The Importance of Financial Planning

Financial planning for your business plan is another essential step, and one that you must learn to do well. Often in business we say that we should delegate the things that we are not good at, but as the owner you must have a basic understanding of financial management to make sure that your business is viable and that you know where you stand financially at all times.    

When it comes to writing the financial projections for your business plan, you will need to work with an accountant. The person you choose should understand your industry, the challenges of new business, tax planning, and the needs of the audience you are preparing your business plan for (whether you are applying for funding through a bank, a grant, etc.).    

If your financial projections are too optimistic, they won’t hold credibility to your investors or banker. Gather some average industry ratios and work with your accountant to make sure your projections are realistic. You’ll need to include and be familiar with terms like profit and loss, cash flow, balance sheet, and break-even. We’ll explore those terms and key financial reports throughout this session.   Depending on the purpose of your business plan, you may need to create one, three, and five year projections. This will be the focus of the final part of this session. 

  What is Finance? 

The Encarta Dictionary defines finance as, “the business or art of managing the monetary resources of an organization, country, or person.” Bookkeeping, banking, and accounting are all separate processes with their own definitions.    

 Seth Godin describes finance as a three-cycle process that continues endlessly:   

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 Recording Financial Transactions

 Bookkeeping is the exercise of identifying, categorizing, and recording all the transactions that take place in a business.

 In general, everything a company does results in a bookkeeping transaction, including things that take place between the business and:

 o Customers, who buy products and services sold by the business

 o Employees, who are paid wages and provided benefits 

o Vendors, who sell services, equipment, and supplies to the business 

o Government agencies, who collect taxes from the business 

o Sources of equity capital (investors or owners who put money in and take it out of the business) 

o Sources of debt capital (banks and lending institutions)   

Accounting, on the other hand, is the methodology used to record the transactions and prepare financial statements and reports. Accounting guidelines govern how businesses record transactions. They also dictate the design of the recordkeeping system that a business uses and how reports are prepared, based on the information gathered and put into the system.    

 General Accepted Accounting Principles (GAAP)

 Accounting is simply a measurement. Measurements allow for consistency. Just like everyone knows what one foot (or 30 centimeters) of distance is, the business owner (or CEO) and all stakeholders should be confident that they know what a company’s assets are. The accounting concepts and standards that govern consistency are called generally accepted accounting principles (GAAP).    

There can be slight differences between regions, but GAAP typically includes the following principles: 

o Comparability among different companies. 

o Reliability of information. 

o The business entity concept: A business is a separate distinct entity from its owner/owners. 

o The matching principle: Earnings and expenses must be recorded in the same accounting period that they relate to each other. 

o The cost principle: Assets and service, and the resulting liability, are taken into the accounting records at cost. 

o The consistency principle: A company’s accounting procedures need to remain consistent over time. If they are changed, the reasons for the change and the financial impact of the change must be documented in detail. 

o The time period principle: The operating period of the business is divided into equal periods of time, such as a month or a quarter. 

o The going-concern principle: The business will continue to operate, using its assets to carry on its operations and, with the exception of merchandise, not offering the assets for sale that are necessary to run the business. 

o The objectivity principle: Whenever possible, the amounts used in recording transactions are based upon objective evidence rather than on subjective judgments.

o The stable currency assumption: The idea that the purchasing power of the unit of measure used in accounting (such as the dollar or the euro) does not change. (In other words, a dollar bill will not become worthless overnight.) 

o The realization principle: This principle defines revenue as an inflow of assets (not necessarily cash) in exchange for goods or services. It requires the revenue to be recognized at the time, but not before it is earned.    

In the next article Business Planning - Developing Financial Projections 2 we will cover Key Reports and Financial Projections - Don't miss it, Follow me @paulag

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