When referring to financial planning, the first thing that comes to mind is budgeting. Financial planning can be much more when done systematically and look at a forecast period beyond 1-2 budget years. Financial plans very often focus on forecasting and analyzing a company’s financial future. The forecast period typically covers at least five years and many times even longer time horizons.

Financial plans can be prepared for personal or for business use. We will only look at financial plans prepared for business use in the following.

This article will explain what a financial plan is, propose a definition, and answer the main question to understand how best to use financial plans in today’s business world.

Why does my Business need a Financial Plan?

Financial plans are needed to obtain more information about the future financial situation of a company for a forecast period of 5 years or more. Those plans are needed by big and small businesses alike. A financial plan translates a business strategy into measurable expected results.

 Very often, financial plans are prepared when starting a new business. They are needed to answer important questions which will be of high relevance to the financial future of either a newly planned venture or any business:

• What will be the sources of revenue?
• What will be the expected sales volumes?
• How much production capacity will be needed by when?
• What will be the prices for products and services?
• How is the business expected to grow?
• What will be the breakdown of revenues and profits?
• Which products/services will contribute how much to the expected profits?
• What costs do we have to expect?
• What profits do we predict?
• At what prices/volumes will we reach break-even?
• How much investment will be required?
• How much funding will be required?
• Which financing sources are we going to use?
• Is a business proposition economically viable?
• How attractive is our plan to investors?
• Will our plan be acceptable to banks?
• Should we invest or not?
• What is the value of our business based on this plan?

Why is a financial plan important? The answer is that businesses need financial plans to answer the above questions.

What are the Objectives of Financial Planning?

Financial plans should describe the financial future and the underlying assumptions. The objective of financial plans includes topics such as quantifying revenues, growing a business, predicting financial performance, specifying assumptions, forecasting cash flows and financial ratios, fundraising from investors, bank financing, business valuations, investment analysis, allocating capital, understanding a business, performing financial (feasibility) analysis, financial decision-making and scenario analysis. This list only offers the shared objectives and by no means should be considered as including all potential topics financial plans can cover.

Developing Financial plans can become very useful to understand better the financial future of a company or a project. In today’s business world, financial plans are widely used for making capital allocation decisions. They enforce management to quantify their business plans into measurable financial results so that investors can understand the financial implications.

Financial plans can also be used for future reference. Years later, the business owners and management can look back, and it allows them to compare how the effective results turned out vs. the original expectations. Comparing previous plans to the actual result allows obtaining valuable conclusions to identify planning weaknesses so that this can be taken into account when preparing a new plan.

Financial Plans also can be used to measure management performance. For example, by using the concept of Economic Profit by comparing the created value to the alternative of investing in the stock market. Financial plans form the basis when using the Discounted Cash Flow (DCF) Valuation Method for business valuations.

Financial plans outline how a business is supposed to grow and create sustainable profits. The aim is to create value for shareholders and stakeholders. A financial plan aims to translate a strategy into a financial forecast so that its capital providers can easily understand it.

Definition of Financial Plan

Financial plans will differ from business to business, from project to project. Some plans will focus on establishing large manufacturing sites and building up distribution or marketing organizations, while other plans might focus on how to market content via the internet or study the construction of a new solar park. Every financial plan is different from business to business. What we need now is a definition of a financial plan. Here is how we define what a financial plan is:

“The financial plan describes the expected financial performance of a business, a project, or an asset and specifies the underlying assumptions. The plan offers comprehensive insights on what is expected to happen mid-to-long term and is essential in translating business strategies into measurable financial projections.”

As you can see, preparing a financial plan allows one to plan for growth and seeks to obtain deep insights into how a business creates profits and what the financial performance should result. A financial plan typically serves as the basis for any capital allocation decisions by business owners, investors, and banks.

Financial Plan vs. Business Plan?

What is the difference between a financial plan vs. a business plan? You might have noticed that many times in business, the word “business plan” is used simultaneously for a financial plan. The reason is that a financial plan should be part of a business plan.

The business plan describes the company’s strategy, its planned positioning in the market, outlines what problem will be solved, the products and services to be delivered, what makes the company unique and how they will be marketed. The business also describes how the company will operate and what team will execute the business plan. The financial plan typically is added at the end and converts the business plan into numbers and projections. This allows capital providers to understand the expected financial performance of the envisaged business proposition. Therefore, investors and banks are often more interested in the financial plan than the business plan itself. That is why the word “business plan” is used as a financial plan proxy.

Bottom-up vs. Top-Down Financial Planning

Financial plans can either be prepared using a bottom-up or a top-down approach.

Bottom-up Planning: We talk about a bottom-up plan when forecasting the fundamental parameters of a business which, when combined, define revenues, costs, profits, and cash flows. Bottom parameters are factors that the company can directly influence. Examples are using prices, volumes, and costs on a per-product basis to prepare a financial forecast. Bottom-up planning looks at the specific situation of a business and uses observable parameters from the “bottom” to prepare the forecast. Bottom-up planning is more detailed and tedious than top-down planning.

Top-Down Planning:

Opposite to analyzing the parameters from the bottom, we look at them from the top. Top-down parameters typically refer to parameters that are the results of a company’s actions. E.g., like the market share. So instead of using price x volumes to forecast revenue, we use market size x

market share. We use a global perspective in light of the likely results that seem obtainable. Top-down financial planning often is quicker to do. However, top-down planning fails to tell us exactly what we need to do to get the desired results, such as revenues.

The quality of a financial plan depends on which approach is being used. The bottom-up approach typically offers a better financial plan quality as it explicitly answers what we need to do and what parameters to influence to get the desired result. Parameters such as the market share will then be the output rather than the input of the financial plan.

Most of the financial model templates listed on eFinancialModels.com typically use the bottom-up approach and offer many planning details.

What does a Financial Plan look like?

Financial plans usually are developed in the form of a financial planning worksheet in Excel spreadsheet.

They might include multiple worksheets and assumptions, calculations for the individual financial positions, a financial statement forecast, and a summary and analysis section.

Volume and Price Assumptions

Below an example of a distillery business is shown. Here assumptions are collected for planned sales volumes and prices for select market segments, among other assumptions. Sometimes assumptions are pretty detailed, while in other cases, a financial plan will use simple assumptions, e.g., the volume growth rate for years 6 to 10.

Cost Assumptions

There are different types of costs, such as initial capital expenditures, direct costs, employee costs, and operating expenditures. While operating expenditures typically are fixed costs, the direct costs are variable. So here, assumptions are used on a per bottle basis so that when the volume forecast changes, the resulting direct costs will adjust accordingly.

Employee costs in this example are estimated based on the hiring plan of the business plan for this distillery business. Operating expenditures are estimated fixed costs for the first five years in this example.

Financial Statement Forecast

The assumptions outlined before are then used to forecast our distillery business’s financial statements. These include the Income Statement, Balance Sheet, and Cash Flow Statement. We also add a section where we calculate the resulting financial ratios to develop a comprehensive financial plan for a projection period of 10 years.

Free Cash Flow Forecast

What matters in business is cash – “Cash is king .”Profits potentially can be manipulated, but cash cannot be manipulated. Therefore, financial plans will often focus on the available free cash flow forecast during the following years.

These screenshots were taken as an example from the Distillery Financial Plan Template.

When do you need to prepare a Financial Plan?

Preparing a financial plan takes time and effort. Therefore, a plan is mainly prepared on an “as needed” basis. Typically, there are several specific events where a financial plan will be needed:

• Starting a new Business
• Fundraising from Investors
• Bank Financing
• Business Valuations
• Sale or purchase of a company
• Shareholder buy-outs
• Investing in a Business
• Turnaround Situation

The one thing these situations have in common is that they require a financial decision. Given that a large amount of capital is at stake, a financial plan will be needed to justify this decision.

 A common trap is already making such a decision before even analyzing and preparing such a plan. In those cases, what happens is that the plan reflects a decision that has already been taken.

 A better way is first to analyze a business proposition, prepare a financial plan, and then based on that plan, conclude. Sometimes we are not aware of this or forget it, but this is very important to be open and properly do the financial analysis before concluding.

Who prepares a Financial Plan?

A financial plan is only as good as the people committed to delivering this plan. Without a capable team putting this plan into effect, a financial plan is often worthless. Usually, the people who run the business will have to organize the preparation of the financial plan and assume responsibility for it. This is usually the management team, meaning the CEO, CFO, or the Founders of a Startup. If no management team is available, then the task of preparing such will fall to the owner or investors.

A financial plan is only as good as the people who are committed to delivering this plan. Without a capable team putting into effect this plan, a financial plan many times is worthless.

Preparing a financial plan requires financial expertise and industry know-how. Often, specialized financial consultants, financial modelers, M & M&A advisors, or investment bankers will assist with preparing a financial plan. Important here is that the management team assumes responsibility for the plan and its execution, and the plan will not be left as a pure document prepared by consultants only.

Like the business plan, in the end, a financial plan is only as good as the people who will execute it.

How to Build a Financial Plan Worksheet?

Financial planning worksheets can be built quite systematically. The suggested process would be the following:

1. Financial Analysis of Historical Results: Analysis of the financial statements, management accounts, and the relevant key performance indicators of the last three years
2. Industry Research: A good understanding of the industry, trends, competitors, demand, supply, barriers to entry, and other factors contribute to a good planning quality.
3. Management Discussion: Once the company’s current situation is analyzed and understood, it is time to get the views of the management team. A thorough discussion will help identify what assumptions should be used when building the plan.
4. Preparing a Financial Model: The next step is to create the financial plan mainly in an Excel Spreadsheet. This requires building a financial model with assumptions, calculations, tables, and analysis.
5. Scenario Analysis: A financial plan should be tested first to see how solid it is. One of the best ways to do this is to simulate several scenarios to understand the plan’s downside risks and upside potential. This will help identify the crucial assumptions and often lead to the revisions of such.
6. Commitment: A commitment is needed from the people responsible for the execution of the plan that they stand behind it and will assume responsibility for its execution.
7. Presentation: Last, the financial plan will need to be presented to the target audience. For fundraising, this would mean presenting the plan to investors or banks for the sale negotiations of a company to a potential buyer. When presenting a financial plan, it is essential to anticipate the likely questions in advance so that the answer to those questions are ready.

Factors that affect the Planning Quality

We have already touched on several points above that affect the planning quality. Let us review and extend this topic by listing the factors which typically help to increase the quality of any financial plan:

• Research: Financial planning follows the “garbage in, garbage out” principle. A financial plan is only as good as the assumptions’ quality. Therefore, good research on the industry and the business is needed.  
• Industry Expertise: Very often, the views of industry experts matter. Therefore, additional information sources are often interviews with the leading industry experts or reviewing their latest statements.
• Customized Plan: Every business is different, and so are financial plans. While the structure might be the same, every business needs to consider its circumstances. You can start with a financial plan template to speed up things but will need to adjust the plan for your specific business case.
• Management Commitment: As financial plans need to be executed, the plan becomes dependent on the capabilities of the management team involved. Therefore, a plan needs to reflect their view and be signed off by them. The people responsible for its execution need to be committed to the plan.
• Bottom-up Planning: As mentioned previously, using a bottom-up planning approach typically leads to a better plan quality than a top-down approach.
• Three Statement Model: Financial plans that focus on direct cash flow often neglect to check the consistency of the plan itself. Comprehensive financial planning will build a Three Statement Model – including a forecasted Income Statement, Balance Sheet, and Cash Flow Statement – that allows for calculating the relevant financial ratios. Inconsistencies in the plan are easier to spot and correct this way.
• Business Logic: Another factor affecting planning quality is how well the business logic is factored in when preparing the plan. E.g., a financial plan can lead to different results already when costs assumptions use $/ton instead % of sales. Are fixed costs fixed, or are they jump-fix or even variable costs? While high-level plans often neglect this, more detailed planning can help implement more accurate business logic.  
• Target Audience: A financial plan is nearly always prepared for a specific purpose. This can be fundraising, demonstrating the business value when selling it, or similar. This purpose can add a bias to the plan itself as the view that went into it can be biased. E.g., a business buyer might not buy into a financial plan presented to him by the seller as he thinks it is unrealistic from his point of view.
• Scenario Analysis: A good way to increase the planning quality further is to run a scenario analysis. This can either be done via Sensitivity Analysis or by simply playing through what a downside and upside case would have to look like. A base case financial should not be overly optimistic. Therefore, if there is no room to make the scenario better, maybe this indicates that the plan is overly optimistic. If a downside scenario quickly leads to losses, maybe the proposition is quite risky. Scenario analysis helps us to better understand in which range of assumptions our plan will work and where it will not. All you need for this is a well-designed financial model that allows you to change the assumptions to play through different scenarios.

As we have outlined above, various factors influence planning quality. Please keep in mind that not every financial plan has the same planning quality. It is essential to be aware of this.

How much does a Financial Plan cost?

Financial planning can be cheap or expensive, depending on the desired level of details and planning quality. What is expensive is the manual labor that has to research the assumptions and prepare the plan. But very often, it’s also a question if you can afford not to plan.

One way to reduce the costs and make it affordable is to purchase a financial model template from eFinancialModels.com. Most templates are priced between $50 to $200. Prices depend on the quality of the financial model template and the amount of work that went into preparing such. Financial planning becomes easier when starting with a template, and also the quality of the plan can increase this way.