Without sound financial planning, a small business can run into trouble. This article will explain why you need financial planning for your business, by looking at the following areas:
- What is financial planning?
- Long-term growth and goals
- Smart allocation of budget
- Risk and crisis management
- Measuring profit and loss
What is financial planning?
The financial plan in a business is the financial section of your business plan. This is where your figures highlight the direction the business is going in, and show how well your idea is working in the current market (if you’ve already begun trading).
Financial planning and projections are not a case of copying and pasting your accounting results, but rather the process of choosing goals that are most important to your business and then assigning each a budget, to make sure you achieve them.
When trying to secure funding from a bank or investor, the first thing they will ask to see is your business plan. If it doesn’t include a financial plan, you will have little chance of convincing them to part with their money. No financial plan means you may have limited insight on your business spending and where you could be making smarter decisions. Next we will look at four more reasons why you need financial planning.
Long-term growth and goals
A business plan allows you to set out where you want the business to be in six months, a year or five years. It can be a long-term guide for growth and development, once you know that your company is viable and sustainable in the marketplace.
Setting milestones that you want to achieve will help you focus on growth and what it will take to get there, financially speaking.
For example, an artisanal bakery might attempt to sell more online as well as in-store. Setting an objective such as ‘Use social media advertising to drive half of the sales by the end of next year’ will help focus on the activity needed to achieve the goal.
By choosing a time frame to achieve a goal you can then use financial planning to help plot where the money needs to go.
Using the same example, the bakery could spend an appropriate budget on making sure the website was functional for website and mobile sales, as well as allocating funds to build a following on social media and boost performance on their business social pages.
Measuring profit and loss
Your financial plan will also detail the current cash flow of the business. Simply put, this is the total amount of money coming in and out of the company. You can find out more details about cash flow here. Once you have been trading for a while, you will be able to create detailed projections on cash flow and be able to plan when you can invest in bigger projects.
It can be common for new businesses to spend more than they make at first, but part of this journey is understanding what is an acceptable level of spend to ensure your future profitability. Financial planning can ensure that you are equipped for a variety of scenarios and you will be more likely to be able to cope with them by being prepared.
There may be seasonality in certain industries, where your products or services are more in demand at certain times of the year. Plotting these and carefully planning a structured budget for when you spend your money will prevent you from having a difficult time if your sales dip seasonally.
Smart allocation of budget
After determining your cash flow figures, you’ll see how much money you have to spend on other areas of your business, such as marketing.
If you have been trading for a while, start by examining where you have spent money in the past and what was successful for you. Which methods, marketing or investment in which areas helped you achieve your goals the best?
Businesses usually spend from 7-10% of their total budget on marketing. It’s important to decide what your business goals are before you assign a budget, in order to understand which areas need the most investment. For example, if you are a small company looking for fast growth or improved sales via your marketing channels, you might choose to spend up to 15-20% on marketing alone.
A good rule of thumb for budget allocation (in terms of marketing and total budget) is to use the 70 – 20 – 10 rule.
- 70% of the budget should be spent on strategies that you know work.
- 20% of the budget can be assigned to new strategies that you haven’t tried before, to reach your objectives.
- And the final 10% of your total budget can be saved for trying new technology or strategies that you can test.
This allocation rule allows you to test new things, as well as carry out the necessary spending to reach the goals you set.
Risk and crisis management
With all the data and figures you’ve pulled together on your finances, you will be better equipped to spot potential issues before they arise and create plans as a safety net.
Your financial plan should have space for unexpected issues too. Financial planning can help you avoid unexpected pitfalls in business such as:
- Business insurance expenses
- Unexpected losses (like the pandemic caused)
- Unforeseen expenses (this could range from legal support to damage to your premises, machinery or vehicles)
- New competition in the marketplace
- Cash flow issues due to poor forecasting
With financial planning you are able to adapt and buy your business time to survive if any of these scenarios occur unexpectedly.
Keep on top of your business finances
Now that you’ve learnt why financial planning is so important, find out how Countingup can help you save time and money on financial admin. The business current account and accounting app is saving business owners hours of time-consuming admin, and helping thousands keep on top of their finances. Find out more here.