Financial Planning for Small Business Owners

There is a lot more to small business success than just sales. A profitable business may not be able to pay its suppliers or find the cash to pay the taxes or other debts. There are many reasons for this, and a lack of strategic financial planning is often the primary reason.

A financial plan creates a framework to help a small business owner understand the overall financial ins and outs of their business. The plan helps business owners understand the ebb and flow of their business and the cash it generates. More importantly, it prepares the small business owner to understand the financial decisions they will need to make to ensure the long-term viability of their business.

Financial plans are imperative regardless of the nature and size of your business. The plan helps fortify your business.

What Is Financial Planning for a Small Business?

Financial planning is the process of organizing and allocating a business’s financial resources to achieve the business goals and objectives.

Budgeting for a single year is not financial planning. Financial planning structures a company’s future with regard to revenue, expenditure, cash flow, savings, taxes, debt, investments, protection from risks, expansion, and the owner’s financial goals.

Financial planning provides structure to the company’s finances. With financial plan in place, the owner can plan for capital expenditures and cash outflows in advance.

Why Financial Planning Matters

High sales do not indicate the health of a business’s finances. A business may have lots of customers and still be financially unstable if the customers pay invoices by unfortunately timed large cash outflows, unexpected large cash inflows, high cash outflows due to raw material inventory, or large tax outflows.

Financial planning helps the owner determine if the business is prepared to expand and set up an emergency fund. Further, the plan helps the owner reduce the company’s spending and plan for taxes and loans.

1. Separate Personal and Business Finances

Separating personal and business financial transactions is an essential aspect of managing a business.

The primary account through which a business accepts and makes payments is a business banking account. Likewise, a consistent and systematic approach to business owner compensation is also essential to the financial management of the business.

When personal and business financial transactions are separate, it aids the bookkeeping process and allows the business owner to gauge the financial health of the business. Furthermore, separation of financial transactions is essential when business financial records are requested and/or submitted by business owners to accountants, banks, investors and tax authorities.

2. Create a Realistic Business Budget

The other essential financial management skill is the development of a realistic business budget. A business budget is the plan for the expected business financial expenses and revenues for a given period.

To develop a business budget, it is important that the business owner understand the expected financial obligations (expenses) for a given period. Business expenses include rent, employee compensation, office and business supplies, utilities, marketing and advertising costs, and the cost of goods sold (COGS).

Business budgets should be reviewed and revised. Revenues and expenses may change unexpectedly and materially from the budgeted amounts. Business budgets should be re-forecast to reflect management's best expectation.

3. Prioritize Cash Flow Management

Although profit and cash flow are closely related, they are different financial measures of a business. A business may report a profit but may be cash flow negative. This is the case when customers pay for the business' products and services after the business has incurred the expense to provide the good and/or service.

A cash flow positive business may need improvement in its processes and systems for collecting cash from customers, making payments to suppliers, and/or controlling the level of business inventory. These, among other strategic initiatives, will improve the cash flow of a business.

Cash flow forecasts are helpful to a business because they project cash receipts and disbursements and therefore enable a business to plan for potential cash shortages.

4. Build an Emergency Business Fund

It is inevitable in business that there will be surprises and setbacks. Transactions can be lost due to a competitor getting the sale first or equipment can break down. It is a good practice to plan for the unexpected by creating an emergency business fund.

One approach to planning for the unexpected is to save enough cash to cover three to six months of routine business expenses. This approach will vary by business. A business with high and variable business expense will require a larger emergency fund compared to a stable and predictable business.

5. Review Key Financial Statements

Business owners do not need to know accounting to be successful. However, a basic knowledge of financial reports is necessary to assess the health of the business. The reports indicate the profitability and cash position of the business.

The cash position of the business can be determined by evaluating the cash flow statement. This statement indicates the cash received and paid out by the business during a specific time period.

The financial position of the business can be evaluated using the balance sheet. This report indicates the business' assets and liabilities.

The profitability of the business can be evaluated using the income statement. This report indicates the revenue and the expenses of the business.

6. Manage Business Debt Carefully

A business owner’s familiarity with financial statements enables them to make intelligent business decisions such as limiting business expenses and making smart business investments.

Borrowing money is essential for a business to purchase new equipment or to fund an expansion.

However, there are negative consequences if a business repeatedly borrows money to cover operating expenses. This generally indicates that a business has poor cash flow management.

If a business absolutely needs to obtain a loan, the business must carefully evaluate the costs of the loan and the impact the loan will have on the business' cash flow.

Debt should only be used to fund business expansion to support the achievement of the business' strategic goals.

7. Reinvest in Business Growth

Earnings can be used to enhance a business.

After settling business expenses and taxes, and setting aside cash to meet the business' obligations and reserves, the business can fund enhancements that will improve the business's future.

Funds can be used to purchase or develop business assets, automate business processes, enhance the business' customer relationship and/or business management systems, and expand the business to new locations.

8. Plan for Taxes Throughout the Year

Taxes should be planned for in the year the taxes are payable.

A business should keep a complete and accurate record of all the business's transactions. Based on the transactional records, the business should estimate the amount of taxes that will be payable in the future. The business should set aside the estimated taxes.

In a well-organized business, the records pertaining to the operation and finances of the business will be integrated. Digital accounting systems can help achieve integration.

Tax obligations are determined by the jurisdiction and the type of business. So, the particular choices a business makes may need input from an accountant or tax professional.

9. Protect the Business Against Risk

Protect the Assets and Operations of the Business

As a business grows, it may be prudent for a business owner to protect the business assets and operations.

Insurance is a type of risk management. Other forms may be the use of secure servers and backup systems. The types of risk management a business operates needs to consider are largely dependent on the nature of the business.

A business owner can determine if financial management is needed by evaluating the major business risks.

10. Prepare Financially for Expansion

The financial situation of the business should allow the business to expand. Before launching a new product or service, opening a new business location, or expanding to a new geographic location, the business should determine if it is financially prudent to do so. Some of the questions to consider may be, do we have the financial allocate resources to hire more employees? Do we have the financial resources to purchase more equipment? Can we produce and sell enough of the product or service to support the new expansion?

Common Financial Mistakes to Avoid

Some problems slowly and quietly get worse in a business and become unexpected crises.

Some of these problems are rapid turnover of profits, chaos in the books (or no books at all), selling services or goods at prices below costs, carrying too much merchandise, failing to plan for taxes, unexpected costs business emergencies, and borrowing money.

It is a common mistake to concentrate solely on sales figures, failing to analyze the expenses and profits, cash on hand, and debts.

Although sales are necessary for business health, a business is not stronger if larger sales are made at the cost of larger business losses.

How Technology Supports Financial Planning

There are several business management programs and applications which help with business cash flows and other financial management functions.

These programs can help with collections, payments, and cash flow. Some of these programs aid in the management of business inventories. With these programs, business management becomes less labor intensive and real time consuming.

The goal is not to incorporate more technology for technologies’ sake. Ideally, the technology should provide the business owner with timely and accurate information to assist in the making of business informed decisions.

Financial Planning and Personal Wealth

Often, the finances of a business owner and their business are not fully separate. However, relying too much on the business for wealth creation can be risky.

A business owner needs to determine their personal wealth and financial security, including savings and retirement, through investments and insurance. Along with business planning, a business owner should have a succession and an estate plan.

It is important to plan financially to ensure that the business owner and their family are not financially impacted if the business owners are no longer able to work due to an unforeseen event.

A Simple Financial Planning Checklist

A good starting point for a financial plan is to review personal and business finances at least once a quarter. This should include cash flow, debt, investments, tax and retirement planning, major financial performance goals, and reviews of financial statements.

An over-elaborate plan is of little use if it is not regularly reviewed.

Final Thoughts

Financial planning helps small business owners see where their business is now and what future possibilities and constraints may be.

Finances are integrated and interconnected with many areas of a business. Therefore, strategies and plans associated with financial management may include budgeting and cash flow management, saving for and management of debt and emergency funds, tax and expense management, and investment and risk management.

Not every financial management strategy needs to be implemented. Initially, concentrating on expense control and cash flow management may be more beneficial. Also, a business owner should know the company’s key financial numbers and priorities.

A financial management plan should be updated and changed to align with the business plan.

A business should have numerous sources of and ways to generate revenue. Long-term business health and viability may depend on the company’s ability to control the cash flowing through the business and to manage the risk and investment associated with the business.