Sustainable Business/Forecasting your business

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Financial Forecasts

The financial section is where all the threads of your business plan are pulled together and expressed in monetary terms. A key aspect of this section is to show the timing of your expenditure, before the business is operational and then into its first 12 months of trading.

It is important to note those earlier identified 'threats' to your business to ensure that as you forecast you can see the deviation of the best and worst models. For example, if a business has previously identified the threat of a diminishing cheap labour force, then their forecast needs to reflect that the price of labour (or any other resource such as power) is going to go up.

The traditionally the financial section had three key forecasts:

• Cash flow forecast
• Profit forecast
• Balance sheet

The cash flow forecast seeks to forecast a bank balance after a period – typically 12 months. This forecast shows the sources and application of funds.

The profit forecast modifies the cash flow in an attempt to calculate taxable income and in the process forecast a businesses income tax liability. There are two differences between a cash flow and a profit forecast. The cash flow forecast includes all expenditure in the period where as the profit forecast looks to match revenue with the costs associated with generating that revenue and to achieve that uses non-cash-expenses to estimate some of the costs associated with running a business.

These two forecasts are reconciled with a forecast balance sheet.

We have aimed this publication at a smaller business and while forecasting balance sheets demonstrates completeness and a high level of technical integrity in forecasting we the process is complex and better left to a professional. We also feel that the additional benefit is outweighed by the costs for a small business.

In preparing financial forecasts always assume they will be reviewed by a bank manager or investor. With this goal in mind you will be guided to keep your forecasts tidy and easy to understand by grouping cash inflows and outflows in simple ways that are easy to understand at a glance.

With this in mind we have set out specific points of interest to lenders and investors that need to be addressed.

• The profitability of a business reflects a sound relationship between market-driven sales projections and accurate cost estimates.
• Have you planned to have sufficient cash to meet your regular bills and also non regular costs (like annual insurance premiums).
• Does the financial position of the business remain sound when growth is forecast (this is what the balance sheet of for)
• Is there a sensible balance between borrowings and the amount contributed by the owner (when the business is raising capital in its own right)
• Are short and long term obligations matched with relevant finance options
• Key business ratios remain within sensible bounds

It is always easier to forecast future performance of a business if your business is already up and running as there are past trading results to look at. When a completely new venture is being planned a certain amount of imagination is required however this is in no way a license to be overly optimistic.

As a general rule you should create three forecasts

• Optimistic
• Pessimistic
• Most realistic

By completing these scenarios you gain an insight into the various risks that a business faces. Spreadsheet programmes make this quite easy if they are well set up.

The sales forecast

This is the dominant influence on the performance of your business. Also may expenses have a link to the level of activity in a business.

For existing businesses past sales are the best predictor of future sales, for new businesses it is less simple but once the businesses is established you will find you have a better understanding between the businesses products and its markets.

The most important thing is to keep detailed records of sales as it is these records that provide you with the growing ability to forecast income accurately

Try doing the following Talk to industry experts Talk to potential customers Remember your capacity limits (ex-marketing section)

Forecast the number of units you expect to sell Begin with an analysis of current performance Divide sales into appropriate categories Consider factors that affect each category Internal factors might include staffing changes (for service industries) External factors might include the impact of inflation ??? – current relevance Now attempt to forecast unit sales in cash category

Multiply by unit price

Determine market price How do you compare Table

Cost plus

Expected mark-up

Cash flow

Every business needs cash (sometimes called liquidity) to keep going. Forecasting cash flow lets us anticipate liquidity problems and then lets us provide solutions.

Cash Flow To Trading Commencement

This sets out all the expenses to be made up until trading commences. It is best to keep this on a separate spreadsheet as it will contain many items that are not relevant to the time after trading commences which if added to an operational cash flow makes for a more complext trading cash flow. On a more practical basis even when cash flows are printed having more than 12 periods of time means that A3 paper must be used or the print compressed to such an extent that reading the report can be difficult.

First 12 months

This is the most crucial forecast that needs to be completed. Here we take our sales forecast, sources of funding and expected cash outflows in the first year of operations and forecast whether we will be viable at the end of the first years trading. In essence we are trying to forecast the bank balance 12 months into the future.

In doing this we make some simplifying assumptions, the first being that interest is paid or charged on the average balance in the trading account (cheque account).

Trial

First 3 years

It is important to forecast more than one year as it often takes more than 12 months for a business to build sales. In some cases where the product is highly innovative and never existed before it can take many years to build a market for example Blis Technology.

Profit determination

The essential difference between cash flow and profit it that cash flow includes all items of income and expense and profit seeks to match income and costs related to the generation of the income in a period in time, this is usually 12 months.

To facilitate the calculation of profit (and hence the income tax due) the cash flow statements were split into 4 sections. We now take the total of income and the operationl costs into a Profit Statement. We add depreciation to the operational costs and subtract our adjusted operational costs from income the difference being profit (where the difference is positive) or a loss (where the difference is negative).

Where there is profit we need to then calculate income tax. This calculation depends on the legal structure adopted for the business. For planning purposes we could simply assume the rate of income tax to be 30%.

Where a business is registered for Goods and Services Tax we take only the net payments and receipts.