Subscribe to Entrepreneur for $5

Do You Need to Write a Formal Business Plan?

Opinions expressed by Entrepreneur contributors are their own.

Every entrepreneur needs a plan for his or her business. However, they may or may not need a formal business plan.

First, let's start with the basics. Every business must answer these three questions:

1. Why should a prospective customer buy your product or service rather than a competitor's?

2. Is there a segment of the market that values what differentiates you and is it large enough to support your business?

Related: How to Write a Business Plan Banks Can't Resist

3. How will you reach this segment with your message?

Once you resolve these very basic issues, whether you need a formal business plan is a function of cash flow. If your business will have significant negative cash flow before it starts to throw off cash, or if you need your business to throw off cash from day one (say to pay the bills), a formal business plan may be in order.

Let's consider examples at each end of the spectrum. You have an idea for a fantastic new product. You want to launch a business to bring the product to market. However, you'll need to make a significant investment in product development. Then, you'll need to purchase equipment, rent space and hire people to manufacturer it. There will be a lot of cash outflow before there is any income. You're looking for investors to help make your dream a reality. You are going to need a formal business plan.

At the other end of the spectrum, suppose you want to launch a business that has no fixed cost. No upfront investment is required. You'll be cash flow positive from day one. Further, let's assume that you are not counting on income from this new venture to pay your monthly bills. An example might be a residential cleaning business. You'll use the customer's equipment and supplies.

Related: 4 Reasons Your Business Plan Might Need to Be Trashed

You have already had two prospective customers approach you about cleaning their homes. You know that a large number of working people in your area use housekeepers, so there is a good market. Your prices are competitive and you consistently do a better job than the franchise cleaners do. Therefore, you expect that your business will grow through word of mouth.

You certainly have a plan for your business. You've answered the three questions every business must answer. However, we would not encourage you to hire a consultant to help you develop a formal business plan with revenue, expense and cash-flow projections. Instead, test and learn. Fail fast and fail cheap. Learn from your mistake and move on.

Most businesses fall between these two extremes. The key to whether you will want to invest the time and effort to develop a formal business plan is your cash-flow situation.

If you are looking for outside funding or you are going to dig a deep hole before you become cash-flow positive, invest the time to develop a formal business plan. If you will be cash flow positive from day one, answer the three questions above and get on with your business.

Related: The Entrepreneur's Simple Guide to Business Concepts

Entrepreneur Editors' Picks