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Basics of Financial Planning for Small Businesses: Setting Goals & Budgeting Strategies

The basics of financial planning and strategies to help you find success.

Written by: Joe Valeo

December 11, 2023

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The basics of financial planning and strategies to help you find success.
7 min read

Running a small business can be a significant challenge, with only two out of three surviving beyond the three-year mark, as highlighted by BLS data. The key to enduring and thriving in the current small business economy is financial planning and strategic budgeting. This article looks into basics of financial planning for small businesses, outlining steps and offering practical budgeting tips to navigate the complexities of financial management.

What is financial planning?

Financial planning for small businesses involves creating a roadmap to manage finances effectively. It entails setting long-term financial goals, budgeting, forecasting future revenues and expenses, and preparing for unforeseen financial needs. This process is important for guiding a business towards its objectives while ensuring financial stability and operational sustenance.

Why is Financial Planning Important for Small Businesses

Financial planning is a cornerstone for small businesses, offering numerous benefits.

  • It provides a clear overview of the company’s financial health, allowing owners to make informed decisions.
  • Effective financial planning also identifies potential areas of growth and investment, assisting businesses in capitalizing on opportunities.
  • Moreover, it facilitates strategic long-term goals, ensuring the business is stable and geared for future success.

Understanding the Basic Components of a Small Business Financial Plan

A small business financial plan is a comprehensive document outlining a company’s financial status and projections. It typically includes key financial statements, forecasts, and analyses that can be utilized to make sound financial decisions. It’s a tool for mapping a business’s finances, including income statements, balance sheets, and cash flow projections.

Income Statement

The income statement highlights the company’s revenues, expenses, and resulting profit or loss over a specific period, such as quarterly or annually. Small businesses may find it beneficial to prepare income statements more frequently, like monthly, to monitor financial performance closely. This statement helps business owners understand how their revenue is transformed into net income, providing insights into operational efficiency and profitability.

Balance Sheet

For small businesses, a balance sheet is a fundamental financial statement that provides a snapshot of the company’s financial health at a given moment. It lists all assets (what the company owns), liabilities (what it owes), and equity (the owner’s stake). To create a balance sheet, list all assets, including cash, inventory, and equipment. Then, outline all debts and liabilities, such as loans and accounts payable. Finally, calculate equity by subtracting total liabilities from total assets.

Assets and Liabilities

In a small business financial plan, assets and liabilities play pivotal roles. Assets include cash, inventory, property, and accounts receivable, representing the resources a business uses to operate and generate income. Conversely, liabilities consist of loans, accounts payable, and any other debts reflecting the company’s financial obligations. These elements are used for the balance sheet and determine a business’s net worth. Understanding the differences between assets and liabilities is a must for maintaining healthy finances and driving growth.

Sales Forecast

Sales forecasting involves analyzing past sales data to identify trends and fluctuations, which is important for predicting future sales. For small business revenue, this means looking at past sales data analysis and considering factors like seasonality, market trends, and customer behavior. Using this data as a foundation, businesses can better predict future sales, helping them effectively plan inventory, staffing, and marketing strategies. Accurate sales forecasting is key to managing cash flow and setting realistic revenue goals.

Cash Flow Projection

Cash flow projection is essential for small businesses, enabling them to anticipate future financial difficulties. It should be conducted on a monthly, quarterly, and annual basis to identify potential financial challenges and opportunities for growth or investment. A comprehensive cash flow projection includes three main categories: operating activities (day-to-day business operations), investing activities (such as buying or selling assets), and financing activities (like loans or equity funding). Each category is used to maintain positive cash flow, ensuring the business can meet its financial obligations while pursuing growth strategies.

Break-Even Analysis

Break-even analysis is a fundamental financial tool that helps small businesses understand the point at which total revenue equals total costs. Evaluating the relationship between fixed costs and the profits generated from each additional unit sold is crucial. Businesses can make informed pricing decisions by determining the break-even point and understanding the financial implications of expanding their operations. This analysis aids in setting sales targets and pricing strategies to ensure profitability.

6 Steps of Financial Planning for a Small Business

1. Define Financial Goals and Objectives

Defining financial goals and objectives is a key step in small business planning. This process involves setting specific, measurable, and attainable financial milestones to be achieved within a set timeframe. Goals could range from increasing revenue by a certain percentage to reducing debt or expanding business operations into new markets. The first step is anticipating significant large expenses such as equipment purchases or facility upgrades. Then, building a financial safety net, like an emergency fund, can provide a buffer against unforeseen costs, ensuring the business remains stable and poised for business growth.

2. Factor in Startup Costs of Your Small Business

Startup costs can be significant for any small business. These costs are categorized into fixed and variable expenses. Fixed costs, such as rent, salaries, and insurance, remain constant regardless of business performance. Variable costs, including inventory prices and sales commissions, fluctuate with sales volume. For effective budgeting and financial planning, you need to differentiate and plan for these expenses. Creating a dynamic budgeting process that can adjust to changes in business performance and scale is essential.

3. Prepare Financial Statements for Your Small Business

Preparing financial statements is another important process for small businesses. It involves compiling three key reports: the income statement, balance sheet, and cash flow statement.

The income statement highlights revenue, expenses, and profit, showing the business’s profitability over a period.

The balance sheet provides a snapshot of the company’s financial health at a given moment, listing assets, liabilities, and equity.

The cash flow statement tracks the movement of cash in and out of the business. Regularly reviewing and adjusting these statements can offer insights into financial performance and help adapt the financial plan to current business realities and future projections.

4. Managing Small Business Budgeting & Expenses

Effective budgeting is foundational for small business success. It acts as a financial blueprint, guiding spending decisions and tracking expenses. Proper budget management ensures resources are allocated efficiently. Some common small business budgeting tips include:

●     Purchase Inventory in Bulk

When you purchase inventory in bulk, you can create a cost-effective strategy for small businesses. Bulk purchases often lead to significant cost savings, reducing costs per unit and enhancing profit margins. It’s important to research suppliers, negotiate favorable terms, and ensure proper storage facilities to maximize these benefits and maintain inventory quality. This approach requires careful planning to balance inventory levels with business demand.

●     Overestimate Costs

In small business budgeting, it’s sometimes best to overestimate costs, a prudent strategy to mitigate risk. By anticipating higher expenses, businesses can create a buffer against unexpected expenses, ensuring financial stability. This approach involves adding a contingency percentage to estimated expenses, monitoring spending closely, and regularly reviewing financial forecasts. Overestimating helps prepare for unforeseen circumstances.

●     Streamline Operational Process

You can sometimes improve the operational efficiency of a small business when you streamline the operational process. This can be achieved when you eliminate redundancies, merge similar roles to reduce labor costs, cutting down unnecessary meetings to save time, simplifying supply chains for better management, and integrating automation or technology where possible. These measures improve efficiency and contribute to cost savings and overall business productivity.

●     Save Energy Save Money

Small businesses can achieve significant cost savings and save money by adopting energy-saving measures. Switching to LED lighting, investing in energy-efficient appliances, and implementing smart energy management systems can drastically reduce utility bills and save energy. Besides the immediate financial benefits, these measures contribute to a smaller environmental footprint, enhancing the business’s reputation among environmentally conscious consumers and potentially opening new market opportunities.

●     Update Business Technology

Keeping technology up-to-date in our interconnected and online world is an easy way to improve your small business profitability. This includes adopting the latest financial management software, which offers automated analysis and reporting capabilities. One could also explore the role of business technology in enhancing operational efficiency and aiding informed decision-making. Popular financial management tools for small businesses include QuickBooks, FreshBooks, and Xero, which streamline various financial processes and provide valuable insights into the business’s financial performance.

●     Outsource Non-Critical Tasks to Third-Party

Outsourcing non-critical tasks to specialized third-party agencies can be a strategic move for businesses. This approach allows businesses to focus on core activities while reducing costs and tapping into expert skills. Functions commonly outsourced include accounting, IT support, and digital marketing. This results in cost savings and ensures that these key operational areas are handled by experts, potentially leading to better performance and efficiency.

●     Recalibrate Budget Based on Market Trends

Regularly spending time to recalibrate your budget in response to market trends is one step not to be missed for small businesses. By monitoring changes in the market, business owners can anticipate potential changes in the business environment that may impact their financial planning. This proactive approach involves adjusting the budget to align with current market conditions, ensuring the business remains competitive and financially sound. Regular review and adaptation of the budget enable businesses to respond quickly to new opportunities or challenges, maintaining financial agility and resilience.

5. Forecasting Revenue and Cash Flow of Your Small Business

Forecasting revenue and cash flow is a good exercise in financial planning for any small business. This process involves analyzing past sales data and market trends for future revenue estimation. Techniques like seasonal trend analysis and customer demand forecasting are employed to predict sales. Understanding cash cycles is equally important as it helps in managing liquidity effectively. Accurate revenue forecasting enables businesses to anticipate their income, prepare for future expenses, and ensure they have sufficient cash on hand to meet operational needs.

6. Securing Small Business Financing

Securing small business financing is a critical aspect of building growth and maintaining the financial health of a small business. There are two primary financing options: debt financing, which involves borrowing money to be repaid with interest, and equity financing, where funds are raised in exchange for ownership stakes or shares in the business.

Debt financing typically does not dilute ownership but comes with repayment obligations, while equity financing avoids debt but may reduce control over the business. When choosing between these options, small businesses must consider factors like their current financial situation, risk tolerance, and growth aspirations. Preparing key financial statements such as the income statement is a start to demonstrate the business’s financial viability to potential lenders or investors when seeking funding.

About the Author

Joe Valeo

Joe Valeo has over 37 years of experience in finance and sales. His leadership and expertise have served financial services and alternative working capital organizations such as LendingPoint and Capital Access Network, where he oversaw the growth of more than $5 billion in capital for small businesses. He also led sales strategy and management at First Data Corporation and Visa. Joe oversees SmallBusinessLoans, where he strives to make lending more accessible for small business owners.

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