Financial Plan

The is the tenth article in a series of posts focused on deconstructing the essential elements of creating a Business Plan. 

 

Business Planning Articles:

 

Business Plan Introduction

The Executive Summary

General Company Description

Product & Services

Marketing Plan

Operational Plan

Management & Organization

Startup Expenses & Capitalization

Valuation & Ask

Financial Plan

Appendixes

Refining Your Plan

 

 

The Financial Plan Essentials

 

The tenth and last part of your business plan involves formulating the financial plan for your business.

Within this section entrepreneurs are expected to include a number of financial statements;

 

A. A 12 Month Profit & Loss Statement

B. A Four-Year Income Statement

C. A Cash Flow Projection

D. A projected Balance Sheet

E. A Break-Even Analysis. 

 

Together these statements constitute reasonable estimations of your company's finical future.

Accompanying these statements should be detailed explanations on the assumptions used to calculate the projections and financial results across every statement. 

More important than the actual statements, the exercise of thinking through and developing your financial plan will improve your insight into the financial mechanisms and potential of your company. 

Here, we analyze each finical statement to provide practical insights of how to construct each statement and why they matter. 

 

12 Month Profit & Loss

 

The first statement of your financial plan, the 12 month Profit & Loss Statement, demonstrates how your business will generate income and whether the company made or can make a profit or will incur a loss during12 months of operations reported in the statement. 

In most cases the projection should be a forward looking analysis, however for business that are already generating income it is common to include the financial data of the current year with future projections. 

The profit & loss analysis is mean to offer an idea to the reader, including investors, how much initial investment is required and the time it will take before your business begins generate a profit.

For companies with ongoing operations this analysis may be useful to determine the viability of developing a new product, a new product line, or of entering a new product category. 

For startups the analysis demonstrate how much investment it will take to support the company at a  loss before the business generates income.

Structurally, the profit & loss statement is analogous to an income statement and relates all of the company’s expenses and revenues during a particular period. In this case specific case, month-by-month over the course of a year. 

For revenue generating startups, the financial data provided in a profit & loss statement indicates how revenues, the money received from the sale of a product/service before expenses are taken out (the “top line”) is transformed into net income, which represents the result of subtracting all expenses against revenues, including write-offs, depreciation, amortization and taxes, commonly known as net profit (the “bottom line”). 

Imbedded in your Profit & Loss statement are 3 fundamental month-by-month forecasts; a projections of Sales, a projection of Costs of Goods Sold, and a projection of Overhead Costs. 

The results of these projections dictate whether or not your business will generate profit or a loss. 

 

1. Sales Forecast

 

The sales forecast is in many ways the most difficult part of the company's economic performance to forecast, particularly for startups. 

Depending on your type of business, starting at a sales level that would make your business break-even is a good place to start the sales forecast. 

For existing businesses, start with your sales history and follow the trends the data reveals. Take the upward or downward sales trend into account, and modify the forecast to reflect the impact of any introduction or subtraction of new products/services on the future sales of your business.

It is important to remember that a Sales forecast is a goal you set for your business, and that you proactively try to achieve.

A sales forecast can be approached in 2 ways:

 

A. Forecasting using the Unit Method

 

Under this approach, list all the products & service you plan to market and forecast how many units of each solution you plan to sell. Different industries apply different metrics to measure units, so use whatever standard in your industry commonly adopts. 

Then, estimate the selling price of each unit by applying the following formula:

 

Price Per Unit  xNumber of Units Sold  =  Revenue

 

It is important to keep in mind that the pricing data provided in your Marketing Plan and the production strategy explained in your Operating Plan must support the financial data provided in your sales projection. 

Consistency across your business plan is essential. Without it the reader and/or investors will believe that you have not taken the exercise seriously or are ill-equipped to develop such a comprehensive analysis. 

 

B. Forecasting With Sales Method 

 

Some business cannot reasonably use unit sales. Sometimes it is impossible to predict the unit sales for each item your company markets, particularly if your businesses holds a large inventory of a great a variety of items, for instance a pharmacy. In this cases, entrepreneurs should adopt a revenue forecast. 

If your business is broken down into logical departments or categories, forecast the revenue of each category and tally them up to produce a revenue forecast which can serve as your sales forecast.

The formula is rather simple:

 

Category A Expected Revenue  +  Category B Expected Revenue  +  etc...

=  Total Revenue  

 

To produce a logical forecast compare your business to competitors of similar market size and use their performance sales and/or revenue data as a guide for your projection. 

 

 

2. Cost of Goods Forecast. 

 

The Cost of Goods Forecast relates directly to the sales forecast because it represents all of the costs associated with producing the good/service your company markets. Simplified as COGS, the forecast varies directly with the level of sales your business achieves. 

The fewer product or services your business produces, the lower the cost of goods sold, and vis versa. 

There are 2 ways to calculate the cost of goods forecast, the unit costing method and the percentage costing method. 

 

A. Unit Costing Method

 

This approach is similar to the unit sales forecast, however instead of using the price of your company's solution you apply the cost per unit of your product or service. 

 

Cost of Goods Sold  =  Number of Units Sold  X  Cost Per Unit

 

For complex inventory businesses, apply this formula for each product or service category. The sum of the costs represents your business’s total Cost Of Goods Sold.  

 

B. Percentage Cost Method

 

The second approach involves applying an estimation for your calculation of your company's Cost Of Goods Sold. Particularly for retail businesses, where mark-ups and markdowns are common, it is typical to use the cost complement to calculate the COGS. 

 

Cost Complement

The cost complement represents the precent of revenue, or the selling price, which corresponds to the cost of the good. 

For instance, if a product cost $10 dollars to produce and is sold for $20 dollars, then the cost complement is $10.00 / $20.00 = 50%.

Moreover, if the cost complement equals 50%, then you can infer that the gross profit margin of the product is 50%. 

 

If you are unsure what a logical percentage to apply for your estimation, examine the financial data of analogous competitors in your industry, and apply the standard COGS percentage to your Cost Of Goods Sold analysis. 

 

3. Overhead Expenses Forecast

 

The overhead forecast represents an estimation of your company’s total overhead expenses during the 12 month period. Overhead represents an account term that refers to all the ongoing business expenses your company incurs to operate, that are not directly related to the developing of your product or service. 

Overhead expenses are the costs you pay regardless of how much of a product or service your product an sell. Practically this means all of your business expenses other than direct labor, materials, shipping & handling and other third party expense that are billed directly to your customers. 

Typical overhead expenses of small business include:

 

Advertising & Promotion

Automobile

Bank & Finance Charges

Communications

Commissions & Royalties

CRM Tools

Depreciation

Email & Online Accounts

Entertainment & Meals

Insurance

Mail and Office Supplies

Occupancy/Rent

Professional Fees

Professional Development

Salaries & Benefits

Travel & Accommodations

 

Overhead expenses should reflect the list of fixed costs within your break-even analysis. 

 

A supplemental expense that entrepreneurs can include or exclude in their Profit & Loss analysis is the inclusion of a tax expense projection. 

When taxes are omitted from the Profit & Loss statement the ending result, Net Income, is typically referred to as EBITA, which stands for Earnings Before Interest, Taxes, and Amortization. 

Entrepreneurs should clearly state that their finical analysis does not include Taxes, Interest and Amortization expenses by labeling the end result EBITA and by clearly stating there omissions in the assumptions that correspond to the 12 Month Profit & Loss Statement. 

When taxes, interest expenses and any amortization expenses are included the ending result is typically referred o as Net Income. 

 

Tax Forecast

 

The last element of the income statement is to forecast the tax obligation of the business on the income the company generates.

Entrepreneurs should include local, state and federal taxes in their calculation. Generally speaking tax obligations will total between 25-35% of income depending on the industry your company operates in and the location of your business. 

 

The best way to approach the 12 Month Profit & Loss Statement is by discovering the exact costs of of all your business expenses and revenue generating items, or of prudently estimating them, on a month by month basis. 

Entrepreneurs should be encourages to find out as many exact costs as possible because the process will illuminate a variety of service options, like banking and credit card services, per category available to small businesses, and the effort will develop a more accurate financial analysis. 

For some expenses, a calculated management decision is necessary to determine how much you plan to spend in order to achieve specific revenue objectives. 

If your business already has an operating history than use the prior data of your expenses as a guide for your forward looking analysis, and make sure that the increases and decreases in costs are consistent with your revenue projections. 

 

Simplified 12 Month Profit & Loss

 

 
 

 

All of the projections in the 12 Month Profit & Loss Statement should be accompanied by a narrative that explains the major assumptions used to estimate your companies revenue generating activities and business expenses. 

The best approach is to list between 5-10 core assumptions adopted to calculate your company’s profits & losses.

Entrepreneurs should consider keeping detailed notes on their assumptions to explain them in more detail to the reader and/or investors, and to keep track of the underlying logic used in developing the finical statement should any reversions become necessary. 

 

Four-Year Income Statement Projection

 

Following your 12 month Profit and Loss projection, entrepreneurs are encouraged but often not required to provide a 4 year Income Statement Projection.

Practically speaking, the 4 Year projection is structurally identical to the 12 month profit and loss statement. The only difference is that the forecast is calculated in yearly intervals and projected 3 years into the future.  

 

4 Year Profit & Loss Projection Example

 

 
 

 

Again, it is important to keep track of all your assumptions and make sure that your projections match the data provided in your Marketing and Operations Plans as well as the other statements of your Financial Plan. 

 

 

Projected Cash Flow

 

The next statement to provide in your financial plan is the statement of Cash flows. The cash flow is your most important financial tool and the best indicator of the health of your business because every part of a company requires cash to operate. 

The cash flow reveals how much cash your business has on hand during a specific period.

For the financial plan, entrepreneurs should consider providing a Projected Cash Flow that includes between 2-4 years of your future operations.  If you elect to provide a projected Four-Year Income Statement, provide four-year projections to all of your financial statements.

Consistency is always good practice. 

The purpose of the analysis is to demonstrate that your business currently has enough cash, or requires a certain amount of cash in the form of an investment or loan to properly operate and cover the startup and the operating expenses with enough leeway to build cash reserves for future or unforeseen expenditures. 

The fundamental importance of the Cash Flow analysis to a business rests in what is called the Current Asset Conversion Cycle. 

 

Current Asset Conversion Cycle

 

The Current Asset Conversion Cycle represents the amount of time, in days, it takes your business to purchase raw materials, develop a product, sell the solution and then collect the financial reward for the product. 

For instance, suppose a business buys $1000 of raw materials at the beginning of the month. The company then takes on month to manufacture or produce the product for $2000, one month to sell the solution, and finally another month to collect the cash from the customer. 

 

Asset Conversion Cycle Diagram

 

 
 

 

In this example an initial outlay of $1000 took 3 months to collect $2000. During this time the company still needs to pay overhead expenses. Therefore, without adequate cash on hand or access to credit, a business risks going bankrupt. 

Entrepreneurs should be acutely aware of this cycle and plan accordingly.

Failing to understand in importance and complexity of proper cash planning is among the most common reasons young business go bankrupt. 

 

To keep a good perspective of your Cash Flows, the financial statement should be routinely updated in order to help foresee possible shortages of cash in time to do something about it, including; cutting expenses, raising more capital or negotiating for a loan. 

To construct your statement of Cash Flows, first determine when you expect to receive cash, typically from sales or other revenue generating events, and then determine when you expect to write checks or pay for the expense items. 

 

Cash Flow Structure

 

Structurally, the cash flow statement is divided into 3 parts; receipts, disbursements, and the cash flow calculation. 

 

A. Receipts

 

Receipts represent events when cash enters your business, similar to making a deposit in your current account. The main sources of receipts include;

 

  1. Cash Sales

  2. Collections from Accounts Receivable

  3. Loan Proceeds, including; term loans, start-up loans, lean of credit and notes. 

  4. Investments & Shareholder Loans. 

 

For matters of organization, these sources of cash are typically grouped into 3 categories;

 

A. Receipts form Operations,

B. Receipts from Loan Proceeds, and

C. Receipts from Investments. 

 

For startups, forecasting the annual revenue forecast from sales and accounts receivable must take into account any possible seasonality that might affect the growth of the business.

It is not sufficient to simply divide your annual sales and operating receipts by 12 and forecast the same level of sales each month. Such an approach will be deemed unsophisticated and inaccurate by the reader and possible investors. 

Similarly, initial investments should be recorded in the start-up month of your operations and subsequent investments or loan receipts should be forecasted in the month they will be received. 

 

B. Disbursements

 

Disbursements represent events when cash leaves your business. The main sources of disbursement include;

 

  1. Cash Expenses or Inventory Purchases

  2. Payments of Accounts or Expenses Payable

  3. Loan Repayments 

  4. Shareholder Repayments, including Dividends. 

 

These sources are typically grouped in 4 categories;

 

A. Disbursement of Purchases & Labor,

B. Disbursements of Administrative Expenses,

C. Disbursements for Capital Purchases, and

D. Disbursements for Debt Repayments & Dividends. 

 

For startups, it is important for entrepreneurs to properly forecast operative purchases, variable costs, and inventory build-ups to match the seasonal nature of sales and the growth of the business. 

Overhead expenses should be forecasted in three different ways depending on the type of expense your business incurs; 

 

  1. Evenly each month throughout the year. Lease payments are a good example.

  2. As a percentage of sales. Advertising is often done this way. 

  3. Manually, when you know a payment is due. For instance an annual license. 

 

One of the challenges entrepreneurs face on a regular basis is maintaining consistency with the way in which individual, and reoccurring expenses are recorded in the cash flow statement. Therefore, it is important to apply rigor and use resources like Microsoft Excel to simplify the process of recording all financial events.

 

C. Cash Flow Calculation

 

The cash flow calculation represents the financial result, or the end of month cash balance, from subtracting all your business disbursements from cash receipts.

The formula can be represented by the following equation: 

 

Starting Cash Balance + Cash Receipts - Cash Disbursements

= Ending Cash Balance

 

Each month, the ending cash balance becomes the starting cash balance of the next month, and the calculation is repeated indefinitely as long as your business is operating. 

For startups, it is common practice to label the starting cash balance as the “start-up balance” to represent the initial investment made into the business when the company first launches it’s operations.

 

Simplified Cash Flow Example

 

 
 

 

In developing a cash flow statement, the terms for positive and negative results are called surpluses and deficits, rather than profits or losses. 

To calculate your cash flows effectively, entrepreneurs must closely follow how the company operates on a daily or weekly basis in order to keep track of items that significantly impact the cash flows, including sales and inventory or equipment purchases.

It is always important to maintain a good handle of your cash balance and anticipate when large expenditures will be made or when significant income will be achieved. 

 

Benefits Cash Flow Exercise

 

Aside from providing a clear depiction of the financial health of your business, doing a cash flow analysis provides among the following benefits:

 

  1. A format for planning & managing the most effective use of your company’s cash. 

  2. A schedule for the anticipated cash receipts.

  3. A schedule of priorities for the payment of accounts payable. 

  4. A perspective of the significant and unexpected changes in market or operating circumstances that affect cash. 

  5. A list of all the bills that need to be paid in chronological order.

  6. A estimation of the amount of money your business needs to borrow, or the capital you need to raise in order to finance your day to day operations.

  7. An financial outline to demonstrate to lenders that your business has enough cash generating resources to make loan payments on time. 

 

With the right approach, the Cash Flow statement will reveal whether the business has enough working capital to operate on a sustained basis.

If the projected cash balance goes negative at any point, it is a clear indication that the business requires more capital investment. 

If the projected cash balance remains positive and grows over time, then you can be assured that your financial planning is sound and the business will be able to operate with the investment already made and it's reoccurring proceeds. 

Lastly, it is important to share your underlying assumptions with the reader, particularly the assumptions that differ or were not relevant for the profit & loss (income) statement. 

A number of Cash Flow assumptions entrepreneurs should consider explaining include:

 

  1. If a sale is made, when is cash collected? Otherwise known as your purchase or sales terms. 

  2. When you purchase inventory or materials, do you pay in advance? Upon delivery or later? And how will this affect your cash flow?

  3. Are any expenses payable in advance? If so, when?

  4. Are there regulatory expenses that should be budgeted? 

 

Regulatory expenses that entrepreneurs should consider may include; quarterly tax payments, maintenance and repair costs, and seasonal inventory buildups. 

Entrepreneurs should also make sure to include payments made for loans, equipment purchases, and any dues or dividends owed to the shareholders of the company. 

 

Balance Sheet

 

The Balance Sheet is among the most commonly understood financial report companies are expected to provide for any financial reporting exercise.

The Balance Sheet provides a simple analysis of all the company's assets and liabilities at a specific period in time. 

Assets are any and all items that provide or represent value to the company, while liabilities are debts the company owes. The result of the difference between assets and liabilities is called the shareholder’s equity.

The underlying formula of the Balance Sheet can be represented by the following equation;

 

Assets  =  Liabilities  +  Shareholder’s Equity

 

The Balance Sheet gets it’s name from the fact that the two sides of the equation, assets on the one side, and liabilities plus shareholder’s equity on the other, must balance out.

The logic is that a company has to pay for all of the things it owns, it’s assets, by either borrowing money, a liability, or from the investment of the company’s shareholders, the equity. 

Structurally, the Balance Sheet is divided into 3 sections; Assets, Liabilities and Shareholder’s Equity. Each section is comprised of several smaller accounts that breakdown the company’s finances. The breakdown of accounts in each section vary widely depending on the type of business and the industry the company operates in. 

 

Assets

 

Within the Assets section of your Balance Sheet, accounts should be listed from top to bottom in the order of their liquidity. This means how easily the asset can be converted into cash. 

To make these structurally easy to understand, the accounts should be divided into current assets, which represent assets that can be converted into cash in one year or less, and long term assets, which are assets that cannot be easily converted into cash during the current year. 

A general order to asset accounts may adopt the following structure; 

 

A. Current Assets

 

1. Cash & Cash Equivalents

These represent the most liquid assets including treasury bills, short-term certificates of deposit, and hard currency. 

 

2. Accounts Receivable

This represents moneys that are owed to the company by customers. Business leaders may consider creating an allowance for doubtful accounts to represent a portion of customers who can be expected not to pay. This is common for business who allow customers to pay on credit. 

 

3. Inventory

This represents all the goods available for sale, valued at the market price. 

 

4. Prepaid Expenses

This represents any expense that has already been paid for including; insurance, advertising, and rent. 

 

B. Long-Term Assets

 

1. Long-Term Investments

This represents assets which cannot be transformed into cash during the current year. 

 

2. Fixed Assets

This represents a variety of assets that are typically acquired, and not developed in house including; property, land, buildings, machinery, technology and equipment. 

 

3. Intangible Assets

This represents a variety of assets that cannot be easily quantified, including; patents, trademarks, copyrights, franchises, and goodwill.

 

Asset Portion of Balance Sheet Example

 

 
 

 

Liabilities

 

Liability are the moneys a company owes to internal and external parties including; bills to suppliers, interest on bonds issued to creditors, utilities and salaries. 

The liabilities should also be divided into 2 sections; current liabilities, which are dues that must be paid within one year and listed in the oder of their due date, and long-term liabilities, which are due at a future date beyond the current year. 

A general order to the liability accounts may adopt the following structure; 

 

A. Current Liabilities

 

1. Bank Indebtedness

This represents the amount owed to the bank in the short term, such as a bank line of credit. 

 

2. Accounts Payable

This represents the amount owed to suppliers for products and services that are delivered but not paid for. 

 

3. Wages & Salaries

This represents amounts owed to employees, contractors and government agents. 

 

4. Rent, Taxes & Utilities

Represents the amounts owed to service providers, landlords and the government. 

 

5. Accrued Expenses

This represents any expenses that are received in a period prior to it’s scheduled or related cash payment. 

 

6. Customer Repayments

This represents payments received by customers for products and services that the company has yet to deliver on. 

 

7. Short Term Loans

Sometimes called notes payable, represents the amounts owed to creditors in the short term and includes the interest associated to the loan. 

 

8. Dividends

Represents dividend payments to shareholders that have not yet been paid. 

 

9. Current portion of Long-term Debt

This represents the portion of the long-term debt liability that is owed within the year. 

 

10. Current portion of Capital Lease Obligation.

This represents the portion of any long-term capital lease obligation due within the current year. 

 

B. Long Term Liabilities

 

1. Notes Payable & Long-term Debt

This includes payments that are owned beyond the current year, and the interest and principle on any issued bonds to creditors.

 

2. Pension Fund Liability

This represents the money a company is required to pay it's employees' retirement accounts. This is typical of larger corporations and companies that offer significant benefits. 

 

3. Differed Tax Liability

This represents taxes that are accrued by the company and that are not owed for another year. 

 

4. Long-term Capital Lease Obligation

This represents the agreements between property owners and tenants to use and/or rent the property for a specified period of time beyond the current year. 

 

Liabilities Portion of Balance Sheet Example

 

 
 

 

Shareholder’s Equity

 

The shareholders equity, sometimes called “net assets”, is the financial value attributed to the owners or shareholders of the business. The figure can be calculated by the following formula;

 

Shareholder’s Equity  =  Assets  -  Liabilities

 

Within Shareholder’s Equity are a few accounts that represent different forms of equity including; namely retained earnings, treasury stock, preferred stock, commons tock and additional paid-in capital. 

 

Retained Earnings

Retained earnings represents the net earnings a company either reinvests into the business or uses to pay off company debt. Whatever is left over is typically distributed to shareholders in the form of dividends. 

 

Treasury Stock

Treasury stock represents the stock a business either repurchases or has yet to issue. Treasury stock is typically held to be sold at a later date in order to raise cash or to repel a possible hostile takeover from another company or interest group. 

 

Preferred Stock

Preferred stock represents a class of stock ownership that has a higher claim on the assets and earnings of a company compared to owners of common stock. Preferred stock is typically held by company owners and investors, and generally has a dividend. 

 

Common Stock

Common stock represents a class of stock ownership in a company. Common stock owners typically exert their power by electing a Board of Directors, but are the last benefactors in an event of liquidation after bondholders, debt holders and preferred stockholders.

Both the common and preferred stock accounts are calculated by multiplying the par value of the stock, typically $0.01, by the number of shares issued by the company. 

 

Additional Paid-In Capital

Additional Paid-In Capital, sometimes referred to as a capital surplus, represents the amount of capital shareholders have invested into the company in excess of the common and preferred stock amounts. 

 

Shareholder's Equity Portion of the Balance Sheet

 

 
 

 

All businesses strive to produce a positive result for their shareholder’s equity as it demonstrates that the business can cover, or account for, all of it’s liabilities. 

Companies with a negative balance in their shareholder’s equity are in a difficult financial situation and often experience bankruptcy. 

 

Balance Sheet Example

 

 
 

 

Startup’s should consider developing a projected balance sheet to show the estimated financial position of the company at the end of the first year of operations, or a year from when your share the business plan.

A projected balance sheet is a very effective tool to share with potential investors of the financial strength of the company at a future time should they provide capital investment to your business. 

As with the other projected statements, entrepreneurs should be encouraged to provide a 2-4 year Balance Sheet projection. 

 

Break Even Analysis

 

The last financial statement entrepreneurs should provide, particularly startup leaders, is a Break-Even Analysis, which provides a forecast of the necessary sales volume, at a given price, a business is must achieve to cover all of its expenses over a period of time. 

Simply put, a Break-Even Analysis represents the sales level between operating at a loss and operating at a profit. The Break-Even point indicates what sales level is required for your business to survive, and provides a good indication of the viability of your business. 

The analysis can also be used to evaluate a company’s expansion, expenditure or venture into a new category. In this case the question because how much additional revenue will be required to cover the costs of the new strategy. 

 

Calculating Break Even With Unit Sales

 

A common way to calculate Break-Even is to determine how many units the business needs to produce and sell to cover all of the expenses associated with developing the units. 

The Break-Even Analysis can be summarized with the following formula;

 

Break-Even Sales Volume = Fixed Costs /

(Sales Price per Unit - Variable Cost per Unit)

 

Where:

Fixed Costs = overhead costs that do not vary directly with sales, including; salaries, advertising, office supplies, utilities, etc… These costs are incurred regardless of your company’s sales level. 

Variable Costs = The expenses directly associated with developing the product or service, including; materials, production, labor and shipping. 

Selling Price = the cost of the product in the market, it’s price. 

 

The outcome, in this case Break-Even Sales Volume, otherwise called break-even units of production, represents the capacity of the business to generate an output at no loss.

To determine the Break-Even point in dollar terms, simply multiply the Break-Even Sales Volume by the Sales Price per Unit. 

 

Break Even Sales in $ = Sales Price per Unit X Break-Even Sales Volume

 

Startups should apply a rigorous Break-Even Analysis to determine the cost of operating the business prior to launching full-time operations. 

One of the complexities of a Break-Even Analysis is recognizing that the break-even point varies for different price points. This is because the variable costs will vary at different production levels. 

In this way, Break-Even is non-linear and can be represented graphically by a curve. 

 

Breakeven Level Chart

 

 
 

 

The area above the Break-Even curve represents profitability, while below the curve represents operating at a loss. 

 

Break Even With Gross Profit Margin

 

When a company does not sell a specific product, or sells a great variety or products, for instance a retail business, doing a Break-Even analysis based on units does not make much sense. 

In this cases, entrepreneurs should calculate their company's Break-Even sales level with revenue rather than units. 

To determine the Break Even sales level with revenue projections, first determine the gross margin of your products or service by applying the following formula. 

 

Gross Margin = (Unit Price - Unit Costs) / Unit Price

 

Then apply the Gross Margin to the following Break-Even formula:

 

Break-Even Sales Level = Fixed Costs / Gross Margin

 

Should you be unsure of how to calculate your projected gross margin, examine the common standards of the industry your company operates in and apply the gross margin percentage to your calculations. 

 

Lastly, a common practice of sound financial statement projections is to create a line item after your sources of income and all of your expenses called “contingencies” to represent potentially unforeseen costs. 

Including a contingency account to your projection will not only provide a more conservative result to your break-even analysis, but it will demonstrate to potential investors that you are taking into account the high probability that your total costs are underestimated. 

To account for contingencies, multiple your fixed costs by 15% - 25% and add the result to your total fixed costs to your break-even analysis

 

Break-Even Example

 

 
 

 

As with the other financial statements, it is important to provide detailed explanations to the assumptions made in constructing your Break-Even analysis. 

Adding a contingency line represents one of the assumptions you should consider, along with the gross margin percentage if you applied an industry standard figure. 

 

Finical Plan Cheat Sheet

 

Startup Costs:

  1. Estimate Current Assets
  2. Estimate Capital Assets
  3. Estimate Start-up Expenses

 

Starting Income Statement:

  1. Estimate Startup Costs
  2. Forecast Revenue
  3. Forecast Cost Of Goods Sold
  4. Forecast Overhead Expenses

Revenue - Expenses = Net Profit

 

Starting Cash Flow:

  1. Estimate Monthly Sales
  2. Adjust Monthly Sales for Accounts Receivable
  3. Account for Loans & Investments
  4. Calculate Total Receipts
  5. Estimate Monthly Purchases
  6. Adjust for Accounts Payable
  7. Estimate Monthly Overheads
  8. Estimate Loan Repayments
  9. Estimate Startup Costs
  10. Calculate Disbursements

Starting Balance + Receipts - Disbursements = Ending Balance

 

Starting Balance Sheet

  1. Total Assets
  2. Planned Investment (Equity)
  3. Planned Liabilities

Assets = Liabilities + Equity

 

Break-Even Analysis

  1. Fixed Costs
  2. Variable Costs
  3. Price
  4. Gross Margin

Break-Even Sales Level = Fixed Costs  /  (Unit Price - Unit Cost)

 

Conclusion

 

One of the crucial aspects entrepreneurs must take into account when developing their finical plan is that it is nearly impossible to get everything right the first time you construct your statements and make your calculations. 

The financial plan is more of a process than an individual exercise, and it is important to explore different scenarios to discover how different outcomes will affect your business's strategy. 

Every line item should be questioned. What if you were to use used equipment instead of new equipment? What if you were to lower or raise the price of your solution? What is you raise or lower salaries? What is you took on a loan rather than an equity investment? 

By asking a great multitude of questions, you will discover what it will take to make your business financially viable and economically strong. 

To guide you on your financial planning journey try to adopt these 4 tips: 

 

Be Persistent

Most entrepreneurs lack finical planning expertise. This is ok. take your time when preparing your plan and treat the excercise was a journey. practice patience. 

 

Take Advantage of Information

Before constructing your plan, review guides like this one and others that are available across the web, in your public library, or from friends and acquaintances. Be resourceful and try to master each concept as you build your financial plan. 

 

Be Consistent

It is vital that the information you provide in your financial plan match the rest of your business plan. Review each section when they are done for consistency. If your pricing section of your marketing plan says your profit margin is 40%, make sure it is reflected in your income statement projection. 

 

Create Simple Templates

Entrepreneurs should use programs like Excel or Numbers to construct their plans. The software provides a number of excellent tools that make calculations easy, and projections simple to build. 

 

The last element for entrepreneurs to consider is to always seek outside help and guidance wherever it is necessary. There is not avoiding the fact that constructing a financial plan is a complex and tedious task. 

Ask for help developing your statements and have someone with finical expertise, like accountants or financial consultants, to review your work to make sure that all of your calculations, projections, statement structures and assumptions are sound. 

You must believe in the numbers you provide to convince the reader and any investor that the plan is not only reasonably but probable. 

Finally, review your finical plan on a periodic basis, and check whether or not it matches what your business actually does. This practice will help you identify potential areas where your assumptions were wrong or correct, and improve how you anticipate problems before they arise.

Download PDF

 

Share your thoughts! 

Send me a question: moebius@zenofwuwei.com