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FINANCIAL PLAN

What is a Financial Plan?

A Financial Plan is a document that looks at and analyzes current financial situation and uses that information in order to come up with a prediction of what the future financial situation might be. This can be used by either individuals or businesses to achieve a certain Financial Goal. It looks at various financial statements such as: the Income Statement, Balance Sheet, and Cash Flow Statement. These statements are analyzed in order to determine a person's or a company's current financial status. From this financial status, predictions can be made regarding what the financial status will be in the future.

Once these predictions have been made, you would look at these predictions and evaluate them based on what items can be adjusted in order to make sure that the Financial Goal is achieved.

Why do I need to learn Financial Analysis?

Being able to perform Financial Analysis is critical not only for businesses, but for individuals as well. Financial Analysis can give you a lot of information. It can tell you how quickly you are able to turn your assets into cash. This is relevant because the ability to have cash, makes you more able to acquire new assets, or pay for liabilities.

You would also be able to determine which expense uses up majority of your income. This makes it easier for you to determine which of these expenses you should adjust in order to make sure that you achieve your financial goal.

How do I perform a Financial Analysis?

1. Calculate Financial Ratios. Financial ratios are numbers that are calculated using information that can be found in various financial statements. They are used to compare the performance of an individual or a business with previous performances, other companies, or with a standard for companies in the same industry. These Financial Ratios are more commonly used in businesses rather than individual finances since people don't usually keep an account of what is a current or a long term asset.

a. Liquidity Ratios. Liquidity is the ability of a person or business to convert assets into cash so that it can be used to either pay off debts or acquire new assets. There are two types of liquidity ratios: Current Ratio and Acid Ratio. Refer to the WIKI: Liquidity Ratios for more information.

b. Asset Management Ratios. Asset Management Ratios are used by businesses in order to determine how well assets are used in order to generate income. There are two types of Asset Management Ratios: Accounts Receivable Turnover Ratio and Inventory Turnover Ratio. 

Refer to the WIKI: Asset Management Ratios for more information.

c. Debt Management Ratios. Debt Management Ratios are used by businesses in order to determine how much the business relies on debts in order to keep their business running. There are two types of ratios that you will learn about: the Debt-to-Equity ratio, and the Debt- to-Income ratio. Refer to the WIKI: Debt Management Ratios for more information.

d.Profitability Ratios. Profitability Ratios tell you what percentage of your Revenue do you actually get as income after deducting all your expenses. This is a good indicator whether some changes should be made in order to make sure that you are getting more of an Income from the Revenue that you earn. You may refer to the WIKI: Profitability Ratios for more information.

e.Savings Ratios. As a general rule of thumb, it is good to have at least 10% of the income going into Savings or Investments. This ratio will tell you how much of your income goes into savings. Refer to the WIKI: Savings Ratios for more information.

2.Perform a Vertical Analysis. A vertical analysis is used in order to determine how large an item in a financial statement is in percent.

a. Income Statement

  i. Look at the total value of your Revenue account from the Income Statement. This is considered your 100%

  ii. Look at each item in your Income Statement and divide that by the amount of your Revenue.

iii. Convert that number into percent. The percentage tells you how big each expense is as part of your total Revenue.

b.Balance Sheet

  i. Look at the total value of your Assets. This is considered your 100%.

  ii. Look at each item in your assets and divide that by the amount of your total assets.

  iii. Convert that number into percent.

  iv. Look at the total value of your Liabilities and Equity. This total is considered 100%.

  v. Look at each item in your liabilities section and divide that amount by the total of Liabilities and Equity.

  vi. Convert that number into percent. The percentage tells you how big each item is from your total Assets.

  vii. Look at each item in your Equity section and divide that amount by the total of Liabilities and Equity.

  viii. Convert that number into percent. The percentage tells you how big each item is from your whole Liabilities and Equity.

3. Perform a Horizontal Analysis. A Horizontal Analysis is used to compare the value in Financial Statements over a period of time.

a. Ensure that you have at least 2 periods of the same Financial Statement.

b. Make sure that items with the same account title are aligned in a row.

c. Take the value of the earlier year and subtract it from the latest year. In the example below, you would subtract Year 1 from Year 2.

d. The result of that, you would divide by the value of the earlier year. In the example below, you would divide the amount by the value of Year 1.

e. You would then convert that value into percent. This value represents how much something has changed from the previous period to the current period.

f. If you are comparing more than 2 time periods, make sure that it gets compared to the same earlier time period. For example, if you have Year 1, Year 2, and Year 3; you would compare Year 2 against Year 1, and you would also compare Year 3 against Year 1.

4. Interpret the results. Look at the vertical and horizontal analysis below. From it you can gain the following information:

  a.Sales increased by 31.52% from Year 2 to Year 3.

  b.The company's biggest operating expense is used for Payroll.

  c.You only increased the amount you pay your workers by 2.67%, and still they generated a 31% increase in Sales.

  d.You increased spending on Promotions and Marketing by 7.69%.

  e.Your taxes have also doubled in a year.

  f.Your net income has also doubled in a year.

What this could mean is that by increasing you spending on Promotions and Marketing, you were able to reach more customers, therefore increasing the amount of Sales. Since there wasn't a huge increase in the amount you pay your staff, it's more likely that you increased the salary of your existing workers rather than hiring a new one.

5.Adjust the Financial Goal. Based on the information that you obtain from the Analysis, you will be able determine whether you should adjust your Financial Goals.