Most entrepreneurs would be hard-pressed to determine whether they are making a loss or profit because of their financial management skills. Financial management is often ignored or postponed because most entrepreneurs assume that once their enterprises start making money, they will somehow acquire the skills required to manage it. This has devastating results given that lack of a financial plan is among the top reasons why small and medium-sized enterprises in Kenya fail within the first three years.
Why is a financial plan important?
- To distinguish between personal and business goals
Financial freedom is one of the most cited reasons for starting a business. In the quest for a personal retirement plan or an alternative source of income, the financial goals of the business can easily get lost. For a business to thrive, it requires a steady cash flow to operate. If an enterprise intends to have steady growth, expenses such as marketing and hiring need to be budgeted for. A financial plan enables the entrepreneur to assign a monetary value to their goals. It provides a means for sifting through the long term and short-term business goals. It helps the entrepreneur separate his personal goals from his business goals.
With a financial plan in place, an entrepreneur is trained to not only focus on daily problems that obscure him or her from the bigger picture. The financial plan provides a mechanism through which the entrepreneur can appreciate how monthly expenditures add up to annual expenditure that has an impact on the realization of the long-term business objectives
- To help in filing tax returns
As the deadline for filing tax returns in Kenya approaches, most enterprises find themselves scrambling to file their returns. This is due to a lack of proper financial records that would enable them to declare their returns with ease. A financial plan sets the basis for the maintenance of proper records that help the enterprise keep track of its expenditures. Some applications can be downloaded for free which can help in keeping track of receipts and invoices, but these tools are useless to the entrepreneur who lacks financial management skills.
- To help in the identification of priorities
An upgraded digital printer for a graphic designer may be necessary for the long term but ensuring that the electricity bills and rent have been paid are important. Spending priorities are not always obvious for small and medium-sized entrepreneurs. Larger organizations have the mechanisms that allow them to do a cost/benefit analysis for their priorities. Small and medium-sized enterprises can use their accounting tools to keep track of essential expenditures.
- To keep track of the progress that has been made
A financial plan enables the business to keep track of growth in sales and accounts for profits and losses. Startups find it difficult to determine the progress that they have made given that startups face hurdles that seem insurmountable at times. A financial plan can offer the much -needed motivation as it enables the entrepreneur to quantify the steps, they have taken towards making their dream a reality.
What are the components of a financial plan?
This comprises of regularly incurred expenses, associated expenses, and future expenses. Regular expenses refer to current ongoing expenditures such as rent, payroll, and utilities. Having regular expenditures documented enables the enterprise owner to determine whether there are costs that can be managed or eliminated. For instance, a business owner may opt to move to a less expensive business premise and use the money that has been saved as a result of such a move by creating an application that allows the clients to make their orders online.
Associated expenses may include estimated costs of expenses such as the expansion of the enterprises to accommodate deliveries that have been made online or the cost of hiring and training a new hire. Keeping track of associated expenses prevents the entrepreneur from being financially overambitious during business expansion.
Statement of financial position
Small entrepreneurs often underestimate the value of their assets such as tools and machinery. They also underestimate their liabilities hence they end up in an endless cycle of financial chaos. A business owner needs to analyze their liabilities and work towards ensuring that they are managing them well. Poorly managed debts that cannot be accounted for are a liability that can make the best business collapse within months. Hiring too many workers yet the business cannot afford the pay the workers presents a liability. The statement of the company's financial position enables the business owner to determine the financial health of the enterprise.
Cash flow projection
The future might be uncertain but that does not mean it should not be planned for. A wise businessperson projectscash flow on a monthly, quarterly, and annual basis. Having an annual financial plan allows the business owner to foresee any challenges that might be encountered and have mechanisms in place that allow them to conquer those challenges. For instance, a caterer can project their cash flow during the peak and off-peak seasons. Based on the projections, she can put in place measures to ensure that operational expenses are still met during the off-peak season. Based on cash flow projections, a business owner can plan for investments for the business such as insurance and asset acquisition.
This allows the business owner to carry out an analysis of the profits earned through the sale of each additional unit versus the fixed costs associated with the business. This is critical in understanding the growth of revenue from the business versus the growth of the input into the business. A break-even analysis can be useful in determining the costs associated with each unit produced by the business. A wise businessperson should work towards setting the price of his or her goods or services at a competitive margin that allows the businessperson to earn a comfortable profit margin.
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