When you hear financial planning, what comes to your mind? Most people think of it as developing a budget. Financial planning goes beyond designing or developing a budget for your business or organization. Nobody wants to start up a business and see it fail or get packed up because of money issues.

SCORE stated that 82% of businesses fail due to cash flow issues, and CBInsights states that 38% of startups fail because they ran out of cash. This shows that finance is one of the top issues that sends companies packing.
You can have the best management team, resources, skills, and goals, but without a solid financial plan, your business is at risk.

The question now is: What does financial planning entail? Financial planning is the cornerstone of a business’s success. It is a strategic approach to ensuring organizational financial stability, growth, and sustainability.

Businesses thrive on profit, and without profit, businesses cannot thrive. Here in this article, we look at what financial planning truly entails, the fundamentals of financial planning that every business owner, whether seasoned or new, ought to know.

What is Financial Planning?

Financial planning is the process of assessing the current financial status of a business to identify and set future financial goals. It doesn’t stop here. It entails designing a strategic framework to manage and achieve the set financial goals through the careful management of finances, optimizing resources, and maximizing revenues.

In simpler terms, a financial plan can be seen as a document that serves as a roadmap for organizational financial growth. It shows the current status of the business, the progress that needs to be made, and the approach to getting it done. It usually includes long-term growth, investment, and financial decisions. It is the blueprint that guides a company’s financial decisions.

To come up with a solid financial plan, you need to get accurate business data, identify the financial indicators of your business, and the key drivers of your business finance.

Financial Indicators of a Business

Understanding these financial indicators helps you get a current, comprehensive view of your business’s financial health, which is essential in laying the foundation for your business financial plan.

1. Sales

Sales refer to the total revenue generated from the sale of goods or services over a specific period. It is the primary source of income for a business. You have to assess your sales level. High sales figures indicate strong demand for the business’s products or services.

If the sales figures keep increasing, it signifies business growth and expansion, but if the sales are decreasing, you need to assess factors such as changes in market demand, competitive pressures, economic factors, ineffective marketing or sales strategies, product issues, or customer dissatisfaction. If you need to change strategy or pricing to align with current market realities, please do so.

2. Profitability

Profitability is a business’s ability to generate profit from its operations. It indicates how effectively a company converts sales into net income. Determining your business’s profitability gives you insight into your business’s operational efficiency, sustainability, and investment potential.

• Key Metrics:
  • Gross Profit Margin: (Gross Profit / Sales Revenue) x 100. This refers to the percentage of revenue left after the cost of goods has been deducted.
  • Operating Profit Margin: (Operating Profit / Sales Revenue) x 100. It indicates the percentage of revenue left after deducting operating expenses.
  • Net Profit Margin: (Net Profit / Sales Revenue) x 100. It represents the percentage of revenue remaining after all expenses, taxes, and interest.

You must understand that profit isn’t the same as cash flow. Cash flow is the actual inflow and outflow of cash within your business. It shows how cash is being generated and used over a while.

3. Liquidity

This refers to your business’s ability to meet its short-term obligations using its most liquid assets. High liquidity shows your business can easily cover its short-term liabilities.

• Key Metrics:
  • Current Ratio: Current Assets/Current Liabilities. When the ratio is above one, you have sufficient assets to cover liabilities.
  • Quick Ratio: (Current Assets – Inventory) / Current Liabilities. Also known as the acid-test ratio, it measures the ability to meet short-term obligations without relying on inventory sales.
  • Cash Flow: This refers to the net amount of cash being transferred into and out of a business. Positive cash flow indicates good liquidity management.

Understanding the Key Drivers of Your Business’s Finance and Customer

Understanding the key drivers of your business’s finances gives you insight into the specific strategy to incorporate into your financial plan.

1. Customer Demand
   Customer demand is the desire for your products or services. High customer demand translates to increased sales and revenue. Also, assessing customer demand helps you understand the value of your business and your market positioning.
2.  Cost Drivers
   Cost drivers are factors that influence the costs associated with producing and delivering your goods or services. These can be variable costs (e.g., raw materials, labor) or fixed costs (e.g., rent, salaries). Understanding your cost drivers helps you effectively control your business expenses and improve profitability. Additionally, it helps you set competitive prices while maintaining margins.

Key Considerations:

• Variable Costs: Track and optimize variable costs such as raw materials, direct labor, and production supplies. Look out for opportunities to increase production volume to reduce per-unit costs.
• Fixed Costs: Monitor fixed costs like rent, utilities, and salaries and explore ways to reduce or optimize them.
• Cost Reduction Initiatives: Explore cost-saving measures such as process improvements, waste reduction, and supplier negotiations.

3. Economic Factors

This refers to external elements that influence your business’s financial performance. It can be macroeconomic conditions, industry trends, or regulatory changes. Stay informed on key economic indicators such as interest rates, inflation rates, trends, and development within your industry. This gives you the insight to modify strategies and adapt to the current realities.

Use of Accurate and Complete Data Inputs

The use of accurate and complete data inputs is fundamental, as it helps you to make informed decisions and draft robust strategies. There are good financial software and tools that can help you automate data collection, analysis, and reporting processes. There are QuickBooks, Sage Intacct, Cube, NetSuite, Xero, etc.

Consideration for Risks: Business and Financial Risks

In drafting a business financial plan, it is important to consider possible business and financial risks that might occur. Business risks are the types of risks that arise from the business environment, operations, and strategic decisions. These include market risks, operational risks, and compliance risks. On the other hand, financial risks are risks relating to the financial health and transactions of the business, such as credit risks, liquidity risks, and market risks (interest rates, and currency fluctuations).

Assess the impact of these risks on your business and develop mitigation plans beforehand. For high-impact risks, develop contingency plans.

Financial Planning Tools: Budgets and Forecasts

After you have identified and understood your business’s financial indicators, and key drivers and have gotten accurate data, the next thing to do is to develop a budget. Effective financial planning relies on key tools like budgets and forecasts. With these tools, you can effectively allocate resources, monitor performance, and adjust strategies to ensure your financial goal is achieved.

ALSO READ: The Finance Function of the Future

A budget is a detailed plan for managing financial resources, controlling costs, and measuring performance against set targets. Forecast offers projections of future financial performance, which helps businesses anticipate changes, make informed strategic decisions, and manage risks.

There are lots of techniques and procedures involved in developing a reliable and solid budget. In this article, we will comprehensively look at the best practices for developing a reliable business budget.

Conclusion

Financial planning is essential for business success, encompassing much more than just setting a budget. It involves a strategic approach to ensure financial stability, growth, and sustainability. Developing a sound financial plan requires you to understand financial indicators like sales, profitability, and liquidity, as well as key drivers such as customer demand, cost drivers, and economic factors. Utilizing accurate data inputs, considering risks, and employing tools like budgets and forecasts help in making informed decisions to ensure long-term business viability and success.