here's no way around it. If you don't control your company's finances, they'll control you. No matter how hard you work, how great your products are, or how much your customers love you, financial mismanagement can put you out of business fast. That's the best reason to keep a close eye on your finances. The second best reason is that lenders-and investors look at the financial section of your business plan first—and if they don't like what they see, you won't like what they say. End of lecture. Time to get down to business.

First, decide which forms you need.

There are three main categories of financial statements that are included in a business plan. Which ones you need will depend on your stage of development and needs for financing.

1. A funding source and use plan is written in outline form and tells prospective lenders and investors how much money you have and how much you need, how you plan to use it and how you plan to pay it back.
2. Pro forma Statements must be included in-every business plan. They are: a 12-month income projection with assumptions, a 3-year income projection, a 12-month cash flow, a projected balance sheet, and a break-even analysis.
3. Historical Statements are CPA or internally prepared financial statements covering the historical performance of an existing business. These include a balance sheet, an income statement, and a statement of cash flows.

KEY QUESTIONS

THIS SECTION WILL HELP YOU ANSWER

• Which financial forms will I include with my business plan?
• How will I complete these forms—by estimation or by using existing data?
• How can I use ratios to help me see how things are going?
• Which supporting documents will be necessary for my business plan?

To decide which forms you need, match your situation with one of the four listed below. You'll find a sample of each form you need, along with a brief explanation of its use, included in this section.

In all cases, comparisons to similar size businesses in your industry will be important. A series of commonly used financial ratios are provided on pages 99-105 to help you make these comparisons. Lenders will appreciate having this information.

New business, seeking investors and/or financing.

• Funding source and use plan (Page 75)
• Pro forma statements (Worksheets 21 through 25)
• Comparison to industry

New business, not currently seeking investors or financing.

• Pro forma statements (Worksheets 21 through 25)
• Comparison to industry

Existing business, seeking investors and/or financing.

• Funding source and use plan (Page 75)
• Pro forma statements (Worksheets 21 through 25)
• Historical financial statements (last three years) (Worksheets 27 through 29)
• Comparison to industry

Existing business, not currently seeking investors or financing.

• Pro forma statements (Worksheets 21 through 25)
• Historical financial statements (last three years) (Worksheets , 27 through 29)
• Comparison to industry

FUNDING SOURCE AND USE PLAN

Before you complete this document, determine what type of financing you will pursue. This will be'a determining factor in how you complete the funding source summary. Generally speaking, there are two kinds of financing available:

1. Short-term financing, provided through notes to be paid within one year. This is the kind of loan you would seek for short-run production or construction, short-term cash flow needs, or to finance seasonal inventory. It is typically repaid in one lump sum with cash made available through inventory turns, cash flow, or collected receivables.
2. Long-term financing, repaid from operating profits in more than one year. Payments are in fixed monthly amounts of principal payments plus interest. This is the type of loan you would seek for new equipment or for working capital during a period of rapid growth. You might also seek a long-term loan for real estate financing (to buy or build a building).

Loans are usually made on a secured basis, using company assets as collateral. The sample Financial Source and Use Statement for Quinby's Incredible Fantasy Furniture is for a long-term loan.

SAMPLE FUNDING SOURCE/USE PLAN
FOR QUINBY'S INCREDIBLE FANTASY FURNITURE

PRO FORMA INCOME STATEMENTS

Pro forma income statements are based on projected (pro) future performance (forma). As you try to project your future business performance, you will probably reuse these statements several times. Be patient with yourself as you learn.

The 12-month and 3-year income projection

The best and easiest way to begin your projections is to forecast a 12-month income statement (Worksheet 21: 12-Month Income Projection). You should begin with a list of assumptions, and spread the numbers over 12 months. It's also important to remember that the income statement does not reflect cash receipts or disbursements. The income statement is an orderly list of revenues, expenses and profit for a given period of time. Always check your numbers to make sure they make sense t and are consistent and reasonable.

The three-year pro forma income statement (Worksheet 22: Three-Year Income Projection) includes annual projected income and expenses only. It is expected that both your income and expenses will increase over the three-year period covered by this projection. When making projections, you should consider the following factors:

• Previous sales and trends
• The economy
• Status of the industry
• Population/demographics
• Plant capacity
• Financial constraints to borrowing-or equity
• Availability of qualified work force
• Raw materials cost and supply
• Pricing
• Sales and trends
• Seasonality

Projecting annual sales and expenses for years two and three will reflect your sales growth potential and ability to contain costs. Begin hy taking the totals from the 12-month forecast to complete year one. Then, come up with a list of assumptions, apply percentages as appropriate from your 12-month forecast, and watch those profits grow.

Healthy cash flow = confidence

You've probably heard it before, but for most businesses, especially start-ups, cash flow is king. Your cash flow is an indicator of profitability. You must have enough cash flowing in to pay salaries and expenses, and to cover operating costs.

You also need enough cash to plan for big expenses and to cover your company when business activity fluctuates. Forecasting cash flow will also help you structure your short-term borrowing needs and your long-term debt repayment.

Most importantly, if you don't know how much cash you have on hand, you could run out. No cash, no business. Comprende? Great. Let's get on with it.

12-month cashflow projection

A cash flow statement (Worksheet 23: 12-Month Cash Flow Projection) works like a checkbook to show how much money you have flowing in and out of your business every month. The difference between the deposits to the bank and the checks withdrawn is your net cash flow (into or out of the bank account).

A cash flow forecast is the single most important financial assessment tool you have—especially if your business is seasonal or requires large investments in capital or materials. It's also critical if you sell on credit; or if i,t takes several months to convert your inventory into cash sales. In fact, there's no business where managing cash flow isn't critical to success.

Cash in

The two main sections of your cash flow statement are "Cash on Hand" and "Cash Paid Out." Cash on Hand lists everything that brings cash into your business, such as sales or collections from accounts you've billed (receipts).

There is a difference between revenues and cash receipts. Revenues are the result of providing goods and services. Cash receipts are a result of being paid for the goods and services you provided. If you sell on credit terms, you may not be paid for your first month's revenues until 30 or 60 days later, which will reflect on your cash flow statement.

Cash out

Cash Paid Out is anything that takes cash out of your business, such as salaries, materials and supplies, overhead, and so on.

For example, you may need to maintain a certain base inventory level and purchase to produce the forecasted sales. If there's a lag in delivery, you'll need to account for the lag in your cash flow projection.

Remember, expenses from the income forecast represent an obligation to pay. Cash disbursements on the cash flow forecast represent actual payment.

Words of advice

Use a pencil. Don't get discouraged if your initial projections are way off target. That's why you're using a pencil. If you have past records that will help you make your projections, use them. If not, don't worry. As time goes on, you'll become a better forecaster.

You may want to begin with the "Cash Paid Out" section first, since it's more straightforward.

Since very few of us know where our money will come from next, "Cash on Hand" can be difficult, but give it a shot anyway. Once you've filled in both columns in the worksheet, total them and then subtract the total "Cash on Hand" from the total "Cash Paid Out" and you'll have your ending Cash Balance.

The ending Cash Balance from one month is the Starting Cash Balance from the next, so carry that figure up to the next month and begin again.

Projecting your financial worth

Possibly the most feared of the financial forms, the balance sheet lists everything your company owns that has monetary value, and everything it owes. The liabilities are subtracted from the assets, and the remaining amount is your company's net worth.

When the net worth is added to the liabilities column, your assets and liabilities should balance. Hence, the term "balance sheet."

The hardest part of doing the balance sheet is understanding the results. The rest is quite straightforward. Worksheet 24: Forecasting a Balance Sheet will help.

Finding your break even sales volume

The break even point for any business is the point at which costs exactly match sales—the point at which there is no profit and no loss. You can arrive at your break even point by using the information in your three-year income projection to do a calculation as shown below.

There are three steps to arrive at the calculation above:

   Step 1:

   Step 2:

   Step 3:

Compute your break even sales volume along side the one on Worksheet 26: Projected Break Even Point that was calculated for QIFF

HISTORICAL STATEMENTS

Your financial history

If your business has been around for several years, you should provide three years (or as many years as you've been in business, if less than three years) of CPA or internallv prepared income statements, balance sheets, and statements of cash flow, which we'll see later. You will also need to provide personal financial statements current within the last 90 days for all owners of your company.

If your business is new and you have no business financial history, you should provide personal financial statements and your individual tax returns for the last three years.

The last document you'll need is the Historical Statement of Cash Flows. Your statement of cash flows can be compiled internally or by your accountant representing changes in your balance sheet accounts from period to period. It will show what operations generated cash and how the cash was used. If you prefer to prepare the statement internally, we've provided a form to help you.

The balance sheet worksheet (number 28) and the worksheets on the following pages will be all you need for vour financial history.

Supporting documents

There are a tew more things you need to include to put the finishing touches on your business plan. These documents can be included in an appendix at the back of your plan, and referenced in the main text:

• Resumes of management—keep them short and pertinent to the kind of business your plan covers.
• Owners/stockholders personal financial statements, income tax returns, and credit reports—these are important if your business has no financial history.
• Copies of leases—for real estate, equipment, etc.
• Letters of reference—from professional references, suppliers, customers, and others who can support any aspect of your business plan.
• Contracts—these represent commitments by suppliers, customers, and others that validate your financial projections.
• Market research reports—any focus groups, surveys, intercept studies, or customer interviews that you do can also be included in the appendix of your business plan.
• Other documents—any other documents that are important to your business plan may also be included in an appendix and referenced in the main text of the plan. Don't include a bunch of non-essential material, however; investors and lenders will not appreciate it.

Comparing your business to industry standards

As you begin or expand your business, you can estimate how well you are doing by plugging some of your financial tigures into a few commonly used ratios. These ratios help diagnose the financial condition of the company. They also offer key performance indicators that allow you to compare your business to industry standards, so you have an idea of how your company is doing compared with other companies ot similar size. For more industry comparisons, refer to the RMA Annual Statement Studies published by Robert Morris Associates in Philadelphia (available at your local library or bank). RMA provides statistical financial information for companies of various sizes, as well as details and illustrations.

Solvency ratios

Solvency ratios provide a good indicator ot your ability to pay the bills. The current ratio measures the amount of money available in current assets (or the assets that can be turned into cash within a year) to pay current liabilities (or the debts that must be paid within a year). Ideally, the current ratio should be greater than 2:1. But even if your current ratio is 2:1 or greater, you could still have a solvency problem based on timing.

For example, all your current assets consist of inventory that will not be converted to cash for 12 months, and all your current liabilities consist of notes payable due in 30 days, the current ratio does not reveal the problem of eleven months of delinquency.

The quick ratio recognizes this problem a little better; a good quick ratio is 1:1. As a more conservative financial measure, the quick ratio tells you how much is available in easily converted assets to meet immediate liabilities. The quick ratio is a stringent test of solvency and a good indicator of liquidity because it deals with existing cash and accounts receivable.

Safety Ratio

The debt to equity ratio reflects your company's ability to withstand adversity. It compares your total debt to your total net worth. In general, the higher the ratio, the riskier your business. Acceptable debt to equity ratios vary from industry to industry, but as a rule, lenders like ratios of 2:1 or less.

Note that the problem inherent in the debt to equity ratio is the same as that in the current ratio—it ignores the impact of timing.

Profitability ratios

The two ratios that will he most helpful to you are the gross profit margin ratio and the net profit margin ratio. All ratios are calculated using profit before income taxes.

Gross profit margin measures the percentage of sales dollars remaining after deducting the cost of sales. Comparison to the industry is very important for this ratio.

Net profit margin is the percentage of sales dollars left after deducting all expenses except income tax. This is also called return on sales, and comparison to the industry is very important.

Key Asset Management Ratios

Sales to assets measures how the company uses assets to generate sales.

If the ratio is 2.0, it means that for every $1.00 invested in assets, the company generates $2.00 in sales.

If the industry average is 3.5, it means the company should generate $3.50 in sales for each $1.00 in assets.

Return on assets measures how profits are generated from the assets used by the business.

For example, if your ratio is .5% and the industry ratio is 5.0%, your company net profits before tax should be $50,000 instead of the current $5,000 profit you show. This can be addressed by cutting costs, or increasing sales to improve profits.

Return On investment is the percent of return on funds invested by the owners of a business (net worth).

You can compare this return with other investments such as savings accounts, stocks, bonds, etc. It helps you decide whether or not the return is worth the associated risk.

If your return on investment is less than 5 percent, you could invest in a bank savings account with no risk at all and earn more money. Is vour effort worth the risk?

Inventory Management Ratios

Inventory turnover is important because every time inventory turns over, you make a profit.

You can calculate inventory levels that meet the standard guidelines by dividing your cost of goods sold by the industry standard turnover rate. This should be the level of inventory listed on your balance sheet. If your cost of goods sold is $1,000,000 and the industry standard turnover is 4.9, your balance sheet inventory level should be $204,081. If you carry more inventory, your cash can be tight and your profits lower, due to high holding costs such as obsolescence, shortages, taxes and interest rates. That's why it's important to monitor inventory levels on a monthly basis.

Inventory turnover days tells you how many days it takes for your inventory to turn over.

Accounts Receivable Management Ratios

Accounts receivable turnover tells you if your accounts receivables are in line with sales. If you have too many receivables, it affects your cash and may result in credit losses. This ratio should be compared to the industry standard.

Accounts receivable collection period is important to know in order to assess your credit policy and forecast your cash flow. If your collection period is 60 days and you sell on 30-day terms, you need to review your credit and collection policies. You can improve them by working harder to collect or refusing to sell on terms to late payers. Excessive accounts receivable impairs cash flow and, as a non-earning asset, reduces profitability.

* 365, 30, 60 or 90 days

The faster you turn inventory and accounts receivable, the more cash you generate. You can generate cash more quickly by reducing inventory and accounts receivable or by increasing sales while maintaining the same inventory and accounts receivable levels. Analyzing these ratios will help you determine the best levels of inventory and accounts receivable to maximize profitability of sales.

Accounts payable period is important because your trade creditors expect to be paid within the terms of sale. Your creditors may change the terms of future sales to you if you do not pay on time. To check your supplier relationships use the following formula:

Everybody has dreams. But you're smart enough to know that it takes hard work to make dreams come true. Your completed business plan is proof of that.

Unlike many entrepreneurs, you've taken the time to pack a paper parachute that will guide your business toward economic safety. Now you can leap to the next level—securing financing, opening your business, or—expanding your operations—with confidence.

Good Luck—and Good Leap!