¨ Financial forecasts
As part of your plan you will need to provide a set of financial projections which translate what you've said about your business into numbers.
You will need to look carefully at:
how much capital you need if you are seeking external funding
the security you can offer lenders
how you plan to repay any borrowings
sources of revenue and income
You may also want to include your personal finances as part of the plan at this stage.
Financial planning
Your forecasts should run for the next three (or even five) years and their level of sophistication should reflect the sophistication of your business. However, the first 12 months' forecasts should have the most detail associated with them.
Include the assumptions behind your projection with your figures, both in terms of costs and revenues so investors can clearly see the thinking behind the numbers.
What your forecasts should include
Break even analysis
Profit and loss forecast - a statement of the trading position of the business: the level of profit you expect to make, given your projected sales and the costs of providing goods and services and your overheads.
Cashflow statements - your cash balance and monthly cashflow patterns for at least the first 12 to 18 months. The aim is to show that your business will have enough working capital to survive so make sure you have considered the key factors such as the timing of sales and salaries.
Business indicators
Break- even analysis shows how much revenue you need to cover both fixed and variable costs and it is an expected component of most business plans, especially for start-up companies.
Þ The Break-even Point is, in general, the point at which the gains equal to losses.
Þ It defines when an investment will generate a positive turn.
Þ The point where sales or revenues equal expenses.
Þ The point where total costs equal total revenues.
For business management, Break-even Point is the lower limit of profit when prices are set and margins are determined.
The Break-even method can be applied to a product, an investment, or the entire company’s operations. In options, Break-even Point is the market price that a stock must reach for option buyers to avoid a loss.
Break-even analysis is also a useful tool to study the relationship between fixed costs, variable costs and returns. Break-even price analysis calculates the price necessary at a given level of production to cover the costs.
Fixed costs include general overhead expenses, depreciations, interest costs, taxes and other similar categories of expenses that are not directly related to the levels of production.
Variable costs change in direct relation to volume of output. They may include cost of goods sold or production expenses such as labor, electricity, fuel, irrigation and other expenses directly related to the production of a commodity or investment in a capital asset.
Calculation of Break-even Point can be done using the following formula:
BEP = TFC / (SUP – VCUP)
Where:
BEP = Break-even point (units of production)
TFC = Total Fixed Cost
VCUP = Variable Costs per Unit of Production
SUP = Selling price per Unit of Production
Break-even calculation can also be graphically presented at monthly basis.
The Break-even Point should not be mistaken with the Payback Period, the time it takes to recover an investment.
Payback Period is perhaps the simplest method of looking at one or more investment projects and ideas.
It focuses on recovering the cost of investments.
It represents the ammount of time it takes for capital budgeting project to recover its initial cost.
Calculation:
PP = Cost of Project / Investment
Annual Cash Inflows
The Payback Period concept holds that all other things being equal, the better investment is the one with the shorter payback period.
Business income: sales
Business income falls into two categories for profit and loss reporting:
- sales or "turnover"
- other income
Business sales or turnover
Your business' total sales of products and/or services in a trading year is referred to as turnover. This is the starting point for your profit and loss account.
How you record sales will vary according to your business type and size. You may use a simple list or "ledger" in a book, a tailored spreadsheet, or a computer software program. Whichever system you use, you need to ensure that it is accurate and updated regularly
Business income: other
As well as reporting sales income, you need to report income to the business from other sources, for example:
- interest on business bank accounts
- sale of equipment you no longer need
- rental income to the business
- money you put into a limited company from personal funds
For Business plan projections, usually turnover is only used.
Business expenditure
Business expenditure falls into four key areas for the purpose of reporting your profit or loss. You can save yourself, or your accountant, time by grouping your costs accordingly in your purchase list or "ledger". The key areas are:
- cost of good sold
- sales and marketing expenses
- general and administrative expenses
- other expenses
Cost of goods sold
The cost of goods sold is the base cost of obtaining or creating your product.
This might include:
- components/raw materials to make your product
- the cost of stock you buy for resale
- interest on loans to buy stock or production equipment
- labour to produce the product
- machine hire
- small tools
- other production costs
When you create your profit and loss account, you deduct your cost of sales from your overall sales, or turnover, to arrive at your "gross profit". This is your profit before deduction of expenses.
Cost of sales does not usually apply if you supply a service only.
Sales and marketing expenses
These are all the ongoing expenses associated with the implementation of sales programme and include:
- sales employee costs
- motor expenses
- travel/subsistence
- advertising/promotion/entertainment
General and administrative expenses
These are all the ongoing expenses associated with running your business and in general they are:
- administrative employee costs
- premises costs
- repairs
- utilities
- insurance
- general administration
- motor expenses
- depreciations
- any other expenses
Other costs
These are all the expenses associated with outsourcing management and administration like:
- legal/professional costs
- consultancies
You can deduct the sum of sales and marketing expenses + general and administrative expenses + other expenses from your "gross profit" figure on your profit and loss account to calculate a figure of "profit before interest and taxes".
Deducting furthermore interest rates of loans as well as taxation rates you can estimate the net profit of your company.
Cash flow forecasting enables you to predict peaks and troughs in your cash balance. It helps you to plan borrowing and tells you how much surplus cash you're likely to have at a given time. Many banks require forecasts before considering a loan.
Elements of a cash flow forecast
The cashflow forecast identifies the sources and amounts of cash coming into your business and the destinations and amounts of cash going out over a given period. There are normally two columns listing forecast and actual amounts respectively.
The forecast is usually done for a year or quarter in advance and divided into weeks or months. In extremely difficult cashflow situations a daily cashflow forecast might be helpful. It is best to pick periods during which most of your fixed costs - such as salaries - go out. The forecast lists:
The forecast is usually done for a year or quarter in advance and divided into weeks or months. In extremely difficult cashflow situations a daily cashflow forecast might be helpful. It is best to pick periods during which most of your fixed costs - such as salaries - go out. The forecast lists:
- receipts
- payments
- excess of receipts over payments - with negative figures shown in brackets
- opening bank balance
- closing bank balance
It is important to base initial sales forecasts on realistic estimates
If you have an established business, an acceptable method is to combine sales revenues for the same period 12 months earlier with predicted growth.
Note that all forecast figures must relate to sums that are due to be collected and paid out, not invoices actually sent and received. The forecast is a live entity. It will need adjusting in line with long-term changes to actual performance or market trends.
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Cashflow management: the basics
Cash is the oxygen that enables a business to survive and prosper, and is the primary indicator of business health. While a business can survive for a short time without sales or profits, without cash it will die. For this reason the inflow and outflow of cash need careful monitoring and management.
Cashflow is the measure of your ability to pay your bills on a regular basis. It depends on the timing and amounts of money flowing into and out of the business each week and month. Good cashflow means that the pattern of income and spending in a business allows it to have cash available to pay bills on time.
Cash balances include:
· coins and notes
· current accounts and short-term deposits
· unused bank overdrafts and short-term loans
· foreign currency and deposits that can be quickly converted to your currency
It does not include:
· long-term deposits
· long-term borrowing
· money owed by customers
· stock
Difference between cash and profit
It is important not to confuse cash balances with profit. Profit is the difference between the total amount your business earns and all of its costs, usually assessed over a year or other trading period. You may be able to forecast a good profit for the year, yet still face times when you are strapped for cash.
The importance of cash
To make a profit, most businesses have to produce and deliver goods or services to their customers before being paid. Unfortunately, no matter how profitable the contract, if you don't have enough money to pay your staff and suppliers before receiving payment, you'll be unable to deliver your side of the bargain or receive any profit.
To trade effectively and be able to grow your business, you need to build up cash balances by ensuring that the timing of cash movements puts you in an overall positive cashflow situation.
Bear in mind, however, that having a lot of cash in your bank does not necessarily make good business sense. If you do not need to use it immediately, put spare cash in an account where it will earn high interest, or invest it in short-term investments. Get advice from your bank, accountant or financial adviser.
Cash inflows and cash outflows
Ideally, during the business cycle, you will have more money flowing in than flowing out. This will allow you to build up cash balances with which to plug cash flow gaps, seek expansion and reassure lenders and investors about the health of your business.
You should note that income and expenditure cash flows rarely occur together, with inflows often lagging behind. Your aim must be to speed up the inflows and slow down the outflows.
Cash inflows
· payment for goods or services from your customers
· receipt of a bank loan
· interest on savings and investments
· shareholder investments
· increased bank overdrafts or loans
Cash outflows
· purchase of stock, raw materials or tools
· wages, rents and daily operating expenses
· purchase of fixed assets - PCs, machinery, office furniture, etc
· loan repayments
· dividend payments
· income tax, corporation tax, VAT and other taxes
· reduced overdraft facilities
Many of your regular cash outflows, such as salaries, loan repayments and tax, have to be made on fixed dates. You must always be in a position to meet these payments, to avoid large fines or a disgruntled workforce.
To improve everyday cashflow you can:
- ask your customers to pay sooner
- chase debts promptly and firmly
- use factoring
- ask for extended credit terms with suppliers
- order less stock but more often
- lease rather than buy equipment
- improve profitability
You can also improve cash flow by increasing borrowing, or putting more money into the business. This is acceptable for coping with short-term downturns or to fund growth in line with your business plan, but shouldn't form the basis of your cash strategy.
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Manage income and expenditure
Effective cashflow management is as critical to business survival as providing services or products. Below are some of the key methods to help reduce the time gap between expenditure and receipt of income.
Customer management
Define a credit policy that clearly sets out your standard payment terms.
Issue invoices promptly and regularly chase outstanding payments. Use an aged debtor list to keep track of invoices that are overdue and monitor your performance in getting paid.
Consider exercising your right to charge penalty interest for late payment. .
Consider offering discounts for prompt payment.
Negotiate deposits or staged payments for large contracts. It's in your customers' interests that you don't go out of business trying to meet their demands.
Consider using a third party to buy your invoices in return for a percentage of the total.
Supplier management
Ask for extended credit terms. Giving your suppliers incentives such as large or regular orders may help, but make sure you have a market for the orders you're placing. Alternatively, consider reducing stock levels and using just-in-time systems.
Taxation
If you are registered for VAT, it makes sense to buy major items at the end rather than the start of a VAT period. This can often improve your cashflow, because you can set the VAT on the purchase off against the VAT you charge on sales. This may help plug a temporary cashflow gap.
Asset management
Consider leasing fixed assets, eg equipment, or buying them on hire purchase. Buying outright can result in a huge drain on cash in the first year of business.
Cash flow problems and how to avoid them
No matter how effective your negotiations with customers and suppliers, poor business practices can put your cashflow at risk.
Look out for:
· Poor credit controls - failure to run credit checks on your customers is a high-risk strategy, especially if your debt collection is inefficient.
· Failure to fulfil your order - if you don't deliver on time or to specification you won't get paid. Implement systems to measure production efficiency and the quantity and quality of stock you hold and produce
· Ineffective marketing - if your sales are stagnating or falling, revisit your marketing plan.
· Inefficient ordering service - make it easy for your customers to do business with you. Where possible, accept orders over the telephone or Internet. Ensure catalogues and order forms are clear and easy to use.
· Poor management accounting - keep an eye on key accounting ratios that will alert you to an impending cash flow crisis or prevent you from taking orders you can't handle.
· Inadequate supplier management - your suppliers may be overcharging, or taking too long to deliver. Create a supplier management system
· Poor control of gross profits or overhead costs.
Using your cash flow forecast as a business tool
A cash flow forecast can be an invaluable business tool if it is used effectively. Bear in mind that it is dynamic - you will need to change and adjust it frequently depending on business activity, payment patterns and supplier demands.
It's helpful to set up a regular review of the forecast, changing the figures in light of your sales, purchases and staff costs. Legislation, interest rates and tax changes will also impact on the forecast.
Having a regular review of your cashflow forecast will enable you to:
· see when problems are likely to occur and sort them out in advance
· identify any potential cash shortfalls and take appropriate action
· ensure you have sufficient cashflow before you take on any major financial commitment
Using a cash flow forecast to avoid overtrading
Having an accurate cash flow forecast will help ensure that you can achieve steady growth without overtrading. You will know when you have sufficient assets to take on additional business - and, just as importantly, when you need to consolidate. This will enable you to keep staff, customers and suppliers happy.
It is important that you incorporate warning signals into your cash flow forecast. For example, if predicted cash levels come close to your overdraft limits, this should sound an alarm and trigger action to bring cash back to an acceptable level.
Ideally, you should always have a contingency plan, such as retaining a minimum amount of cash in the business, perhaps in an interest-earning account. This "rainy day" money can be used to meet short-term cash shortages.
Refinements to a simple cash flow forecast
There is no single best way to set out a cash flow forecast. However, some refinements to the most basic ways of setting out the information will give you a more sophisticated view of your business' situation.
You could, for example, separate cash flow for business operations from funding cash flow. This gives a clearer picture of the actual performance of your business and is a format that many accountants prefer.
Cashflow from operations
Includes inflows such as:
· cash sales
· receipts from credit sales in earlier periods
· interest on savings
Includes outflows such as:
· payments to suppliers
· hire purchase and lease payments
· expenses - rent, rates, insurance, utilities, telephone, etc
· wages
· taxes and National Insurance
· interest on loans and bank charges
·
Funding cash flows
Includes inflows such as:
· loans from banks
· increase in share capital
Includes outflows such as:
· dividends paid
· loans repaid
With these two types of cashflow separated you can gauge how self-sufficient the day-to-day working of your business is. A net outflow in operational cashflow is usually an indicator of problems that need to be addressed quickly.
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Balance sheet
This is a snapshot of your business' assets (what you own or are owed) and your liabilities (what you owe) on a particular day - eg the last day of your financial year.
Ratios enable you to quickly see the relative value of one thing against another, eg two items on the balance sheet.
Ratio analysis can also be applied to non-financial data. For ease of reference, ratios are often split into the following areas of common control.
| Liquidity ratios | These ratios are used to measure solvency and short-term survival prospects. |
| Capital structure ratios | These ratios measure the adequacy of owners' funding in relation to long-term debt. |
| Activity and efficiency ratios | These ratios measure the operating efficiency of the business in non-financial terms. |
| Profitability ratios | These ratios measure overall profitability and how well the business is using its assets and covering overhead costs. |
Use accounting ratios to assess business performance
Ratio analysis is a good way to evaluate the financial results of your business in order to gauge its performance. Ratios allow you to compare your business against different standards using the figures on your balance sheet.
Accounting ratios can offer an invaluable insight into a business' performance. Ensure that the information used for comparison is accurate - otherwise the results will be misleading.
There are four main methods of ratio analysis - liquidity, solvency, efficiency and profitability.
Liquidity ratios
There are three types of liquidity ratio:
Current ratio - current assets divided by current liabilities. This assesses whether you have sufficient assets to cover your liabilities. A ratio of 2 shows you have twice as many current assets as current liabilities.
Quick or acid-test ratio - current assets (excluding stock) divided by current liabilities. A ratio of 1 shows liquidity levels are high - an indication of solid financial health.
Defensive interval - liquid assets divided by daily operating expenses. This measures how long your business could survive without cash coming in. This should be between 30 and 90 days.
Solvency ratios
Gearing is a sign of solvency. It is found by dividing loans and bank overdraft by equity, long-term loans and bank overdraft.
The higher the gearing, the more vulnerable the company is to increasing interest rates. Most lenders will refuse further finance where gearing exceeds 50 per cent.
Efficiency ratios
There are three types of efficiency ratio:
Debtors' turnover - average of credit sales divided by the average level of debtors. This shows how long it takes to collect payments. A low ratio may mean payment terms need tightening up.
Creditors' turnover - average cost of sales divided by the average amount of credit that is taken from suppliers. This shows how long your business takes to pay suppliers. Suppliers may withdraw credit if you regularly pay late.
Stock turnover - average cost of sales divided by the average value of stock. This ratio indicates how long you hold stock before selling. A lower stock turnover may mean lower profits.
Profitability ratios
Divide net profit before income tax by the total value of capital employed to see how good your return on the capital used in your business is. This can then be compared to what the same amount of money (loans and shares) would have earned on deposit or in the stock market.
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Analytical accounting tools
Analysing financial accounts enables you to compare the company's performance against previous years and with its competitors.
Management accounts
Management accounts are invaluable in helping you to make timely and meaningful management decisions about your business.
Different businesses will have different management accounting needs, depending on the business areas that are important to them. These can include:
- the sales process - including pricing, distribution and debtors
- the purchasing process - including stock records and creditors
- a fixed asset register
- employee records
There is no legal requirement to prepare management accounts, but it is hard to run a business effectively without them. Most companies produce them regularly - eg monthly or quarterly.
Management accounts analyse recent historical performance and usually include forward-looking elements such as sales, cashflow and profit forecasts. The analysis is usually performed against forecasts and budgets that have been produced at the start of the year.
The information in management accounts is usually broken down so that the performance of different elements of the business can be measured. For example, if a business has more than one sales outlet, there might be a separate report for each outlet. There may also be a report produced to show how well a particular product has done across different outlets.
Uses of management accounting
Management accounts will enable you to:
- compare your accounts with original budgets or forecasts
- better manage your resources
- identify trends in your business
- highlight variations in your income or spending which may require attention
They should be used for the following:
Record keeping
- recording business transactions
- measuring results of financial changes
- projecting financial effects of future transactions
- preparing internal reports in user-friendly format
Planning and control
- collecting cash
- controlling stocks
- controlling expenses
- co-ordination and monitoring of strategy/performance
Decision making
- using cost information for pricing, capital investment and marketing
- evaluating market and product profitability
- evaluating the financial effect of strategies and plans
¨ Presenting your business plan
To make sure your business plan has maximum impact, there are a number of points to observe.
Keep the plan short - it's more likely to be read if it's a manageable length. Think about the presentation and keep it professional - even if you only intend to use the plan in-house. Remember, a well presented plan will reinforce the positive impression you want to create of your business.
Tips for presenting your plan
- Include a cover or binding and a contents page with page and section numbering.
- Start with the executive summary.
- Ensure it's legible - make sure the type is ten point or above.
- You may want to email it, so ensure you use email-friendly formatting.
- Even if it's for internal use only, write the plan as if it's intended for an external audience.
- Edit the plan carefully - get at least two people to read it and check that it makes sense.
- Show the plan to expert advisers - such as your accountant - and ask for feedback. Redraft sections they say are difficult to understand.
- Avoid jargon and put detailed information - such as market research data or balance sheets - in an appendix at the back.
Make sure your plan is realistic. Once you've prepared your plan, use it. If you update it regularly, it will help you keep track of your business' development..
Further help and advice
Your accountant, if you have one, or your bank can offer support.
Your local Business Center of any type has specialist advisers who can help you with business planning..
¨ Use your business plan to get funding
A business plan is essential for your enterprise. Whether your business is starting up or established, the business plan is the roadmap for future development.
It is a key document when you are looking for business funding - whether applying for a simple overdraft or looking for new investment or capital.
The business plan helps them understand your vision and goals for the business, how you are going to spend the invested or borrowed money, and how this will benefit the business and potential funding providers.
It is the first source of information that most providers of funding see about a start-up company and is crucial in getting their attention and interest. This guide sets out the key elements that they will be looking for.
ü The essential elements of a business plan
Potential investors and lenders will examine your business plan closely to determine whether to risk their money.
There is no standard format but most plans include:
An executive summary highlighting the main points - to catch people's attention.
Details of key personnel with an organisational chart showing individual responsibilities.
Details of competitors and how your product or service fits into the market - eg who your potential customers are and why you think they will buy your product or service.
Your marketing plan - how you are going to get your product or service in front of potential customers, together with any assumptions made when setting your targets.
Financial information - eg key ratios. These can be used to compare your business' performance against industry benchmarks. It's also a good idea to give details of any major expenditure you've made on long-term assets and explain the reasons behind any changes in working capital items, such as stock, debtors and creditors. Remember to include balance sheet and profit and loss account details. Many lenders ask for three years' financial information. If this is not available, supply details about trading to date.
How you will manage credit, expenditure, stock planning and control, and debtors and creditors.
When seeking funding, include:
A cashflow forecast indicating the amount of funding you need and why. For a start up include estimates of how much finance you will need for two to three years or until you start to make a profit. Indicate contingency funds that might be needed for rough patches. This is usually between 10 and 20 per cent of the total funding requirement.
Financial forecasts for a three to five year period. Try to present this information in the same way as historical financial information, so that straightforward comparisons can be made.
How a loan will be repaid, how investors can get their money back, and when.
Tailor your business plan to the target audience
A business plan serves a number of purposes and you may have to modify information depending on your target audience.
Your bank will be interested in:
ühow you intend to repay a loan or overdraft
üwhat you are going to do with the money
ühow the loan will help the business to grow
üwhat other loan or debt commitments you have
Most lenders operate a credit-scoring system. Make sure you give up-to-date and relevant information. A good relationship with your bank manager will not influence the credit score - the manager may have discretion to negotiate terms but not to change the decision itself.
Tell potential investors about:
üwhat you are going to do with the money
üwhen and how you are going to pay it back
üthe expected return
üyour other sources of funding
üyour management's track record
Include a detailed forecast of your profits and cash flow.
Indicate to shareholders:
üthe prospects for the share price
ühow they may be able to sell their shares
üwhat dividend they can expect on their shares
üyour management's track record
üwhat say they might have in the business
Demonstrate how they can exit with positive returns within three to five years.
Many businesses with growth potential fail to raise funds because they lack investment readiness, ie they do not understand the expectations of investors, cannot turn proposals into attractive opportunities or are unaware of financing sources.
Common reasons why business plans and loan applications fail include:
üa weak management team
üa flawed marketing plan
üunrealistic forecasts
üincomplete and poor presentations
Demonstrate your commitment to the business
If you want to attract outside funding, it is important to invest your own money in your business. If you are not prepared to risk your own capital a lender is unlikely to want to risk theirs.
If you are looking for funds, the business plan needs to show the extent to which you are committing your own resources. It should list all the cash and assets that you have put into the business.
You can demonstrate strong commitment to your business by:
üreinvesting profits from the business rather than taking dividends yourself
üputting in more cash of your own
üusing personal borrowings (eg a mortgage) and guarantees to raise funds
üfinding funds from family, friends and existing investors
It is always helpful to detail the backing you already have from banks and other investors - especially independent investors. Remember that money attracts money. The more backers you have, the easier it is to attract new ones.
Personal credit history
Because your commitment and track record in meeting your obligations are so important, lenders and investors will want to know your personal credit history. Credit references will be taken up for sole traders and each partner in a partnership.
A credit reference agency will discover if you, or any partner or co-director of the business, have a poor credit history or county court judgments.
If you have poor credit rating, use the notes supporting the business plan to state the facts and give your own version of how the poor credit history arose. This is much better than having the new investor find out without any explanation. You should also state what you are doing to repair your credit history.
Getting the best from your business plan - key considerations
Your business plan is a tool you can use to attract new funds or use as a strategy document. Give yourself the best chance of success by following these suggestions.
Before presenting the plan ensure that you:
ücheck that the help you are applying for is still available - you may no longer qualify
üback up any assumptions in the plan with thorough research
üfind out your own credit rating by applying to Experian or Equifax for your credit file - a small charge is payable
üget someone to read the plan to spot spelling and typing errors, and to ensure that it makes logical sense
Write your plan in a way that demonstrates your commitment to the business. Give it a professional feel by limiting the use of graphics, colours and font types. Above all, make sure that your plan is always honest and realistic.
Things to avoid:
üBeing overly ambitious - make sure you can justify any assumptions or projections.
üIgnoring financial difficulties - warn your bank or lender if you anticipate that you may not be able to meet a repayment. There is every chance you will be able to come to some arrangement.
üFailing to devise and implement effective cashflow arrangements, eg have clear procedures for chasing up any accounts receivable.
Once you have presented the plan, ensure you review and revise it as your business grows. If you are refused investment or a loan, take the criticism on board and consider how you might improve the plan.
Professional help
Seek the help of your business adviser or accountant in compiling your business plan or loan application form. They will ensure that the financial information is compiled and presented correctly and that key areas stand out.
A specialist broker can help to find potential investors, usually for a fee and a percentage of funds raised.
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