How to Avoid Key Mistakes in Creating Financial Plans and Business Projections

The first and most important thing that bankers will ask entrepreneurs when they knock on their door to finance an investment is a business plan. Most prepare it ‘haphazardly’ or not at all, often just to satisfy the requested form. Some are aware that it is primarily for them, as through planning (yes, regardless of the socialist connotation, planning is the fundamental ‘work’ of every Western businessman) it actually shows possible outcomes and the business path.

 

However, even when the understanding of the importance of a business plan is part of the entrepreneurial ‘consensus’, it often ends with limited analysis. At least that is the frequent experience Alma Krpan, a finance consultant who provides financial consulting, support, and education services. She has gained long-term experience in banking, in managing credit risks, precisely through analyses of financial statements, financial planning, and cash flow projections, making her an excellent address for inquiries about why a business plan and what exactly it should entail.

 

So, why is it important to write business/financial plans and what should they encompass? – A business plan is created to predict future events and their effects on the business, so that the company can better adapt to the conditions in the environment. It defines business goals and ways to achieve them, and the better we predict future events and solutions to future problems, the greater our chances of achieving the set goals.

 

One of the most important parts of a business plan is the financial one, as it shows the current financial situation of the company and projects its future financial performance. The goal of the financial plan is to show how the company plans to generate revenue, cover costs, invest funds, manage cash flow, and maintain financial stability. However, in creating financial plans and business projections, often only a projection of the profit and loss account for future periods is made, which is not enough – Krpan emphasizes.

Why is this not enough? Because if a company plans only the profit and loss account for future periods, it focuses only on one view of the business and does not look at the broader picture, i.e., the cash flow that arises, in addition to the profit and loss account, from certain items in the balance sheet.

 

– It is like looking through a keyhole and hoping to see the whole room. Very simplified: if a company has revenues of 100 and costs of 50, its profit is 50. But if the revenues are uncollected, i.e., open in receivables, then it actually has no funds, and profit is just a number on paper. Profit is an accounting category determined by accounting standards, while cash flow tells us whether the company has enough funds, what they are spent on, where they come from, and is a combination of many parameters, not just the profit and loss account.

 

And that is why a ‘dynamic’ financial plan should be made, through modeling where changes in the profit and loss account, balance sheet, planned investments, loan repayments, profit distributions, and others will reflect on cash flow – that is the ultimate information you want to get from the business plan, whether there will be enough money to cover everything planned, where the potential ‘gaps’ in cash flow are, and how to resolve them in time – Krpan analyzes, adding that the financial plan, besides the planned level of revenue, costs, and profit, must also take into account:

 

• Planned growth in business volume; estimation of expected revenues and costs

• Planned days for collecting receivables, holding inventory, and paying suppliers

• Planned investments in fixed assets (and then the calculation of depreciation that will impact the final profit) or potential sale of fixed assets

• Sources of financing investments in fixed assets; especially if they are loans

• Returns on existing loans + all new loans (if planned)

• Planned profit distributions

• Other items within the balance sheet that may impact cash flow (for example, days of loans or received grants)

 

All these items, she says, affect cash flow, and any change in parameters affects the final amount of funds that the company will have at its disposal (or will lack funds). If a company plans significant growth in business volume, it must be aware that this requires additional financing. Which can be calculated and planned. However, if customers request longer payment deferrals, this also means that the company will have a shortage of funds that will need to be financed from somewhere.

And this can be calculated, to ensure funds in time. If a company plans to distribute profits, these are outflows that need to be projected to see if there will be enough funds from operations. – Did you think to repay the loan earlier? The financial plan will show whether this is possible and in what timeframe. Have you encountered a good opportunity and would like to invest? Make a financial plan to see if the investment is worthwhile, in what timeframe, whether it will have effects on the business, and where it will be financed from. Decisions should be made based on facts, as ‘feeling’ can sometimes mislead us in assessment. Do not limit yourself only to the profit and loss account; it should definitely be viewed dynamically, in a ‘3D model’.

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I had the opportunity to analyze the business of a retail company that planned an investment for which a long-term loan was sought (to cover 75 percent of the investment value). They made their business projections only up to the EBITDA level (operating revenues – operating expenses + depreciation). Because the bank looks at the EBITDA level as a base (but not the only!) indicator that shows whether the company has repayment potential to cover loan obligations and interest. Meanwhile, the company recorded a constant growth in business volume of 10 percent annually, and planned to continue this way.

 

However, growth in business volume requires additional financing of working capital (working capital is the difference between current assets and current liabilities; in conditions where business volume is growing, that difference also increases, and the company will need additional funds to finance it). Since they did not plan beyond the profit and loss account, the company thought it could finance both the growth in business volume and the investment on its own.

 

However, the business projection I made, which took into account the above-mentioned business parameters in addition to the profit and loss account, showed that the company could not finance both part of the investment and the constant growth in business volume on its own, not because it was performing poorly, but because investing in fixed assets and business growth depletes cash flow – Krpan details, warning that this is precisely why a financial plan should be written – it will highlight risks and ‘thin’ sides of the business, what to focus on and keep under control to ensure stable operations. After all, if we have a plan, it serves as a guideline for where and how to move forward, thus increasing the chances of achieving the set goals.