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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.




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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

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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.
The Break-even Point is, in general, the point at which
the gains equal to losses.
It defines when an investment will generate a positive
turn.
The point where sales or revenues equal expenses.
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 companys 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.
Break even point calculation
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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.

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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.
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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

Your projected profit and loss account.

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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.
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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

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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.

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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:
- 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
The principles of cash flow forecasting

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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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EXTRA
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
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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.

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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
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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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EXTRA

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.

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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.
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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 -
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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
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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.


Projected Balance Sheet
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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.
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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
Business Ratios
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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
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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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EXTRA
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.
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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


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Decision making
- using cost information for pricing, capital investment
and marketing
- evaluating market and product profitability
- evaluating the financial effect of strategies and plans

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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.

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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..

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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.
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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.



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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:
how you intend to repay a loan or overdraft
what you are going to do with the money
how the loan will help the business to grow
what 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.


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Tell potential investors about:
what you are going to do with the money
when and how you are going to pay it back
the expected return
your other sources of funding
your management's track record
Include a detailed forecast of your profits and cash flow.

Indicate to shareholders:
the prospects for the share price
how they may be able to sell their shares
what dividend they can expect on their shares
your management's track record
what 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.




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Common reasons why business plans and loan applications fail
include:
a weak management team
a flawed marketing plan
unrealistic forecasts
incomplete 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:
reinvesting profits from the business rather than
taking dividends yourself
putting in more cash of your own
using personal borrowings (eg a mortgage) and
guarantees to raise funds
finding 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.

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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.

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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:
check that the help you are applying for is still
available - you may no longer qualify
back up any assumptions in the plan with thorough
research
find out your own credit rating by applying to
Experian or Equifax for your credit file - a small
charge is payable
get 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:
Being overly ambitious - make sure you can justify
any assumptions or projections.
Ignoring 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.
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Failing 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.