Chapter 4 – Developing a Business Plan
Your Business Plan
A business plan, if done thoroughly and accurately, will become an important guide for setting up your business and for making strategic decisions later on.
Depending on the nature of your business, your business plan may not need to be elaborate. Funders, suppliers and other important contacts may want the assurance of a business plan before doing business with you. It is important to them because they are putting other people’s money at risk with your idea. It is important for you to have a business plan because you are putting far more at risk: your financial stability, your reputation and your status in the community. It is far easier and less costly to correct your mistakes on paper before you are in business.
There are several ways to develop your business plan. If you wish to write your business plan on a computer, the Business Development Bank of Canada (BDC) and Canada Business Network have easy to follow templates which you can download. These tools let you prepare a professional business plan – a necessity when seeking financing for your project.
Contents of your Business Plan
Your business plan will help make your business idea concrete. Funders look at your business plan to decide their willingness to fund your business.
There are many ways to organize a business plan. One way to organize the information you should include in your plan is as follows:
- Executive summary
- Mission statement
- Company overview
- Strategic business objectives
- Business and market environment
- Marketing plan
- Financial plan
Remember that the person reading the plan may not understand your business and its products, services or processes as well as you do; so, try to avoid jargon. It’s a good idea to get someone who is not involved in the business to read your plan to make sure they can understand it.
Although it appears at the beginning of your business plan, you should write your executive summary last. It is a one to two page summary of the key points of your business plan. Think of it as a snapshot of what you envision your business to be and how you plan to get there.
The company overview provides essential information about the company. It should include:
- The legal name of the company.
- The legal form of the company (sole proprietorship, partnership,
corporation or co-operative).
- The business location.
- Background on key management personnel.
Your mission statement is what you want to happen and where you want to be some time in the future. By writing it down, you will have a benchmark to see whether your objectives have been realized. Your business’ mission statement should:
- Look to the future.
- Clearly state your commitment to your customers (i.e. low price, quality or service).
- Clearly state your commitment to the shareholders and to your employees.
Strategic business objectives
Show how your objectives or targets will fulfill your mission. They should be:
- Related to your mission statement
The following are areas where targets should be set:
Sales – You will need to set a sales target as a first step in developing your business plan.
Service – It will be important to state how you intend to satisfy your customers’ needs. If you are in a manufacturing business, it may be the quality and variety of products available. For a service business it might be turn-around times, friendly service, the best price or attractive financing terms.
Profit or Growth – You may be getting into business to increase your income or you may be willing to sacrifice the amount of money taken out of the company to build a larger company. As an owner, you may have to make a trade-off between income and growth. You may want to sacrifice the money taken out in earnings for future growth. You may want to emphasize growth to protect or strengthen your market share, reduce cost or increase competitiveness.
Social Objectives – As the owner of a small business, you have a social responsibility to your customers, employees, suppliers, the government and to the community. For example, your participation in the community and contribution to charitable causes is a way of thanking your customers for their loyalty and support. It also provides an important message to your clients and your employees about your integrity and generosity.
Diversification – By offering a variety of products or services, you can reduce the risks of changing market demand. This may be particularly important if you operate in a small market or your product experiences seasonal demand.
Business and market environment
All businesses operate in a complex environment. Your success will depend on your ability to anticipate and react to changes in your:
Knowing the marketplace will be the key to your success. Your plans should address:
- Economic trends
- Industry trends
- Community business trends
Good timing is sometimes more important than good judgment. Analysis of business trends shows a direct link between business failures and a general slow down or recession in the economy. Some industries, like real estate, recreation, luxury goods and high fashion, are very sensitive to cyclical trends in the economy.
If your business experiences ups and downs, you should collect information on some of the following economic indicators and use them to anticipate changes in demand for your products or services:
- Private and government investment
- Interest rates
- Unemployment levels
- Cost of living
- Ease of credit
- Consumer expenditures
The industry in which you operate may be experiencing changes quite independent from the broader economy. Statistics are available on a wide range of industries to help you to identify break-even sales, gross margins and capital requirements. If you are able to answer the following questions, you have a good understanding of your industry:
- How many firms are there in the industry?
- Are they profitable?
- Do they vary in size or do they seem to be the same size with similar characteristics?
- Is there a relationship between size and profitability?
- Have you anticipated technological changes?
- If your company will rely on one or two major customers, what are their long-term economic prospects and how strong is their industry?
- Will your company serve only the local market or are there opportunities to expand regionally, nationally or internationally?
Community business trends
Your final step will be to scan what is happening in your community. The size, nature and characteristics of the market, as well as your company’s future possibilities, may be determined by answering the following questions:
- Is the market large enough to sustain your business? Describe your typical client (i.e. for business suits – male, professional and 35 years old). How many customers do you need to meet your sales targets?
- Do people in your community have enough money to afford your goods and services?
- Is the sales volume for this kind of business growing, stable or declining?
- Who is the competition? How big are they? How many? How successful are they
- Who are the main suppliers?
- What is the normal industry return on investment?
Information on economic trends is available from the NWT Bureau of Statistics, Canada Business NWT, industry trade journals, municipal governments and Statistics Canada.
Now that you understand the marketplace, you must position your company so that you can achieve your sales and market share targets. The main components of your market plan are:
- A sales strategy indicating how your product or services will be sold to your customers. Include such items as hours of operation, credit arrangements, customer discounts and specials.
- A pricing strategy indicating how your product or service will be priced compared to your competition. You should also list reasons why your customers would be willing to pay more or less for your product or service.
- A distribution strategy indicating how your product will be sold. For example, through wholesalers, customer direct, brokers, etc.
- An advertising and promotion strategy. Your promotions should build on a single theme or message. How is this message to be delivered – point of purchase, seasonal sales promotions, radio or TV advertisements or sponsoring events?
When establishing a new business it is extremely important that you prepare a financial forecast for at least the first year of operation. The detail will depend on the amount of money and risks involved. If you will be completely dependent on income from the business or if it involves taking bank loans against income generated by the business, you must prepare more elaborate forecasts. You can get help with the financial area of your business plan by consulting with an accounting firm or visit www.bdc.ca for a free financial plan templates.
Forecasting is simply projecting budgets to cover the first one to three years of your business operation. The following forecasts will give you an overall financial picture of the business and provide a detailed analysis of your expenditures, revenues and profits. Financial planning is necessary to ensure the success of your business and to present your proposal to funders. Most funders will not consider your business unless you have done your homework in this area. In preparing your financial plan you will need:
Historical Financial statements
If you are taking over an existing company, your funding provider may want you to provide financial statements for the last three years. The business should have provided you with independently prepared financial statements for each year it has been in business.
There are four main components of annual financial statements:
The balance sheet is a picture of your financial position. It shows what you own (assets) and what you owe (liabilities), as well as what you are worth (shareholders’ equity) at a given point in time. Current assets and current liabilities affect your working capital. Combined, they indicate whether a business has sufficient resources to meet current obligations (those due in less than one year). Capital assets are possessions, such as a machine, which can be used to make money and have a reasonably long life, lasting several years. Long-term liabilities are debts that will not be paid off within one year.
Share capital is the amount paid for shares in the company. Retained earnings are the accumulated earnings after taxes. Together they represent shareholders’ equity.
The income statement (also called the profit and loss statement) shows how much money (revenues) was earned and how much money (expenses) was spent over a given period of time. Subtracting the expenses from the revenues gives the net profit or loss.
Typical items in your income statement include:
- Revenues – Money received from sales, usually broken down by product category or service area.
- Expenses – There are two basic categories of expenses, which include direct expenses (variable expenses such as material, wages and benefits) and administration and overhead (fixed expenses such as amortization, repair and upkeep that are needed to keep a business open).
- Income Before Taxes
- Income Taxes
- Net Income
This is only a sample of what could appear on an income statement. Expense items will vary depending on the type of business you want to start. If the information used to obtain the figures for the income statement is accurate, the statement will identify many of the problems that might occur in the early stages of the business. By preparing a financial plan beforehand, you can identify and address risks, such as insufficient cash flow, that may cause the business to fail.
Statement of cash flow
This statement identifies the changes to the cash position of a company. It specifies cash generated from operations and from loans or issuing shares and how that cash was used as working capital, to purchase fixed assets, to pay back loans or pay dividends.
Notes to financial statements
These notes explain the accounting policies that were applied in developing the financial statements. They provide details related to valuation of assets, long-term obligations and equity (ownership).
Projected financial statements
Whether you are starting a new business or buying an existing one, you will need to project future operations. Generally, planning is done for one year by projecting monthly financial activity.
General rules to follow in projecting financial activity are:
- Be conservative. Be realistic in your numbers.
- Project your budget first. Start with your fixed operating expenses, such as rent, utilities, etc. Next, you will need to estimate your direct expenses: expenses that vary with the volume of business you attain.
- Base your sales projections on your marketing plan.
- Consider several scenarios. Use a worst case, a most probable case and a best case.
The following projection is a basic example of the cash provided and used by normal operations in a six-month period.
Analyzing financial statements
Funders look at the relationships between different parts of the financial statements (ratios) when considering an application. Some of the most common financial indicators you should be aware of are:
- Debt to Equity – A measure of a company’s financial leverage. Debt/equity ratio is equal to long-term debt divided by common shareholders’ equity. Typically, the data from the prior fiscal year is used in the calculation. Investing in a company with a higher debt/equity ratio may be riskier, especially in times of rising interest rates due to the additional interest that has to be paid out for the debt. For example, if a company has long-term debt of $3,000 and shareholder’s equity of $12,000, then the debt/equity ratio would be 3,000 ÷ 12,000 = 0.25. It is important to realize that if the ratio is greater than 1, the majority of assets are financed through debt. If it is smaller than 1, assets are primarily financed through equity. Funders may lend up to three times the amount of equity in the business.
- Debt Servicing – All funders require that your income be greater than what your debt payment would be.
- Return on Investment (ROI) – The percentage return is calculated by taking a business net income and dividing it by its owner’s investment. ROI measures how effectively a company uses its capital to generate profit; the higher the ROI, the better. Simply, ROI is the income that an investment provides in a year.
- Break-even Analysis – This is a calculation funders use to determine what level of sales need to be achieved for a company to reach profitability.
- Quick Ratio – This ratio is a measure of your current cash situation. It is calculated by dividing the amount of quick assets (cash and other current assets, such as accounts receivable, that can be quickly converted into cash) a company has by its current liabilities (accounts payable and debt due in one year). Quick assets are often calculated by subtracting inventory from current assets. Quick ratio measures a company’s liquidity, its ability to pay current debts (higher number means the company is more liquid). For example, if current assets equal $15,000,000, current inventory equals $6,000,000, and current liabilities equal $3,000,000, then quick ratio amounts to: ($15,000,000 – $6,000,000)/$3,000,000 = 3. Since we subtracted current inventory, it means that for every dollar of current liabilities there are three dollars of easily convertible assets. In general, a quick ratio of 1 or more is accepted by most creditors; however, quick ratios vary greatly from industry to industry.
The Capital Budget
Your capital budget will detail the assets needed to start your business. If you are buying an existing business, the cost of assets will be the cost of the business.
If you are starting from scratch, you will need to buy or lease the assets needed to get into business. Assets may include:
- Building and equipment
- Leasehold improvements
- Working capital (the money needed to cover day-to-day operating costs)
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