The Purpose Of This Section
The operations and management plan is designed to describe just how the business functions on a continuing basis. The operations plan will highlight the logistics of the organization such as the various responsibilities of the management team, the tasks assigned to each division within the company, and capital and expense requirements related to the operations of the business. In fact, within the operations plan you'll develop the next set of financial tables that will supply the foundation for the "Financial Components" section.
The financial tables that you'll develop within the operations plan include:
- The operating expense table
- The capital requirements table
- The cost of goods table
There are two areas that need to be accounted for when planning the operations of your company. The first area is the organizational structure of the company, and the second is the expense and capital requirements associated with its operation.
The organizational structure of the company is an essential element within a business plan because it provides a basis from which to project operating expenses. This is critical to the formation of financial statements, which are heavily scrutinized by investors; therefore, the organizational structure has to be well-defined and based within a realistic framework given the parameters of the business.
Although every company will differ in its organizational structure, most can be divided into several broad areas that include:
- Marketing and sales (includes customer relations and service)
- Production (including quality assurance)
- Research and development
These are very broad classifications and it's important to keep in mind that not every business can be divided in this manner. In fact, every business is different, and each one must be structured according to its own requirements and goals.
The four stages for organizing a business are:
- Establish a list of the tasks using the broadest of classifications possible.
- Organize these tasks into departments that produce an efficient line of communications between staff and management.
- Determine the type of personnel required to perform each task.
- Establish the function of each task and how it will relate to the generation of revenue within the company.
Calculate Your Personnel Numbers
Once you've structured your business, however, you need to consider your overall goals and the number of personnel required to reach those goals. In order to determine the number of employees you'll need to meet the goals you've set for your business, you'll need to apply the following equation to each department listed in your organizational structure: C / S = P
In this equation, C represents the total number of customers, S represents the total number of customers that can be served by each employee, and P represents the personnel requirements. For instance, if the number of customers for first year sales is projected at 10,110 and one marketing employee is required for every 200 customers, you would need 51 employees within the marketing department: 10,110 / 200 = 51
Once you calculate the number of employees that you'll need for your organization, you'll need to determine the labor expense. The factors that need to be considered when calculating labor expense (LE) are the personnel requirements (P) for each department multiplied by the employee salary level (SL). Therefore, the equation would be: P * SL = LE
Using the marketing example from above, the labor expense for that department would be: 51 * $40,000 = $2,040,000
Calculate Overhead Expenses
Once the organization's operations have been planned, the expenses associated with the operation of the business can be developed. These are usually referred to as overhead expenses. Overhead expenses refer to all non-labor expenses required to operate the business. Expenses can be divided into fixed (those that must be paid, usually at the same rate, regardless of the volume of business) and variable or semivariable (those which change according to the amount of business).
Overhead expenses usually include the following:
- Maintenance and repair
- Equipment leases
- Advertising & promotion
- Packaging & shipping
- Payroll taxes and benefits
- Uncollectible receivables
- Professional services
- Loan payments
In order to develop the overhead expenses for the expense table used in this portion of the business plan, you need to multiply the number of employees by the expenses associated with each employee. Therefore, if NE represents the number of employees and EE is the expense per employee, the following equation can be used to calculate the sum of each overhead (OH) expense: OH = NE * EE
Develop a Capital Requirements Table
In addition to the expense table, you'll also need to develop a capital requirements table that depicts the amount of money necessary to purchase the equipment you'll use to establish and continue operations. It also illustrates the amount of depreciation your company will incur based on all equipment elements purchased with a lifetime of more than one year.
In order to generate the capital requirements table, you first have to establish the various elements within the business that will require capital investment. For service businesses, capital is usually tied to the various pieces of equipment used to service customers.
Capital for manufacturing companies, on the other hand, is based on the equipment required in order to produce the product. Manufacturing equipment usually falls into three categories: testing equipment, assembly equipment and packaging equipment.
With these capital elements in mind, you need to determine the number of units or customers, in terms of sales, that each equipment item can adequately handle. This is important because capital requirements are a product of income, which is produced through unit sales. In order to meet sales projections, a business usually has to invest money to increase production or supply better service. In the business plan, capital requirements are tied to projected sales as illustrated in the revenue model shown earlier in this chapter.
For instance, if the capital equipment required is capable of handling the needs of 10,000 customers at an average sale of $10 each, that would be $100,000 in sales, at which point additional capital will be required in order to purchase more equipment should the company grow beyond this point. This leads us to another factor within the capital requirements equation, and that is equipment cost.
If you multiply the cost of equipment by the number of customers it can support in terms of sales, it would result in the capital requirements for that particular equipment element. Therefore, you can use an equation in which capital requirements (CR) equals sales (S) divided by number of customers (NC) supported by each equipment element, multiplied by the average sale (AS), which is then multiplied by the capital cost (CC) of the equipment element. Given these parameters, your equation would look like the following: CR = [(S / NC) * AS] * CC
The capital requirements table is formed by adding all your equipment elements to generate the total new capital for that year. During the first year, total new capital is also the total capital required. For each successive year thereafter, total capital (TC) required is the sum of total new capital (NC) plus total capital (PC) from the previous year, less depreciation (D), once again, from the previous year. Therefore, your equation to arrive at total capital for each year portrayed in the capital requirements model would be: TC = NC + PC - D
Keep in mind that depreciation is an expense that shows the decrease in value of the equipment throughout its effective lifetime. For many businesses, depreciation is based upon schedules that are tied to the lifetime of the equipment. Be careful when choosing the schedule that best fits your business. Depreciation is also the basis for a tax deduction as well as the flow of money for new capital. You may need to seek consultation from an expert in this area.
Create a Cost of Goods Table
The last table that needs to be generated in the operations and management section of your business plan is the cost of goods table. This table is used only for businesses where the product is placed into inventory. For a retail or wholesale business, cost of goods sold--or cost of sales--refers to the purchase of products for resale, i.e. the inventory. The products that are sold are logged into cost of goods as an expense of the sale, while those that aren't sold remain in inventory.
For a manufacturing firm, cost of goods is the cost incurred by the company to manufacture its product. This usually consists of three elements:
As in retail, the merchandise that is sold is expensed as a cost of goods, while merchandise that isn't sold is placed in inventory. Cost of goods has to be accounted for in the operations of a business. It is an important yardstick for measuring the firm's profitability for the cash-flow statement and income statement.
In the income statement, the last stage of the manufacturing process is the item expensed as cost of goods, but it is important to document the inventory still in various stages of the manufacturing process because it represents assets to the company. This is important to determining cash flow and to generating the balance sheet.
That is what the cost of goods table does. It's one of the most complicated tables you'll have to develop for your business plan, but it's an integral part of portraying the flow of inventory through your operations, the placement of assets within the company, and the rate at which your inventory turns.
In order to generate the cost of goods table, you need a little more information in addition to what your labor and material cost is per unit. You also need to know the total number of units sold for the year, the percentage of units which will be fully assembled, the percentage which will be partially assembled, and the percentage which will be in unassembled inventory. Much of these figures will depend on the capacity of your equipment as well as on the inventory control system you develop. Along with these factors, you also need to know at what stage the majority of the labor is performed.
Financial Statements to Include
Financial data is always at the back of the business plan, but that doesn't mean it's any less important than up-front material such as the business concept and the management team. Astute investors look carefully at the charts, tables, formulas and spreadsheets in the financial section, because they know that this information is like the pulse, respiration rate and blood pressure in a human--it shows whether the patient is alive and what the odds are for continued survival.
Financial statements, like bad news, come in threes. The news in financial statements isn't always bad, of course, but taken together it provides an accurate picture of a company's current value, plus its ability to pay its bills today and earn a profit going forward.
The three common statements are a cash flow statement, an income statement and a balance sheet. Most entrepreneurs should provide them and leave it at that. But not all do. But this is a case of the more, the less merry. As a rule, stick with the big three: income, balance sheet and cash flow statements.
These three statements are interlinked, with changes in one necessarily altering the others, but they measure quite different aspects of a company's financial health. It's hard to say that one of these is more important than another. But of the three, the income statement may be the best place to start.
The income statement is a simple and straightforward report on the proposed business's cash-generating ability. It's a score card on the financial performance of your business that reflects when sales are made and when expenses are incurred. It draws information from the various financial models developed earlier such as revenue, expenses, capital (in the form of depreciation), and cost of goods. By combining these elements, the income statement illustrates just how much your company makes or loses during the year by subtracting cost of goods and expenses from revenue to arrive at a net result--which is either a profit or a loss.
For a business plan, the income statement should be generated on a monthly basis during the first year, quarterly for the second, and annually for each year thereafter. It's formed by listing your financial projections in the following manner:
- Income. Includes all the income generated by the business and its sources.
- Cost of goods. Includes all the costs related to the sale of products in inventory.
- Gross profit margin. The difference between revenue and cost of goods. Gross profit margin can be expressed in dollars, as a percentage, or both. As a percentage, the GP margin is always stated as a percentage of revenue.
- Operating expenses. Includes all overhead and labor expenses associated with the operations of the business.
- Total expenses. The sum of all overhead and labor expenses required to operate the business.
- Net profit. The difference between gross profit margin and total expenses, the net income depicts the business's debt and capital capabilities.
- Depreciation. Reflects the decrease in value of capital assets used to generate income. Also used as the basis for a tax deduction and an indicator of the flow of money into new capital.
- Net profit before interest. The difference between net profit and depreciation.
- Interest. Includes all interest derived from debts, both short-term and long-term. Interest is determined by the amount of investment within the company.
- Net profit before taxes. The difference between net profit before interest and interest.
- Taxes. Includes all taxes on the business.
- Profit after taxes. The difference between net profit before taxes and the taxes accrued. Profit after taxes is the bottom line for any company.
Following the income statement is a short note analyzing the statement. The analysis statement should be very short, emphasizing key points within the income statement.
Cash Flow Statement
The cash-flow statement is one of the most critical information tools for your business, showing how much cash will be needed to meet obligations, when it is going to be required, and from where it will come. It shows a schedule of the money coming into the business and expenses that need to be paid. The result is the profit or loss at the end of the month or year. In a cash-flow statement, both profits and losses are carried over to the next column to show the cumulative amount. Keep in mind that if you run a loss on your cash-flow statement, it is a strong indicator that you will need additional cash in order to meet expenses.
Like the income statement, the cash-flow statement takes advantage of previous financial tables developed during the course of the business plan. The cash-flow statement begins with cash on hand and the revenue sources. The next item it lists is expenses, including those accumulated during the manufacture of a product. The capital requirements are then logged as a negative after expenses. The cash-flow statement ends with the net cash flow.
The cash-flow statement should be prepared on a monthly basis during the first year, on a quarterly basis during the second year, and on an annual basis thereafter. Items that you'll need to include in the cash-flow statement and the order in which they should appear are as follows:
- Cash sales. Income derived from sales paid for by cash.
- Receivables. Income derived from the collection of receivables.
- Other income. Income derived from investments, interest on loans that have been extended, and the liquidation of any assets.
- Total income. The sum of total cash, cash sales, receivables, and other income.
- Material/merchandise. The raw material used in the manufacture of a product (for manufacturing operations only), the cash outlay for merchandise inventory (for merchandisers such as wholesalers and retailers), or the supplies used in the performance of a service.
- Production labor. The labor required to manufacture a product (for manufacturing operations only) or to perform a service.
- Overhead. All fixed and variable expenses required for the production of the product and the operations of the business.
- Marketing/sales. All salaries, commissions, and other direct costs associated with the marketing and sales departments.
- R&D. All the labor expenses required to support the research and development operations of the business.
- G&A. All the labor expenses required to support the administrative functions of the business.
- Taxes. All taxes, except payroll, paid to the appropriate government institutions.
- Capital. The capital required to obtain any equipment elements that are needed for the generation of income.
- Loan payment. The total of all payments made to reduce any long-term debts.
- Total expenses. The sum of material, direct labor, overhead expenses, marketing, sales, G&A, taxes, capital and loan payments.
- Cash flow. The difference between total income and total expenses. This amount is carried over to the next period as beginning cash.
- Cumulative cash flow. The difference between current cash flow and cash flow from the previous period.
As with the income statement, you will need to analyze the cash-flow statement in a short summary in the business plan. Once again, the analysis statement doesn't have to be long and should cover only key points derived from the cash-flow statement.
The Balance Sheet
The last financial statement you'll need to develop is the balance sheet. Like the income and cash-flow statements, the balance sheet uses information from all of the financial models developed in earlier sections of the business plan; however, unlike the previous statements, the balance sheet is generated solely on an annual basis for the business plan and is, more or less, a summary of all the preceding financial information broken down into three areas:
To obtain financing for a new business, you may need to provide a projection of the balance sheet over the period of time the business plan covers. More importantly, you'll need to include a personal financial statement or balance sheet instead of one that describes the business. A personal balance sheet is generated in the same manner as one for a business.
As mentioned, the balance sheet is divided into three sections. The top portion of the balance sheet lists your company's assets. Assets are classified as current assets and long-term or fixed assets. Current assets are assets that will be converted to cash or will be used by the business in a year or less. Current assets include:
- Cash. The cash on hand at the time books are closed at the end of the fiscal year.
- Accounts receivable. The income derived from credit accounts. For the balance sheet, it's the total amount of income to be received that is logged into the books at the close of the fiscal year.
- Inventory. This is derived from the cost of goods table. It's the inventory of material used to manufacture a product not yet sold.
- Total current assets. The sum of cash, accounts receivable, inventory, and supplies.
Other assets that appear in the balance sheet are called long-term or fixed assets. They are called long-term because they are durable and will last more than one year. Examples of this type of asset include:
- Capital and plant. The book value of all capital equipment and property (if you own the land and building), less depreciation.
- Investment. All investments by the company that cannot be converted to cash in less than one year. For the most part, companies just starting out have not accumulated long-term investments.
- Miscellaneous assets. All other long-term assets that are not "capital and plant" or "investments."
- Total long-term assets. The sum of capital and plant, investments, and miscellaneous assets.
- Total assets. The sum of total current assets and total long-term assets.
After the assets are listed, you need to account for the liabilities of your business. Like assets, liabilities are classified as current or long-term. If the debts are due in one year or less, they are classified as a current liabilities. If they are due in more than one year, they are long-term liabilities. Examples of current liabilities are as follows:
- Accounts payable. All expenses derived from purchasing items from regular creditors on an open account, which are due and payable.
- Accrued liabilities. All expenses incurred by the business which are required for operation but have not been paid at the time the books are closed. These expenses are usually the company's overhead and salaries.
- Taxes. These are taxes that are still due and payable at the time the books are closed.
- Total current liabilities. The sum of accounts payable, accrued liabilities, and taxes.
Long-term liabilities include:
- Bonds payable. The total of all bonds at the end of the year that are due and payable over a period exceeding one year.
- Mortgage payable. Loans taken out for the purchase of real property that are repaid over a long-term period. The mortgage payable is that amount still due at the close of books for the year.
- Notes payable. The amount still owed on any long-term debts that will not be repaid during the current fiscal year.
- Total long-term liabilities. The sum of bonds payable, mortgage payable, and notes payable.
- Total liabilities. The sum of total current and long-term liabilities.
Once the liabilities have been listed, the final portion of the balance sheet-owner's equity-needs to be calculated. The amount attributed to owner's equity is the difference between total assets and total liabilities. The amount of equity the owner has in the business is an important yardstick used by investors when evaluating the company. Many times it determines the amount of capital they feel they can safely invest in the business.
In the business plan, you'll need to create an analysis statement for the balance sheet just as you need to do for the income and cash flow statements. The analysis of the balance sheet should be kept short and cover key points about the company.
Source: The Small Business Encyclopedia, Business Plans Made Easy, Start Your Own Business and Entrepreneur magazine.