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Business Planning Tips: The Financials


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How to Improve Cash Flow

Cash flow is the life blood of every business and lack of cash is a much more significant cause of business failure than trading losses. The management and preservation of cash is a priority task which must be performed day in and day out in every business. This task is so routine that its importance is often overlooked. Here are some ways to improve cash flow:

  • Sales - Become more selective when granting credit.
  • Costs & Systems - Improve systems for billing and collection.
  • Credit Management - Generate regular reports on receivable ratios and aging.
  • Purchasing - Make prompt payments only when worthwhile discounts apply.
  • Inventory - Sell off or return obsolete/excess inventory.
  • Investment - Use leasing etc. to gain access to the use of productive assets.
  • Financing - Use factoring or discounting to accelerate receipts from sales.

For a list of over 30 ways of improving cash flow, visit the Checklist for Improving Cash Flow. Central to any program to improve cash flow is an accounting system to handle inventory, invoicing, receivables and payables. Allied to this is the need for frequently-updated cash flow projections to provide early warnings of possible liquidity problems and a foundation for improvement plans. For more on this, see the paper on Making Cash Flow Forecasts and download and try the Cashflow Plan software tools for making rolling 12-month forecasts and creating cashflow improvement plans.

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Presenting the Financials in a Business Plan

The financial section of a business plan should be based on monthly projections for the first year covered by the plan plus quarterly (or annual) projections for the next two years. In the case of a complex or seasonal business, monthly projections may be required for 2+ years with less detailed projections for subsequent years. The projections for each forecasting interval should comprise fully-integrated income statements, cash flows, balance sheets and key ratios.

Financial projections must not be prepared in isolation from the rest of the plan. For example, the results of market research should flow into your sales projections which, in turn, should drive the revenue forecasts. Under no circumstances should you do the detailed financial projections and then write a plan to suit. By all means, do some high-level financial planning at an early stage to get a feel for the basic figures and sensitivities but don't let the plan become a financially-driven document without any strong market basis. For further tips and traps, refer to the white paper on Preparing Financial Projections.

Keep this financial section within four-eight pages by ensuring that only high-level projections are presented in summary tables and use simple charts to show trends. Do not include any detailed spreadsheet tables as no one will bother to read them! Instead, place them in an appendix at the back of the plan (or even withhold them for the plan and only make them available on request).

For simplicity and clarity, the key topics in the financial section could be presented in a series of short sub-sections (from half- to a full-page long) covering key assumptions, projected income statements, cash flow forecasts, projected balance sheets, ratio analyses and sensitivity analyses.

Our fully-integrated financial planner - Exl-Plan - offers comprehensive facilities for generating financial projections for a business plan as well doing sensitivity and ratio analyses. It also generates summary reports which are idea for use in the body of a business plan. For more help, check the Business Plan Guide to see how the section on Financial Projections fits into the overall business plan.

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Stating Your Funding Requirements & Proposals

Having made great progress with writing your business plan and crunching the financials, you may identify a significant funding need that cannot be bridged from your own resources (and those of your relatives, friends, colleagues, credit cards, local bank manager and so on) or from the business's cash flow. Consequently, you will need to raise external finance in the form of equity or loans or an equity/loan combination. When writing your plan, devote a short main section (immediately after the financial section) to present your needs and proposals. Here are some suggestions:

  1. To assess funding requirements, compile your projections without any external funding and take note of the peak cash deficit and its timing. Your total funding requirement is likely to correspond to this deficit. It should be injected (in one or more tranches) ahead of being required so as to eliminate (or minimize) deficits and perhaps create cash cushions. Analysis of projected financial ratios (debt/equity, interest cover and current asset) will help determine the optimal mix of debt and equity.
  2. When assessing funding needs in #1 above, you should plan to finance the "most likely" case, or even "worst" case, rather than for the "best" case as revealed by sensitivity analysis. Whilst the "best" case may show the smallest funding need, it may be unattainable due to the inevitability of some aspect of the double (costs), double (time) or half (revenues) rule.
  3. Summarize and tabulate your funding requirements. Indicate planned uses, possible sources and forms (equity, loans, grants, credit etc.), likely timing, security offered and desired terms. Mention any conditional or firm funding commitments already secured. For the benefit of prospective investors, indicate the likely equity funding required; range of the equity stakes on offer; exit routes (IPO, trade sale, buy-back etc.); board representation; and make a stab at the projected returns on their investment.
  4. If presenting funding proposals, bear in mind the golden rule - he who has the gold makes all the rules. If valuing your business, be realistic and base it on more than one method of valuation e.g. net asset value, price/earnings ratio, capitalization/revenue ratio, industry yardsticks and so on. Take account of market sentiment/conditions, "going rates", maturity of the business and degree of risk associated with its plans.
  5. Restrict this section of your business plan to less than one page. Keep it factual and avoid any "over-the-top" hyping of your business as the greatest investment ever !
  6. If planning to raise equity from venture capital or "angel" sources, allow adequate time to raise it. Depending on the amount needed and track record of the promoters/business, this may take several months and tie up significant management resources throughout - brace yourself for several re-drafts of the business plan and financials.

Of course, you may wish to withhold specific funding terms until you have met possible investors or lenders face-to-face and heard their initial reactions. In this case, this section would be confined to a description of funding needs and possible uses, sources and forms.

Our fully-integrated financial planner - Exl-Plan - offers comprehensive facilities for generating financial projections for a business plan as well doing sensitivity analysis and exploring "what-ifs" and alternative funding scenarios. Check the Business Plan Guide to see how the section on Funding Requirements and Proposals fits into the overall business plan.

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Managing a Business Means Managing Working Capital

Cash is a business's life blood and every manager's primary task is to help keep it flowing and to use this cash flow to generate profits. If a business is operating profitably, then it should, in theory, generate cash surpluses. The faster a business expands, the more cash it will need for working capital and investment.

The cheapest and best sources of cash exist as working capital right within business. Good management of working capital will generate cash will help improve profits and reduce risks. There are two elements in the business cycle that absorb cash - Inventory (stocks and work-in-progress) and Receivables (debtors owing you money). The main sources of cash are Payables (your creditors) and Equity and Loans.

Cash flow can be significantly enhanced if the receivables are collected faster. Every business needs to know.... who owes them money.... how much is owed.... how long it is owing.... for what it is owed.

Management of payables is just as important as the management of receivables. It is important to look after your creditors - slow payment by you may create ill-feeling and can signal that your company is inefficient (or in trouble!).

Managing inventory is a juggling act. Excessive stocks can place a heavy burden on the cash resources of a business. Insufficient stocks can result in lost sales, delays for customers etc.

When planning the development of a business, it is critical that the impact of working capital be fully assessed when making cashflow forecasts. Our financial planning software packages - Exl-Plan and Cashflow Plan - can facilitate this task as they provide for the setting of targets for receivables, payables and inventory. See also the Checklist for Improving Cashflow.

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Making Better Cash Flow Forecasts

Cash is the lifeblood of every business and more businesses fail for want of cash than lack of profit. These may be cliches but they are very, very true.

A key element of controlling cash is to forecast cash flows and requirements. This entails forecasting and tabulating all significant cash inflows relating to sales, new loans, interest received etc. and then analyzing in detail the timing of expected payments relating to suppliers, wages, other expenses, capital expenditure, loan repayments, dividends, tax, interest payments etc. The difference between the cash in- and out-flows within a given period indicates the net cash flow. When this net cash flow is added to or subtracted from opening bank balances, any likely short-term bank funding requirements can be ascertained.

Typically, a spreadsheet-based plan can be used to compile cashflow forecasts, assess possible funding requirements and explore the likely financial consequences of alternative strategies. Used effectively, this plan can help prevent major planning errors, anticipate problems, identify opportunities to improve cash flow or provide a basis for negotiating short-term funding from a bank.

When planning to seek external funding, the time horizon covered by the forecasts should be equal to or greater than the period for which the funding is needed. The greater the amount of funding required and the longer the period of exposure for the provider of these funds, the more comprehensive must be the supporting projections and plan.

For short-term cash planning you should make assumptions on sales, costs, credit, funding etc. to produce monthly cash flow projections for up to a year ahead. Initial assumptions can be readily altered to evaluate alternative scenarios. For example, the plan could be used to explore the extent to which future sales could be increased whilst holding bank borrowings within predetermined limits; to assess the effects on cash flow of varying sales, costs or credit terms; or to determine the likely short-term funding requirements for a business.

Our Exl-Plan range of financial planners generate fully integrated profit & loss accounts with cashflow statements and balance sheets for up to five years ahead and Cashflow Plan is a specialist cashflow planner covering 12 months ahead, with weekly projections for the initial three months.

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Traps to Avoid when Projecting for your Business Plan

When preparing financial projections for your business plan, be conscious of the pitfalls and dangers listed below. These can arise as the result of a lack of foresight or insight, or because of excessive optimism. As they can lead to underestimation of the resources required to develop a business with potentially disastrous consequences, it can be counterproductive to overstate its potential.

Financial Planning Traps
  • Using financial forecasting as a substitute for business planning.
  • Ignoring historic trends or performances at company, sectoral and national levels.
  • Overstating market shares and growth, sales forecasts, and profit levels.
  • Giving insufficient consideration to working capital requirements.
  • Underestimating costs and delays likely to be encountered.
  • Disregarding industry performance norms and competitors' responses.
  • Breaching generally-accepted financial guide lines and ratios.
  • Making unduly optimistic assumptions about the availability of loans, trade credit, grants, equity etc.
  • Seeking spurious accuracy while failing to recognize matters of strategic importance.

Realistic views should always be taken of a business's prospects, prospective profits, funding requirements etc. There is often merit in compiling "worst" case projections to complement "most likely" or "best" forecasts. In practice, the realization of financial projections, especially for a new business without any trading history, might easily take twice as long and cost twice as much as expected. This is the double (costs), double (time) or half (revenues) rule. Remember that it is much less painful to deal with a flaw in a business at the planning stage, than later on when commitments have been made and the business has started trading.

Our software planners - Exl-Plan and Cashflow Plan - offer comprehensive facilities for doing sensitivity analysis and exploring "what-ifs".

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Difference between Profit and Cash Flow

When planning the short- or long-term funding requirements of a business, it is more important to forecast the likely cash requirements than to project profitability etc. Whilst profit, the difference between sales and costs within a specified period, is a vital indicator of the performance of a business, the generation of a profit does not necessarily guarantee its development, or even the survival. Bear in mind that more businesses fail for lack of cash flow than for want of profit.

Sales and costs and, therefore, profits do not necessarily coincide with their associated cash inflows and outflows. While a sale may have been secured and goods delivered, the related payment may be deferred as a result of giving credit to the customer. At the same time, payments must be made to suppliers, staff etc., cash must be invested in rebuilding depleted stocks, new equipment may have to be purchased etc. For further information on the cash cycle and working capital, click here.

The net result is that cash receipts often lag cash payments and, whilst profits may be reported, the business may experience a short-term cash shortfall. For this reason it is essential to forecast cash flows as well as project likely profits.

The following simplified example illustrates the timing differences between profits and cash flows:

Income Statement: Month 1
Sales ($000) 75
Costs ($000) 65
Profit ($000) 10

Cashflows relating to Month 1: Month 1 Month 2 Month 3 Total
Receipts from sales ($000) 20 35 20 75
Payments to suppliers etc. ($000) 40 20 5 65
Net cash flow ($000) (20) 15 15 10
Cumulative net cash flow ($000) (20) (5) 10 10

This shows that the cash associated with the reported profit for Month 1 will not fully materialize until Month 3 and that a serious cash short- fall will be experienced during Month 1 when receipts from sales will total only $20,000 as compared with cash payments to suppliers of $40,000.

Our Exl-Plan range of financial planners generate fully integrated profit & loss accounts with cashflow statements and balance sheets for up to five years ahead and Cashflow Plan is a specialist cashflow planner covering 12 months ahead, with weekly projections for the initial three months.

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  Financial  
 Projection 
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 Cashflow 
  Forecasting  
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  Software  
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  Software  
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  Business  
      Plan      
     Guide     
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   Freeware   
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