Essential Financial Planning: Liquidity, Profit, and Assets

1. Components of the Financial Plan

The Financial Plan consists of three essential parts:

• Cash Plan (Liquidity Management)

  The objective is to anticipate if the company will need money in any given month and plan how to obtain it. This plan addresses the company's liquidity and short-term financial viability.

• Income Statement (Profit and Loss)

  Used to determine if the company is generating profits or incurring losses.

• Balance Sheet

  Provides information regarding the company's assets (what the company owns), liabilities (what the company owes), and equity (what the company should have).

Overall, the Financial Plan assesses both economic viability (profitability) and financial viability (solvency/liquidity).

2. Developing the Liquidity Plan (Cash Flow Projection)

The Liquidity Plan is a projection of monthly cash inflows and outflows.

Why is Liquidity Planning Important?

If you know the needed money in advance, you can determine the cheapest way to obtain financing, such as opening a credit account or securing a loan.

Considerations for Calculating Inflows and Outflows

• Inflows (entries) are recorded only when they actually become effective (cash basis).
• Both inflows and outflows are projected figures. It is prudent to estimate inflows conservatively (downward) and outflows aggressively (upward).

Calculating Projected Liquidity

The next step after calculating inputs and outputs is subtracting the outflows from the inflows to obtain the projected net liquidity.

• Positive Result: Indicates surplus money available in the bank account.
• Negative Result: Requires planning where to obtain funds. The most common solution is opening a credit facility or line of credit.

Model for Calculating the Liquidity Plan

The concepts used for input and output are indicative; you must include all concepts relevant to your specific situation. The important thing is that the reason for the money entering or exiting is clear and documented.

3. The Income Statement (Profit and Loss Account)

The Income Statement calculates the profits or losses at the end of the financial year. It is highly advisable to project this statement for the first three years of operation.

Utility of the Income Statement

It clearly indicates the profit or loss generated by the company, calculated based on total income and total expenses.

Understanding Depreciation as a Special Expense

When discussing costs, we must account for depreciation. Depreciation is the systematic allocation of the cost of a tangible asset over its useful life. For example, when buying a machine, we divide the total price by the number of years it will be used; this resulting amount is included as an expense each year.

Structure of the Income Statement

The statement records projected revenue and expenditure, leading to the final result (Net Income).

Interpreting Financial Results

In the initial years, companies often incur high interest charges, but eventually, if the business performs well, these financing costs should decrease or disappear.

(Note: An outline of the income statement structure is typically referenced here, e.g., Figure 5.3.)

Interpreting Net Results:

• If the net result is positive, the company is performing well.
• If the net result is negative, further analysis is required:
  • If Operating Results are positive, but the net result is negative due to financing costs, the gravity of the situation is less severe.
  • If Operating Results are negative, these losses absorb all potential profit, indicating a serious issue with core business activities.

If both operating results and financing results are negative, the amount of operating losses must be carefully analyzed and compared against the figures who run the company.