Today I’m going to talk about financial planning. So prepare yourself for some sweeping generalisations :p
Last time we looked at what a financial model is in general terms. So how does this compare to traditional financial planning? In small businesses and startups, planning often takes a back seat to hard work and the pursuit of new opportunities. When planning is done it tends to be quite different to modelling, but the data to do modelling is all there.
Typically, most new businesses and startups will recognise a financial plan as…
“The page of numbers tacked on the end of my ‘Business Plan’ document.”
Ok, so I’m a bit derisive above… I’m sorry – there are some really great business plan templates out there. I spend all day in a financial environment and so planning is really important to me. But in a lot of business plan templates I’ve seen it seems to be an afterthought, rather than the main event. And this, to me, is a problem.
This is because the numbers should be even more important to startups than they are to me. Why is it then that the financial section of a business plan often feels so lightweight?
Something I’ve heard expressed a lot around this kind of planning is that it’s “just guesswork”. To be honest, this is exactly what I would have thought 6 years ago. “How can I plan what I am going to make, the business hasn’t even started yet!” If you’ve got a raw startup, with no comparative data from competitors, then it can be intimidating to imagine what your revenue will be like.
But even if you don’t know if you’re going to be making £10 or £10,000 in your first month, there will be some figures you do know.
A business’ costs, either regular or one-off can be predicted. Having a set of expected costs over time provides some certainty around the funding the business will need and the effects of low/high revenue on the business’ short term survivability. Now this, thankfully, is something encouraged by most financial planning templates.
While you may not know how well your products will perform, you can gauge the costs of starting up, keeping the lights on, and the direct costs of making sales. Instead of following this up with a single estimate of your revenue, you need to make several estimates of revenue to represent different conditions. The amount of revenue will also affect any direct costs of selling that you have, and the amount of funding you require, which in turn affects the capital and/or interest you’ll be paying on top of your normal business costs.
What a lot of financial plan templates don’t encourage enough is testing your business, and showing it in different lights. Planning what will happen based on one set of expectations is not great planning. It does not cover best and worst-case scenarios, and it’s hard to ask meaningful questions of such an inflexible forecast. Cash flow problems are the biggest killer of new businesses out there, and any great financial plan needs to be able to identify these dangers before they become a reality.
This is where a lot of financial plans fall down – because they produce a single static output, or at best a set of outputs based on general assumptions. What plans inherently lack is flexibility. It’s hard to ask bold new questions of a financial plan without going away and remaking the plan. With a financial model however, the data is all there – you just need to ask questions of it.
In the next article, I’m going to be talking about the specifics how financial modelling can help being some clarity to business planning.