The lead up to the end of the financial year is a great time to understand how well your business has performed this past year, and what your targets are for the next year. This is where a financial roadmap, which incorporates a budget and a cashflow forecast, comes in handy.
A ‘financial roadmap’ will help improve profit and cashflow by ensuring funds will be available to spend on developing new products and services, marketing, sales, operations, customer service and human resources. If you want to grow a business you must have funds available at the right time to cover your needs.
The easiest way to develop a financial roadmap is to have a budget and a cashflow forecast. Here’s an explanation of the difference between the two:
A budget is a financial plan of what you are going to sell, what it is going to cost you and what overheads you are likely to incur. It also includes finance costs such as interest. The budget sets out how much profit or loss the business is planning to make, usually on a monthly basis.
A cashflow forecast is a plan of when the cash will flow into and out of the business. It’s important to have both because a budget may show that you’re going to make profit, but customers take time to pay and suppliers require payment, often before customers have paid you. It’s vital to plot this all out in black and white, so that you can see where the ‘peaks and troughs’ are likely to occur and plan what you’re going to do to manage them.
A budget is often required by lenders and only done for that purpose. If you do a budget for yourself as a business owner it provides a fantastic financial roadmap and helps to clarify what everyone needs to work towards for the business to be profitable and successful.
People will often say “I can’t do a budget because I don’t know exactly how much I’m going to sell.” This is a reasonable enough statement, but shouldn’t put you off developing a budget.
The best way to start a budget is to work out your break-even point, which helps you to work out how much you need to sell to make neither a profit nor a loss i.e. a zero result. Obviously this isn’t what you’re in business for, but it’s a great place to start to give you targets to work towards and to avoid losses. To work out your break-even point, the best place to begin is with your overheads, that is, the fixed expenses you incur whether you sell anything or not, such as rent, permanent staff wages, equipment leases etc.
You then need to know what your gross margin is on sales. Gross margin is the percentage you make on sales after direct costs of your product or service such as cost of the actual product or labour and materials on jobs are deducted. For example if you know that products or jobs cost you 40 percent (on average) of your sale price, that means you’ve got a 60 percent gross margin left to cover your overheads. If your yearly overheads are $600,000 you will need to sell $1,000,000 to break-even.
Once you know your break-even sales figure you can use this as a basis for your budget by entering the monthly figures into a spreadsheet and play around with increasing and decreasing the monthly sales to see what would be the impact of changes. You could also work it backwards to calculate what profit you desire and therefore what you need to sell to achieve the result. Or if you can find ways to reduce your direct costs how much impact that could have on your profit.
A cashflow forecast is similar to a budget, but looks at the situation from a cash perspective rather than a profit one. You begin with your opening bank balance, then plot in monthly what income you expect to receive, based on when and how much customers pay, against what you expect to pay out based on fixed monthly overheads and amounts owed to suppliers. It also includes items such as tax, repayment of loans and dividends which aren’t included in the budget. By doing this forecast you can see what will be your closing bank balance for each month and where you might experience peaks and troughs. Once you know what to expect, you can play around with a spreadsheet to work out how to retain a positive bank balance or when you may need funds to cover a shortfall. By doing this at the beginning of the year, you can approach lenders with a clear picture of your requirements rather than rushing in ‘cap in hand’ begging for help to cover a shortfall you didn’t expect.
Both of these financial tools will help you to sleep easier at night and be able to plan for the best or worst in your business.
Sue Hirst is the founder of CAD Partners, a nation-wide mobile CFO “On-Call”/financial control/business accounting service for SME owners. CFO On-Call will run webinars on ‘How to develop a financial roadmap’ in May and June. To register, click here.