Looking Into The Financial Crystal Ball

Tuesday 9 June, 2009

by Sue Hirst

The current economic climate makes it absolutely vital to look into the future and prepare your business for increasing or declining revenues. You need to plan the resources you will need, to fulfil the level of revenues expected.

Every business owner needs to plan for the best and worst case scenario. As banks become more demanding about lending applications - and the information they need to base their decision on - they're likely to want accurate projections, cash flows and recent financial statements.  

Financial statements

Your financial statements can make or break your lending application. Bankers will run your financials through a diagnostic to calculate the health of your business. This will include both the Profit and Loss Statement and the Balance Sheet. So it's vital your financial statements are accurate. 
Inaccurate treatment of transactions can really throw out the validity of reports and negatively impact a lending application. Having your financials looked at by a professional prior to a lending application can save time and disappointment.

Projections

If you were lending money to someone you would want to feel confident they had the capacity to repay the loan with interest. That's how bankers look at the future of your business. They want to be sure the business is healthy currently and into the future.
When the subject of Projections or Budgets comes up, business owners often don't know what they're going to sell, so find it difficult to project accurate figures. Start with the fixed costs or overheads in the business:

• Fixed costs
  
  These are the costs that stay the same whether you sell anything or not; such as rent, wages and leases, etc.
  
• Variable costs
  
  You need to know your gross profit margin and calculate the sales you need to make to cover the overheads, less the variable costs to make the sales. Variable costs are those that are only incurred when you sell a product or service; such as direct labour, materials or product purchases.
  
  If you put this into a spreadsheet, you can then play around with the level of sales to see how much profit would be made if sales increase or decrease. You can also factor seasonality into the projection. 

As well as a Profit and Loss Projection you will need a Balance Sheet Projection, so the lender can see the future health of that too. A business can look wonderfully profitable but if it isn't managing receivables, payables, stock and job management, etc. it can become an unhealthy proposition.

Cash flow forecasts

A cash flow forecast is slightly different to a projection as it combines all income, costs and overheads as well as movements in receivables, payables, stock and outstanding jobs, taxes, capital expenditure, etc. 
The cash flow forecast is based on the cash flowing in and out of the business, whereas the Projection is based on the sales and expenses; which don't always result in immediate cash movements. For example, you can make a sale, but it may take as long as 90 days to get paid, and you can purchase something, but you may take as long as 90 days to pay for it.

Peaks and troughs

The cash flow forecast enables you and a lender to see exactly what the cash position of the business into the future will be. If there are peaks and troughs, or if the cash position is moving in and out of positive territory, you can manage the situation by collecting payments from customers more quickly or delaying purchases and payments to suppliers.

Timing capital purchases

You can factor in purchase of capital equipment at the right time so the cash isn't negatively impacted. Payments you don't generally have control over - such as taxes and interest - can be included and planned for in advance so you aren't scrambling around at the last minute to find the money to pay.

Source:ceoonline.com