Let’s Walk Through the Basics
When you first started dreaming about opening a small business—you probably weren’t fantasizing about spreadsheets. Or really any financial analysis for that matter.
But behind every feasible, profitable, full-of-potential new enterprise, there are a lot of numbers to crunch.
Luckily, the equations that make up the backbone of your small business plan aren’t advanced calculus. They’re simple projections, and assumptions, every entrepreneur can wrap their heads around, as they work to set their start up, up for success. Here are a few pointers for the three major components of your small business plan’s financial analysis.
A disclaimer: if you want to do a thorough, deep-dive, forecast for your business’s financial growth, it might be worthwhile to solicit the help of a professional. But if you just want to pulse-check your businesses’ viability, or get a better sense of pricing and profits, here are a few basics you should have in your back pocket.
Why should I conduct a financial analysis?
Your financial analysis is one of your business plan’s core components. And there are a few main reasons to have it on the top of your priorities list:
- Projections for your businesses’ financial success are, as you would guess, a big deal for potential investors. Having these numbers crunched goes along way towards securing the favor of potential loans, grants, and funding.
- How much should you charge? Are you pricing your goods and services to reach an adequate profit margin? An optimal profit margin? Your financial analysis helps you calculate this.
- Should you stock more resources? Expand to another location? Cut back on your supply? Knowing your costs and their impact on revenue is key—and should be outlined within your financial analysis.
- Is your business in a good place to mitigate potential risks? What can you safely project for future earnings? Key equations within your financial analysis help you plan for the future.
Your financial analysis’ four most essential ingredients:
Your bare minimum financial analysis should contain a few key ingredients. We’ll break these down piece by piece—but a quick overview:
A balance sheet: A balance sheet covers your assumed and anticipated business assets, liabilities, and equity.
A cash flow statement: Your cash flow projects the cash coming in based on sales forecasts, minus the cash expenses you anticipate.
Your income statement: Over a certain period of time (usually a year, or a quarter), you should project your businesses total earnings, minus its total costs.
Writing your balance sheet:
Your balance sheet acts as a snapshot of your business’s health at a specific time. You may hear it addressed in contrast to a “profit and loss” sheet—which demonstrates how your business fairs over a specific duration.
At its core, your balance sheet is pretty straightforward. It’s a “net worth” compilation of your existing and projected assets and liabilities.
|Assets: the value of the things you “have”|
|Liabilities: the costs you owe|
– Credit cards
– Payments to vendors
In some cases, you may be asked to compile a second balance sheet that includes loans you’re soliciting.
Determining the networth of your assets is simple addition. It’s the monetary value of all the items and earnings listed above. Liabilities are calculated the same way.
Once you have your assets and liabilities outlined, your equity is easy to calculate. Your total equity is equal to your assets, minus your liabilities.
|Example: My Ice Cream Shoppe|
My Ice Cream Shoppe calculate the value of all their current assets—the cash they’re starting out with and have generated through sales, the value of their freezers, and point-of-sale systems, and serving dishes, and uniforms.
Then calculate the monetary value of what they owe—the rent that’s due, the insurance on their equipment, and the loans they need to pay back.
At the time of calculation, their total assets are $52,100, and their total liabilities are $25,700.
Meaning their current equity is:
Writing your cash flow statements:
At this point within your business plan, you’ll have to start making something assumptions.
But once you have your estimates in place—putting together a cash-flow statement should be relatively intuitive.
|A note on making assumptions: |
Filing your taxes and writing your business plan are very different processes. When you’re doing formal accounting—having your numbers “down-to-the-decimal” correct is paramount. When you’re writing a business plan, you’re summarizing, aggregating, and in the end, educated guessing.
So your numbers don’t have to be perfect, but they should be realistic. You’re not going to make a profit of $4.95 on every $5.00 cup of ice cream—and you’re not going to sell 120,000 scoops on an 8-hour, December day. Look at what you can dig up for past results, or results for other businesses in your industry. Make smart guesses that will make your business look attractive—and you’re projected cash flow plausible.
A quick warning: a cash-flow statement is different than your projected profits. In most cases you’ll have to buy inventory, or put down costs, before you start bringing money in. So even if your profits may come to one figure—timing may have it such that your actual cash flow is lower.
If you want to estimate your cash flow—you’ll need three figures first: your sales forecast, your cash disbursements, and the reconciliation of those two stats. There are a few more robust ways to calculate your cash flow, if you have the metrics already to drill down into specifics. But if you’re just starting out, and working on an estimation, this is probably your best predictive bet.
To get a general sense of your sales forecast you’ll need:
Calculating your sales forecast, or cash revenues:
- Your projected unit sales
- Projected unit pricing
- Unit costs
This can quickly get to be a lot of multiplication—so we’ll start with a simple example.
|Example: My Ice Cream Shoppe |
Projected unit pricing for a single scoop: $3.00
Projected unit costs for a single scoop: $1.50
Projected unit sales for June: 4,720
($3.00*4,720)-($1.50*4,720) = $7,080
Your sales forecast for this item in June is: $7,080
Do this for your other products, to get a total revenue count for the month. Let’s say the ice cream shop sells a few other sweets (sundaes, cakes, waffle cones) at a similar profit margin—and their total sales forecast comes to $21,000.
Calculating your cash disbursements:
Since you already have your balance sheet, this should be a piece of cake. Your cash disbursements are the various expense categories from your ledger, and all the cash expenditures you expect to pay that month. Add these up to get your total “cash-flow out” for the month.
|Example: My Ice Cream Shoppe|
Outside of the per unit costs, factored into the shop’s sales forecast, there are a few regular cash payments they make every month.
Calculating the reconciliation / your cash flow:
Your basic cash flow for the month is then:
|Your cash revenues that month – your cash disbursements that month|
Or, for My Ice Cream Shoppe:
$21,000 – $9,650 = $11,350
But, as you calculate your cash flow throughout the year, you have to carry over (or “reconcile) the opening balance from previous months.
Let’s say My Ice Cream Shoppe had a series of high cost-expenses in May, and started June with a cash deficit.
|Opening balance in May: $-5240.00|
Cash Flow for June:
$-5,240 + $21,000 – $9,650 = $6,110
And $6,110.00 would carry over to the following month.
Your income statement:
Your income statement is what it sounds like. It’s a lot of the same ground work you’ve already done—but at a larger scale. You’ll use the numbers you’ve put in your sales forecast, cash flow statement, and sales disbursements spreadsheets—and use them to extrapolate potential income for the coming years (the best practice is 3 years).
Here, you’ll have to make a few key assumptions—as you consider the role of taxes and interest. But in general, your net profit, or calculated as:
|Your sales – your cost of sales = your margin|
Your margin – (expenses + interest + taxes) = net profit.
|Looking at the cash flow statements, and projecting an industry appropriate margin of growth, My Ice Cream Shoppe predicts total sales forecast, or margin, of $900,000. They predict expenses will stay relatively consistent, and come to about $367,500. |
Their profits, therefore, before interest and taxes are equal to:
To calculate their final profits they expect to pay 10% in interest and 25% in taxes. Therefore, to get their 3 year income statement, they conclude:
$900,000 – (367,500 + (532,500*.10) + (532,500.25)) = $346,125
Summing it up: mastering your business’ financial analysis (and future )
A more robust financial analysis may have additional equations and projections. But once you have your assets and liabilities outlined, your sales forecast projected, your expenses understood, and your net profits calculated—you’re in a good place.
You know “what you’ll have to spend” and “what you can hope to make.” And you’ll be able to use those metrics to evaluate pricing, gain the trust of investors, and giving your business the quantitative foundations it needs.
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