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VIII. The Financial Plan
Developing financial pro-formas or projections is a vital aspect of your business plan. It is important that you take the time to thoroughly research your projections so that they will be as realistic as possible. Be liberal with your expenses and conservative with your revenues. It is much better if your financial surprises are pleasant ones. Too often people try to determine their start-up costs without considering their costs of operation after the business has opened. In order to finance the business properly, determine whether you will need additional cash at the outset to support periods of operating losses that often occur during the early months of operation. With that thought in mind, start the pro-forma with the cash flow statement.

A cash flow statement is nothing more than a presentation of the monthly cash receipts and cash disbursements that you expect to incur while operating your business. It is important to address this on a monthly basis because many businesses pay for their goods and expenses in one month but do not collect the money until the following month, or longer. Numerous businesses fall into this cashflow trap. Also, many of your expenses are going to be fixed expenses; those expenses that stay the same regardless of your sales level. Fixed expenses might be rent, insurance, salaries or contract obligations.

A. The Cash Flow Worksheet
While some businesses may generate “unearned” revenues such as rents, interests, or similar incomes, we will deal with the primary concern of most small businesses, which is sales.

1. Sales – Sales revenue is income your business receives by selling its goods and services to others. Your business may sell more than one type of goods and services, so you should keep your sales figures separated by product or service. Notice on the worksheet (Table 1) how sales are typically lower during the early months of operation. It will take time to develop a customer base for your business, so it will be necessary to borrow enough at the outset to carry the business through this building period. Your first step is to post your projected monthly revenues to your cash flow statement.

2. Cash Receipts – Cash receipts reflect when you actually receive the cash for the goods that you sold. Some of your sales may be for cash, meaning that you received those funds at the time of sale. However, some of your sales may be on credit and you may be required to mail invoices for your sales. If this is true, then you have to “carry” the outstanding cash as accounts receivable. Some of this cash may be received in 30 days, some in 60 days, some longer; some of your accounts receivable may never be collected. All of those considerations must be brought into play when preparing the cash receipts section of your cash flow statement. It is the actual receipt of the cash that determines whether your have the cash on hand to pay your bills.

3. Disbursements – Next, identify the payments you will have to make each month for your expenses. Be careful and realistic while considering these disbursements. The cash flow example on the following page identifies some of the more common expense categories, but each business will experience its own specific expenses.In our example, “material purchases” is the amount that will be paid to suppliers to replace the goods that were sold. It is based upon “sales” and the cost of those sales. Your research should have identified a “cost of goods sold” percentage for you. If that percentage was 50 percent, for example, then your cost of goods sold will be exactly one-half of your gross sales. If your cost was 25 percent, then your cost of goods sold will be one-fourth of your gross sales.Be sure to remember that an increase in sales may bring about an increase in certain disbursements. Sales increases may mean a need to hire additional labor, thus creating higher wages and benefits; it may also mean higher utility costs, higher material costs and increases in other variable costs.

4. Net and Cumulative – Net cash flow reflects the difference between receipts and disbursements, positive or negative, for the current month. The cumulative cash flow, or current position, is determined by adding the present month’s cash flow to that of the previous months.

B. Sources and Uses of Funds
Having completed your cash flow worksheet, you now have some idea of what your sales and operating expenses might be and you can determine how much financing you will need.

5. Sources of Funds – After you have identified your financing needs, address where the funds must come from. Either the investor or investors must provide the necessary capital, or the business must make arrangements to borrow the funds. In most cases, you will use both sources of funds. Our example (Table 2) shows that the entrepreneur has injected $100,000 of his own funds. That is 25 percent of the entire project cost, which is approximately what a bank would require. The remaining 75 percent or $300,000 was arranged through two separate loans: one long-term loan for the land and building and a second, shorter-term loan for the equipment, machinery, and fixtures.

6. Use of Funds – Make a list of what you will need to purchase in order to begin operation and determine the cost of each item. The Sources and Uses of Funds Statement shown in Table 2 gives some of the more common items that you must have before you start operation. Bids need to be secured for any construction, while pricing lists should be provided for equipment, machinery, and inventory. Be sure to ask your local utility company if any deposits are required. Also, refer to your cash flow statement to see if you must prepare for a period of cash shortage.

7. Cash Balance – (Working Capital) – Obviously, the funds remaining after the initial purchases represent your working capital. As shown by the cash flow statement, this additional capital is necessary as a cushion to absorb the negative operating cash flow you have in months 2 - 7 of operation (according to the examples in Table 1).

C. The Income Statement (Profit and Loss Statement)
With the cash flow worksheet completed, the income statement is easy to compile (see Table 3).

8. Sales – Total your monthly sales for each category as shown on your cash flow statement. This figure reflects your total projected annual gross sales. From this figure, deduct any refunds that you gave to customers for returned merchandise. This sum represents your total net sales.

9. Cost Of Goods Sold – This is the cost of the products you sold to your customers. Your beginning inventory ($10,000) is added to any purchases you made during the report period ($118,994) to identify the amount of goods available for sale. Suppose you did not sell everything you had available for sale. At the end of this period you counted your inventory on hand and found that you still had $10,000 of inventory on the date that you prepared this report. Your goods available for sale minus your ending inventory produces the total cost of goods sold (total material costs). In the example, that amounts to $118,994 ($128,994 minus $10,000 of ending inventory).

10. General and Administrative Expenses – These are the annual totals of the expenses as listed on the cash flow statement. Note that there are some changes. Payment of the principal portion of your notes is not considered an expense. It will be accounted for later on your balance sheet but does not appear on the income statement. Also, note the addition of an expense category termed “depreciation”. This is not considered on your cash flow statement because you don’t write a check to depreciation. The purpose of depreciation is to account for the fact that your assets will begin to wear out as you use them. A certain piece of equipment may be expected to last for 10 years, for example. If that equipment cost you $1,000 at purchase and will be worn out or worthless in 10 years, it is said to “depreciate” $100 per year. In our example the building, equipment, machinery, etc., is depreciated by $11,400 per year. You don’t actually write a check for the $11,400, but your assets have devalued by that amount.11. Net Income (Pre-Tax) – Net sales minus material costs and operating costs gives us the net income of the business. However, this amount does not include the payment of taxes on the profit made.

12. Taxes – If you have made a profit operating your business, you will be expected to pay both state and federal income taxes. This aspect of your business should be discussed thoroughly with your accountant.

13. Net Income (After Tax) – After taxes have been paid, the remaining profit belongs to your business in the form of retained earnings.

D. The Balance Sheet
The balance sheet is a comparison of the assets, liabilities, and equity of your business. The one shown in Table 4 is a very basic example of a small business balance sheet.

14. Current Assets
– These are assets that are considered to be liquid or easily converted into cash. The cumulative cash of the business (#4) is listed along with the ending inventory (#9) and accounts receivable – as well as other similar assets – to form the current assets portion. The ending inventory is a listing of the goods held for sale at the end of your accounting period and the accounts receivable is a listing of what is owed to you by your customers for previous purchases.

15. Fixed Assets – The second category of assets is fixed assets. This is a listing of the assets that are long-term in nature (brick and mortar type assets). It is these assets that depreciate in value over a longer period. Depreciation ($11,400) for past periods is therefore deducted from the sum of these assets and shown on the balance sheet as accumulated depreciation.

16. Other Assets – This is a catchall section for other assets such as deposits held by utility companies.

17. Total Assets – This is simply the sum of current, fixed, and other assets (categories 14, 15 and 16).Liabilities.

18. Current Liabilities – Current liabilities are bills and accounts that you must pay within the next year. (Short-term notes or accounts payable are examples). Also considered to be a current liability is that portion of any long-term note that must be paid during the upcoming year. This figure can be provided by your banker, accountant, or your amortization schedule of notes payable.

19. Long-Term Liabilities – Long-term liabilities are the long-term financial commitments your business has made to the bank or other debt holders. If additional debt is not incurred, the “loans payable” section will decrease each year by the amount of principal payments made during the period. In the example in Table 4, the original debt of $300,000 – as shown in the Sources and Uses of Funds Section – is now reduced to a balance due of $291,503. Therefore, $8,497 in principal was paid during that first year of operation ($300,000 minus $291,501). Also, note that $9,447 is deducted and shown as less current portion. That is because it is the portion of long-term principal that will be paid during the upcoming year and it is therefore considered to be a current liability and is listed under that category.

20. Total Liabilities – This is the sum of long-term liabilities.

21. Equity
– The equity section reflects your original investment (#5) as well as the accumulation of profits (#13) of the business (retained earnings).
22. Total Liabilities & Equity
– The sum of your liabilities and equity when added together should equal your assets. Do they balance? If not, you have an error in one of your sections.