5 Steps To Financial Business Planning (Pt.2)

In part one of this article we figured out what a financial business model is and what we need it for. Now it’s time to get it done!

#3 Step-By-Step To An Integrated Financial Model

Define The Goals Of Your Model

Before even starting to build the model you should think about the requirements that the model has to meet. For founders the financial planning usually is an essential part of the business plan. Therefore it is manly used as a controlling tool and as a basis for negotiations when talking to an investor. For the definition of the goals the following questions need to be answered:

• What is the scope of the model?
• What are the features that the model should have?
• Which part of the model will be most valuable?
• Who is using this model and what requirements do these users have?

Before jumping into implementing the modelling tool these questions should be taken into consideration. The implementation highly depends on the answers and subsequent changes can be very time-consuming and therefore expensive.

Specify Features & The Level Of Detail

Based on your goals the second step is to determine specific characteristics of the model. The following aspects need to be clarified beforehand:

Planning Period:

In general the planning period can be divided into short-term planning (up to 1 year: high level of details; break-down possible to monthly, weekly or even daily basis; high probability of realization), mid-term planning (2-5 years: low level of details; break-down possible to quarterly basis) and long-term planning (more than 5 years: aggregated and superficial planning with few background assumptions).
For entrepreneurs it is common and advised to use a mid-term planning period with a detailed planning of the first two business years, especially regarding the financial liquidity of the company.

Top-Down Or Bottom-Up Planning:

Normally any business plan will be set up top-down. This means that the first step is to build a revenue model calculating the revenues (top), which will be the general data basis for calculating all expenses afterwards. The result (down) of this calculation will be a profit or loss. Bottom-up calculation would be starting with a profit at the end and deriving what revenues are required to reach this result.

Level Of Detail:

Another important issue is the level of detail of the entire model. Is it really necessary to split up the expenses for every pen or is it sufficient to estimate the expenses for office supplies (of course under the assumption that you do not run an office supplies company)?
Time as a founder is limited. That is why it is not necessary to build one little detail for 12 hours that can save you 20 EUR later (expenses of a pen in a regular office). Better focus on details that can save yourself 20.000 EUR later (expenses of a pen in an office supplies company).

Calculation Method & Used Units:

Last but not least important is determining methods of calculation (e.g. personnel planning via FTEs or via heads) and unified calculation units (e.g. kEUR or mEUR, weeks or months). A consistent calculation model is much less prone to error. Also it is much easier to read and therefore much easier to handle.

Develop Plan Profit & Loss

The first step of building the actual model is the profit and loss (P&L) statement. Taking into consideration the characteristics from 3.1 and 3.2 the calculation model is now built up with definite figures and assumptions for revenues and expenses.

As recommended, we are opting for a top-down mid-term (5 years) planning. Therefore the first step is to come up with the revenue, which is based on a revenue model. The revenue R is calculated with sales volume V times selling price P:

R = V * P

For this simple calculation we need a price-volume-framework. This function is the answering the simple question of “how many of our products/services are we able to sell in a day/week/month/year and at what price?”.

As soon as this issues is solved we obtain our targeted selling price and our targeted sales volume and therefore we obtain our target revenues.

Subsequently we plan our expenses that are necessary to reach the sales volume. Firstly there are expenses that are directly related to the revenue e.g. cost of material (for a product) or personnel cost (for a service). These expenses need to be directly based on the sales volume. The second step is to plan expenses that are not directly related to sales volume, but are still required to reach the sales goals e.g. office rental expenses or marketing expenses.

At the end, when we are deducting all expenses from the revenues, the result is our profit or loss.

Develop Plan Balance Sheet

The plan balance sheet (BS) can be set up as soon as all basic matters of the plan P&L are finished. With the balance sheet you can see why it is called “integrated planning”, as various figures from the balance sheet, e.g. bank loans, have a direct impact on the profit and loss statement, e.g. interest, and the cash flow statement, e.g. loan repayments. For the balance sheet we need to plan the following:

• Fixed assets: All assets required for the business.
• Current assets e.g. inventory: Inventory is usually planned with the DIO (days inventory outstanding) the Cash Conversion Cycle (CCC).
• Accounts receivable: Receivables are planned with the DSO (days sales outstanding) from the CCC.
• Accounts payable: Payables are planned with the DPO (days payables outstanding) from the CCC.

Develop Plan Cash Flow

The cash flows can be derived from the results of the plan P&L and the plan BS. With these two tools you will be able to determine cash in- and outflows. For every movement in the P&L and the BS you need to determine, if there is a corresponding cash flow (cash effect) or not. It is very important that the cash reserve can be calculated for each and every period.

Integrate & Reconcile Different Parts

Once all three parts – profit and loss, balance sheet and cash flow – have been set up, it is time to check, if changes in the budget figures correctly impact on all parts. With this you can check the link between each part.

For example you can verify if a lowered projected revenue in the profit and loss statement has an impact on the balance sheet and the cash flow. If the model was set up correctly this change should e.g. have an impact on the accounts receivables in the balance sheet and the operating cash flow in the cash flow statement.

Analyse The Results

The results of a thoroughly set up financial planning leads to a variety of analyses and conclusions. Usually you use different Key Performance Indicators (KPIs), e.g. return on sales, return on investment, debt ratio etc., to analyse operating performance.

KPIs have the advantage to be objective and comparable within the same industry or sector. Thus KPIs can be used to compare your company with a peer group. Also the can easily be calculated for each period and therefore keep you informed about the ongoing financial performance of your company.

#4 Which Technical Tool Is Required To Set Up A Detailed Financial Business Plan?

The requirement to set up such an integrated financial planning tool is simple. It is Excel. Yes, it is that simple. Of course it is possible to spend a lot of money on a specific planning software, but it is not really necessary. With your standard Excel software it is possible to individually illustrate all different cases. And that is exactly the flexibility you need when founding your own company.

#5 Success Factors Of Financial Planning

Of course it is also a matter of experience of the financial modeller himself. But the most important factor is the effort that you put into researching and coming up with a concept for the model. When you set up a financial model it is highly important that you put an effort on gathering information, e.g. realistic sales volumes, projected costs, working hours etc. This is where you can separate the wheat from the chaff.
As a founder, even if you do not have an in-depth knowledge of financial matters, you will be able to set up a great financial planning. You should speak to experts, get cost estimates and most importantly be honest to yourself. For example, you should probably not calculate with 1.000 air conditioning units sold on the first day of Christmas (in Europe, of course).

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