Let’s be honest. Not too many people get excited about the financial planning process. (To those who do, we salute you.) Regardless of how you feel about it, it’s an essential part of making sure you’re smart with your money so your business thrives.
As you work to get a better handle on your financial management, the tools you use make all the difference—three to be specific: budgets, AOPs, and forecasts. Each one allows you to get a better handle on how much money you have, how you’ll use it, and (hopefully) how it will increase over time.
Settle in. We’re taking you through the what, why, and how of these financial planning tools so you have what you need to make confident decisions for your small business.
Breaking down budgets
Budgets help you focus on your company’s financial resources and estimate where you’ll spend your money within a certain period. Typically, you’ll set your small business budget on a monthly, quarterly, or yearly basis.
While the old saying goes, “You need to spend money to make money,” there are a few specific reasons you’ll want to set limits for how you’ll spend your money now and in the future.
The benefits of budgeting
Setting a budget requires you to look past your current revenue and spending habits. In doing so, you:
- Establish a financial plan — All the data you gather to establish your budget feeds into a financial management plan that meets your short and long-term goals.
- Point out where you can reinvest funds — Funds not used in certain areas can be reallocated or invested in other areas of your business.
- Track and predict slow months — Identifying patterns of decreased revenue can ensure you plan accordingly and better manage your money during those times.
- Avoid debt pockets — Keep from overextending your resources and falling into more outstanding debt by setting spending limits.
- Estimate profits — Reviewing revenue and cost data lets you figure out where you’ll need to adjust your finances to become profitable and increase cash flow.
If you’ve never made a small business budget, don’t panic. It’s easier than you think.
How to plan a financial budget
Before you sit down to build your annual budget, gather all your financial reports so you have everything organized in front of you. From there, follow these steps.
1. Review your revenue
Compare your income statements from the last 12 months and look for any identifiable patterns. Do you see any seasons where there are spikes in revenue or expenses? What about times when there are dips?
If you’re just starting out and don’t have a full year’s worth of income statements, just reference as many months as you can or be conservative about what you think you’ll bring in for now.
2. Deduct fixed expenses
Next, subtract all of your fixed costs. These are expenses that don’t change based on your revenue, like your rent, employee salaries, debt repayment, property tax, and insurance.
3. Take away variable expenses
Now, take away the costs that change based on your revenue. These can include hourly employee wages, utilities, or raw material costs.
4. Reserve emergency money
Have a surplus after you’ve calculated expenses? Good. Set that money aside in a rainy day fund so, if you’re ever hit with a big surprise, you have extra cash to cover yourself.
5. Figure out profits
Take your total revenue and subtract all your expenses to get your net income. If you get a positive number, congratulations, you’re profitable. If you get a negative number, you have a loss.
Don’t freak out if you’re at a loss. That’s not entirely uncommon for new small businesses.
6. Nail down your budget
Look at your financial statements. Do you have enough profits to allow you to reach your goals, or do you need to make some changes to balance things out and better cover costs?
Use that data to set spending and earning goals, establish caps to support operations, and reduce cash burn.
Analyzing annual operating plans
Annual operating plans are more extensive, high-level plans that define how your business will use available resources. They focus on all operational aspects of the business, not just financial.
By highlighting the connections between your operations and business initiatives, AOPs offer a way to build a more robust plan for departments and resources.
The benefits of AOPs
By using AOPs to recognize all of the different areas of your business, you can:
- Strategically align on larger goals — Get every department within your business on the same page and create a solid plan for everyone to work toward.
- Define resource allocation — Figure out what budgets each department will have to work with as the business aims to hit revenue and growth goals.
- Enable performance evaluation — Outline key performance indicators to measure how well your plan is working or if there are areas in need of improvement.
Making a successful annual operating plan for your small business comes down to establishing straightforward goals and staying on your intended path.
How to create an AOP
Your annual operating plan is your chance to be strategic about the resources, planning, and departmental aspects of your small business. Here’s how you do it.
1. Set clear goals
The goals you decide to set for your business will vary based on a lot of factors, but they should always be S.M.A.R.T. — specific, measurable, achievable, relevant, and time-bound.
Using this standard, you can establish goals that actionably inform every decision you make within your business.
2. Identify KPIs
You’ll use both financial and non-financial performance indicators to keep your business operations on track and accomplish your goals. Tie each KPI to a specific goal, and ensure they’re easily trackable and data-supported.
Financial KPIs can include your top line, revenue growth, financial trends, gross margins, and overall operating expenses. Non-financial KPIs can include metrics you can’t necessarily pull straight from your resource planning systems, like marketing conversion rates or click-through paths on your website.
You should also track the trends of your KPIs themselves. Don’t just set and forget them in a fancy dashboard. See how they change over time and adjust them based on your needs.
3. Use a realistic budget
Don’t be too overzealous in how much you’ll spend to achieve your small business goals. Be practical about your revenue streams, financial projections, and other resources you have at your disposal.
4. Keep clear roles and responsibilities
As different team members collaborate to achieve your larger initiatives, everyone must know where they fit in the plan. Be intentional and clearly establish who is going to be in charge of what tasks so everyone stays on track and you avoid clashing roles.
5. Stick to a timeline
Set strict deadlines and define milestones so you achieve your goal within a specific timeframe. While you’re at it, work up a contingency plan for what you’ll do if you don’t reach your goals and how you’ll pivot to get back on track.
Figuring out financial forecasting
Forecasting is the ongoing process of using past and current data to make predictions about your business. It factors in predictable and unpredictable events to influence your strategic decision-making for your business.
The benefits of forecasting
You’ll end up basing most of your important business decisions on your predictions about your current and future financial activities.
By developing and using strong forecasts, you:
- Provide clarity around expenses — Outline what you can expect to earn and owe so you can make more informed decisions about budgets and operating plans.
- Promote trust and transparency — Deliver a clear view of what you predict your success or failure will look like so everyone knows how the business is operating.
- Develop a framework for management — Use your forecasts to work out your annual budget, AOPs, and investments for leadership to follow.
- Spot problem areas — Identify areas of weakness, see how they’ll negatively impact your future finances, and build a plan to turn things around and reduce risk.
- Help attract investors — Give potential investors data-based predictions of your business’s growth and success to earn buy-in and additional funding.
As you prepare financial forecasts for various areas of your business, you’ll want to pivot depending on the type of forecast you need.
The types of forecasting
For the greatest accuracy, your forecasts should be specific to certain functions. To that end, you’ll choose from four main types of forecasts.
- Sales forecasting — This predicts how much of your product or services you’ll sell within a certain fiscal period. You’ll use these forecasts to inform your resource allocation, budgeting, and production planning.
- Cash flow forecasting — This predicts how much cash you take in and put out within a certain period. It’s most accurate to perform short-term forecasts that will inform your budgeting and funding needs.
- Budget forecasting — This predicts the results of your planned annual budgets and uses information from larger financial forecasts.
- Income forecasting — This predicts how much revenue you’ll make over a certain period and what your growth rate may look like. You’ll use these to inform decisions around cash flow and spend management, funding, and supplier activities.
Forecasts tend to get more complex as you grow your business and learn more about your operations and industry. When so much rides on preparing accurate, robust forecasts, it’s crucial you get the process down pat.
How to perform a financial forecast
Financial forecasting involves taking in a lot of information and funneling it all down into informed, data-supported predictions. Make sure you follow the right steps to ensure those predictions are as accurate as possible.
1. Define your intention
Your reason for performing a financial forecast informs the entire rest of the process.
Decide if, for example, you're looking to see if you’re on track to sell enough of your product to keep things running smoothly or if you need to spell out your future growth to support a future funding round. Your intention can also impact the type of forecasting you perform.
2. Gather all your data
You can only build a strong forecast if you base everything on the right data. Before you try to make any predictions, collect current and past financial data related to your revenue, expenses, investment, debts, share earnings, and operating costs.
3. Decide on a forecasting method
There are two recognized methods when it comes to financial forecasting.
Quantitative forecasting uses existing company data to detect patterns and predict future outcomes. On the other hand, qualitative forecasting uses industry and market expertise and opinions to make predictions about your business’s future.
If you're just starting out and don't necessarily have a lot of data to inform your forecast, the qualitative method might be your better bet.
4. Document your results
After you've put in all the work to develop a financial forecast, make sure you record your predictions. They should be accessible to key players within your business and easy to understand so you can track changes.
5. Monitor your analysis
Since they are predictions, forecasts will never be 100% accurate. You have to monitor your predictions and compare them to the reality of your business. Not only does this let you quickly address areas that deviate from your forecast, but it also lets you use that analysis to inform future forecasts.
6. Rinse and repeat
Speaking of future forecasts, this is not a one-time process. You need to continuously perform this process to adapt to changing market environments, account for changing financial management practices within your business, and keep future predictions accurate.
Financial planning services for your SMB made simple
Now that you know everything that goes into creating these financial plans, you’re ready to go, right? You just have to find all that data, sift through it, make some educated guesses, and hope your math is spot on. Or…
You can let us handle the heavy lifting. At Hiline, we craft a custom-built financial ecosystem tailored to your business. Our technology unifies your data and delivers AI-powered insights with expert human oversight so you can build a roadmap for your future success.
From everyday bookkeeping to fractional CFO services, we have you covered. Ask us how you can enter a healthier financial future.
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