The finance section of a business plan should cover at least the following items:
- Financial performance metrics
- Financial projections for first 5 years
- Barriers to entry
- Capital requirements
- Use of funds
- Exit plan
- Risk
- Intellectual property
Financial performance metrics
A business is a system. The financial performance metrics help the managers and owners of the business understand if the system is in good shape or if some parts of it need improvement. The more complex a business is, the more important these financial metrics become. Here are some examples of metrics that businesses track.
- Growth rate
- Cost of goods sold, as a percentage of sales price
- Marginal revenue
- Marginal profit
- Customer acquisition cost
- Customer lifetime value
- Customer turnover rate (also called churn)
- Employee turnover rate
- Employee onboarding time
If something doesn’t apply to your business, don’t waste time tracking it. If there’s a unique aspect of your business, find or make up a metric to track it. This is a list of the metrics themselves to describe how you will be managing the business. In addition to the list, it may be helpful to know what numbers are typical in your industry so you know what to expect and so you know where your strengths or weaknesses are in comparison to your competitors. If sample data isn’t available, make a guess at what you think it will be.
Financial projections for first 5 years
A financial projection is essentially a guess about the future. It is understood that things may not happen the way you expect. When you don’t have all the information required to make a projection, you’ll need to make up a number. It’s easy to overestimate future successes and underestimate future problems, and this is problematic because when we’re thinking everything will go swimmingly we might fail to adequately plan and this can become disaster for everyone involved in the business. For this reason, people are interested in conservative projections, which means projections in which the successes are not overestimated and the problems are not underestimated.
One way to present the financial projections is to create a series of projected income statements, one for each of the first 5 years of the business. You can add tables, graphs, or charts that highlight some aspects of the projections and how they relate to each other or how they change over time.
There are some milestones you should highlight even if they are not projected to happen in the first 5 years: when you expect the business to become self-sustaining, and when you expect the business to finish paying off any startup loans.
Why 5 years? Because most new businesses fail within the first 5 years. The first two years are critical because about 20% of new businesses fail in the first year and about 30% of them fail in the second year. Most of the rest fail in the next 3 years. If your business can make it successfully past 5 years, you might have something there.
Barriers to entry
A barrier to entry is any obstacle that is in the path between starting a new business and successfully establishing that business in the market. It can be a combination of anything required to establish the business including time, money, knowledge, skills, expertise, connections, location, vehicles, buildings, technology, or having certain operational capabilities.
The effective barrier to entry is the difference between what you or your team’s starting point and the market’s barrier to entry.
In this section, you need to list the barriers to entry and then for each one describe whether it is or isn’t a barrier for you or your team, or how you plan to overcome it.
Learn more about barriers to entry.
Capital requirements
This section of the business plan answers the following questions: How much money is needed to start the business? How much money is needed to continue operating the business until it becomes self-sustaining?
To figure out how much money is needed to start the business, add up all the one-time costs that will be incurred before the business starts collecting revenue from customers.
A capital expenditure budget is like a schedule of one-time costs that will be incurred before and after the business starts. For example, you might need to buy equipment for a single lemonade stand to start, but you plan to buy more equipment later to set up additional lemonade stands. These are one-time costs but they might be spread out over time to reduce risk and to better manage your available cash. This plan of what to purchase and when is the capital expenditure budget or capital expenditure plan.
To figure out how much money is needed to continue operating the business until it becomes self-sustaining, look at the financial projections and add up all the losses until the business becomes profitable enough to 1) cover all its operating expenses, 2) make all loan payments and tax payments, and 3) have enough cash on hand that can be used to self-finance the next inventory purchase, the next marketing campaign, write the next app, or whatever the business does routinely that might require cash to be spent ahead of collecting revenue. This is the operating expense budget.
The capital required to start a business can come from a variety of sources such as your own savings account, family and friends, investors, and lenders. A financing plan outlines how much you will seek and from where (which sources). For example, you might need $100 to start your business, you have $5 in your pocket, you plan to get $10 from friends and family, another $25 from investors, and borrow $60 from the bank.
Something that is easy to overlook about capital requirements is that they are requirements, not wishes. If you know you need $100 to start a business but you’re only able to raise $99, you will need to make a choice about whether to risk starting the business with insufficient funds, which makes it more likely to fail, or to return all the money you raised and explain that you weren’t able to raise enough to get the business started. There’s no shame in that. Your investors will probably appreciate that you didn’t want to risk their money when it turned out that chances of failing were much higher than initially expected. Here’s the important part: If you think you can still make it with $99, then your capital requirements were actually $99, and your initial number of $100 was inflated. It’s a good idea to include a little inflation or “cushion” in the numbers in case reality happens differently than your estimates, but you need to call it out specifically. For example, if your capital requirements are $95 and you add a $5 cushion, your fundraising goal is then $100 and if you only raise $99 then you’ve met your capital requirements and most of your $5 cushion, so you can proceed so start the business and you’d be in good shape.
Most businesses fail within the first 5 years, and of these about 40% fail due to exhausting their cash reserves or their inability to secure additional capital when needed. That means if you get your capital requirements right, your chances of success increase significantly.
Use of funds
A use of funds statement describes how to plan to use the capital you raise. Although some of this might be obvious from everything else you’ve written, the use of funds statement summarizes the other information and provides insight to the reader about your focus and strategy. For example, the investor money might be used for some capital expenses and initial operating expenses, and then you plan to use generated revenue and bank loans to cover ongoing operating expenses while you use the remaining investor capital to expand the business with more marketing and more capital expenses (such as opening additional locations).
Exit plan
This section of the business plan answers the following questions: When and how will you get out of the business? When and how will your investors get their money back?
The two most obvious ways to exit a business are to sell it to someone else or to dissolve it.
Selling to someone else can take a variety of forms: private sale of equity to someone else, being acquired by another business, becoming a publicly traded company, or becoming an employee-owned company.
Dissolving the business is generally accomplished by selling all the assets, separating all the people, paying all the debts and final expenses, and informing the secretary of state that it’s done.
Risk
Every business faces a variety of risks to its continued operation. Some of these risks can be mitigated, and some cannot. In the business plan, you need to outline all the significant and relevant risks that could impact your ability to stay in business and execute your plan all the way to the exit. Some risks are common to most businesses, some risks are common or even inherent in an industry, some risks are due to the location, and some risks arise from the decisions you make.
For example:
- If you’re running a lemonade stand, one risk could be that someone chokes on a seed; you can mitigate it by using a filter when you pour a cup
- If you’re a real estate developer, one risk could be that there is an economic downturn just when you finish construction and there are no buyers; maybe this is a risk that cannot be mitigated
- If you’re building a gym, one risk could be that people hurt themselves with the equipment; you can mitigate it by teaching classes, posting safety signage, and purchasing insurance
Here is a list of risk categories to consider whether they apply to your business and if so, to figure out the likelihood and severity of an incident:
- Operational risk. This could be related to not finding the right people to hire or experiencing high employment turnover, to failures in systems, to ineffective or inefficient processes, or external events like a natural disaster impacting the facilities or employees.
- Strategic risk. This could be related to an error in strategy causing the business to fail to achieve its goals.
- Regulatory risk. This could be related to the government enacting new laws that affect your business, or lack of clarity regarding whether existing laws or regulations apply or don’t apply to your business.
- Market risk. This could be related to not achieving product-market fit, or to customer needs changing after you’ve already invested in a product, or to a change in customer purchasing power or any other force or event which decreases demand such as an outbreak of disease or war, or to an unexpected increase in competition.
- Security risk. This could be related to physical security or cyber security.
- Reputational risk. This could be related to announcements, decisions, or actions that are poorly received by the public and can decrease brand loyalty or repel potential new customers.
- Political risk. This could be related to a drastic change in government policy after elections or to becoming the target of hostile politicians.
Intellectual property
Some businesses obtain trademarks and patents. If your business requires these, outline what is needed in this section. If you already have them, mention that too. If you don’t have them, estimate the time and cost to get them.
Compass
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