses to be incurred in the future and also represents an element of strength to include in the pitch for investors.

Final review and update

Once the financial plan is complete, it is important to carry out a complete review and always keep it updated based on market conditions or changes in your company's financial situation.

The financial plan should be updated every 6 months, but without significant changes, we recommend you do it again at least once a year.

Financial plan mistakes: what they are and how to avoid them

Finally, let's see what are the typical mistakes to avoid when making a financial plan:

• Underestimating costs: the most common mistake is to provide an underestimated calculation of the costs to be incurred. It can be costly, in every sense of the word, because it falsifies the company's actual profitability and puts the company in a bad light in the eyes of potential investors.
• Focusing solely on profit: Another typical mistake when making a financial plan is to take net profit as the only factor in determining the company's financial health. Many other metrics and KPIs offer a realistic view of the business without relying solely on net income.
• Poor understanding of cash flow: not having a clear vision of what are the incoming and outgoing cash flows of the company is very risky, as it distorts what is the net financial need and the resources "to be consumed" ( burn need ) of the company, with an evident impact on net profitability and on the calculation of the break-even point.

Conclusions

In conclusion, the financial plan is an indispensable document that illustrates a commercial activity's financial and economic planning. To summarize, here are the steps required to make a financial plan:

1. Define the objectives to be achieved
2. Create the financial statement
3. Estimate expected costs and expected revenues
4. Draw up the income statement
5. Predict investments
6. Final review and update

Do not underestimate the financial plan's importance: consider it a real roadmap to define business objectives and take all the necessary actions to achieve them.