Your next step is to do the numbers of the plan, which you can do step-by-step. The math is fairly simple. The assumptions are very important, but this is doable with what you know about your business if you just follow the steps. So you want to have a sales forecast. Typically, this will be 12 months monthly and then year two and year three annually. And it will include sales and costs of sales, also called cost of goods sold. We'll look at that in more detail later. Personnel plan for the same times and that plus the sales forecast becomes the core basis of your profit or loss. Sales less cost of sales is gross margin. Then expenses, interest, and taxes are subtracted to give you the profit.
A business also needs to project its financial position called the balance sheet, which is assets, liabilities, and capital. And to do that right, you need to start that balance with an estimate of start-up costs if you're planning a new company or for an existing company past results that set the starting balances. All of this comes together in what is the most important component of the business plan, the cash plan or cash flow projection, also called pro forma cash flow. These various elements of information come together to help you project the most important resource you have, which is cash money to spend.
Your financials are built on just a few key concepts that you need to know. Your profit and loss, also called income statement, takes sales and subtracts costs of sales, also called COGS or cost of goods sold to calculate gross margin. And from gross margin, you subtract expenses, which would include interest and taxes and your regular operating expenses to calculate profit. The balance sheet shows the financial position of the company at any given date. The balance includes assets; which are cash, inventory, accounts receivable, assets like furniture, tables, vehicles; liabilities, which are basically debts, amounts you owe, for example, accounts payable, current debt, long-term debt; and capital, which includes money invested and money earned over time.
Notice that the profit and loss doesn't directly relate to the balance sheet except through profit, which increases capital. And presumably, profit will increase assets whether that's cash in the bank or accounts receivable, but not exactly and not necessarily. The most important by far projection in the business plan is the cash flow, which is simply money received less money spent is money available, liquid cash. We call it cash not referring to coins and bills but liquidity, money in the bank that the business can spend.
The importance of the cash projection is first of all because it's vital to your business survival, but also because it's not intuitive and not obvious. Sales, for example, aren't necessarily money received. They might be money called accounts receivable where goods or services have been delivered to customers, but the business is waiting for the customers to pay for those invoices. And cost of sales might not necessarily be money spent. Cost of sales might come from inventory, which has been sitting in the business for months and was purchased months ago.
Expenses are not necessarily money spent either. Sometimes you receive the invoices for expenses and pay them in your business six or eight weeks later. That happens often. This simple example highlights the importance of laying out the cash flow. We have here a hypothetical company with sales of $500 and profits of $17 and an estimated cash balance of $565, given these assumptions on sales on credit, collection days, and payment days. Sales on credit refers to business-to-business sales in which you deliver goods or services along with an invoice and the customer, usually another business, pays you 30, 45, 60 days later.
Collection days refers to the average waiting period between delivering the invoice and getting paid. And payment days refers to how long your business waits before it pays its bills. So if we simply adjust these assumptions and take no sales on credit, meaning all our sales are in cash and therefore no collection days and we pay late, we can have $1,163 as our cash balance instead of $565. Notice we haven't changed sales or cost of sales or personnel or expenses. We've simply affected the timing. Now let's look at the worst scenario here without changing sales or costs of sales or expenses.
What if we were entirely business to business and we wait 90 days to get paid, and now if we pay our bills at 30 days with $310 missing in our cash balance, if we pay faster than 30 days, we can see we can make this scenario look much worse. That's a minus $768 in our balance here again without changing the fundamental profitability. The solution here is working capital. If these are realistic assumptions for your business, you're still profitable. It's not that you want to go out of business. You simply have to have an extra thousand or so in this worst-case scenario as working capital to support the cash flow of the business. That's why you need to plan.