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Financial Planning Made Simple For The Non Finance Expert |
Numerous statistics in the UK have shown that the BME market considers this subject area as one that presents them with a serious challenge when faced with the task of raising finances from the bank, private investors and public bodies. However, financial planning as a management tool has a wider role beyond the arena of raising capital for a business and hopefully by the end of reading this article, you will get to know more about the purposes and benefits of financial planning in a business context.
So what is financial planning and how should it be done? This article is specifically designed to answer these two questions. Financial planning is a management tool that helps a business to plan in advance the resources it requires to deliver its expected sales income. The process itself can be time consuming, involving thorough market research to gain an understanding of the environment the business operates in. Nonetheless the process can prove very invaluable. Through an effective financial planning, a business is able to determine its profitability and liquidity in advance so that steps will be taken to manage resources effectively or determine whether to carry on with a line of business. Of course no sane individual will want to pursue a business venture that is clearly not viable and so, financial planning helps prevent nasty surprises that could deplete a business’ financial wealth. The ultimate goal of financial planning is to secure the financial viability of a business so that it will operate profitably and generate adequate cash flow to meet its future liabilities as they materialise. The end products of financial planning are: profit and loss (or income and expenditure) forecast, balance sheet forecast and cash flow forecast.
Here is a summary of how to prepare a financial plan linked directly to a business plan:
To calculate sales income /turnover forecast:
A. Make an assumption on the total number of goods and services the business expects to sell each month over the next 12 months. Remember to be realistic as new businesses very rarely start off with a high sales volume. In the case of a new business, you will need to set sales volume very low at the initial stage of the business to reflect the time spent advertising and promoting the services or products in an effort to generate leads and sales.
B. Make an assumption on the selling prices of goods and services set out in “A” above. Again, ensure that the selling prices reflect what the market will be willing and able to pay. This is most likely going to be a reflection of market competition (the number of suppliers against the demand for the goods and services) as well as the purchasing power of the market (i.e. how much money consumers have to spend on goods and services).
C. Multiply the selling prices of goods and services set out in “B” above, by the expected sales volume estimated in “A” above to determine the monetary value of each month’s sales. Remember that where a business provides multiple types of goods and services, the value of sales must be determined for each of them.
D. In the case of voluntary sector organisations that rely on grants, donations and fundraising income, you will need to make an assumption on the type of grants expected and the value of grants in monetary terms based on your market knowledge. In the same vein, you will need to make an assumption on the number of fundraising events the business expects to undertake and the amount expected to be generated from each event. The assumption for donations can either be informed from historical trends or best estimates based on the strategy that will be used to generate them. Whatever approach is used, it is important that the assumptions are realistic to minimise the risk of overstating income. Remember that factors such as: government policy (taxation rate, regulation, public sector spending priority), the health of the economy (unemployment, interest rates, inflation rate etc), and the business’ relationship with its sponsors /wider community will ultimately influence many aspects of the income generated- so keep a watch on these factors.
To calculate expenditure forecast:
E. Make an assumption on the type of resources required to produce the sales income specified in “C” above. Resources in this case may include: staff (type), building (size, location etc), office furniture and equipment (computers, fax, telephone, heating, insurance etc) etc. It is for you to determine clearly what types of resources are required.
F. Make an assumption on the level of resources required as stated in “E” above to deliver the plan based on the assumptions on sales volume in “A” above. For instance, you need to state what type of staff you need and how many, what type of computers or machines you need and how many etc.
G. Make an assumption for the prices of the resources (stated in “F” above) required to deliver the sales volume in “A” above. Remember that the prices of the resources must be realistic and evidence based. An unrealistic price level will undermine the quality of the financial plan in that it will not be feasible (i.e. not achievable). Also remember that the prices of some resources tend to increase in line with the general inflation, whereas others increase at a rate below or above the general inflation index. You are therefore advised to desist from making generalised inflation assumptions (i.e. price assumptions).
H. Quantify the resources required to produce the goods and services by multiplying the prices of the resources by the volume of the resources as set out in “F” and “G” above. At this stage you have determined the value of the different types of expenditure you expect to incur to deliver the business plan. However, it is worth noting that the expenditure will differ in nature and so it is important that steps are taken to carefully categorise expenditure into “Revenue and Capital Expenditure” to ensure correct accounting treatment when producing the “Income and Expenditure Forecast (Profit and Loss Statement), “Balance Sheet Forecast” and “Cash Flow Forecast”. This will become clearer when we look at a worked example. For now, let us briefly define “Revenue and Capital Expenditure”. Capital Expenditures are expenditures that result in the acquisition of tangible items such as buildings, computers or furniture. At the initial purchase of capital items, almost the entire purchased price is shown in the balance sheet with only a proportion of the expense shown in the profit and loss statement to reflect the reduction in value of the items or the value of the capital item consumed during the financial year. Revenue Expenditures are expenditures that do not result in the acquisition of tangible items. They are usually consumed in the financial year they are purchased and will be shown in full as expenditure in the profit and loss statement or income and expenditure statement. If you need to know more about this, please read our booklet titled “Introduction to Financial Statement”. This booklet is packed with lots of practical examples and explanations specially written for non- finance experts.
To determine the Cash Flow Forecast and Income and Expenditure Forecast (Profit and Loss Forecast):
I. To produce a Cash Flow Forecast, you will need to make assumptions for the timing of payment of expenditures and receipt of income. In summary, you will need to state very clearly when you expect to receive the sales income you have assumed you will generate in each month in “C” above and, when you expect to pay for expenditure you expect to incur in each month as specified in “H” above. For instance, you may have made assumptions that you will generate sales of £10,000 in month 1 but in view of your credit policy (i.e. the credit terms and conditions you signed up with customers); you will expect to receive only 50% of the sales income in month 1, whilst the remainder will be received from customers in month 2. This same approach applies to voluntary sector organisations where grants will usually be paid either in arrears or in advance. Finally a similar assumption should be made for expenditure where some will be paid in the month of the purchase (e.g. salaries and rents); whereas some will be paid one month in arrears (e.g. stationery and cleaning services). This is what cash flow forecast is all about. A detailed explanation of cash flow forecast can be found in our booklet titled “Introduction to Financial Management”. Upon completing the Cash Flow Forecast you will be able to determine any possible cash shortfall or surplus in the month and this information will be used to make appropriate decisions. For instances, in periods of cash shortfall you will need to borrow or raise short term capital or long term capital from the bank or public investors. In periods of cash surplus, arrangements will need to be made to invest surplus cash appropriately to maximise returns.
• To prepare an Income and Expenditure (Profit and Loss) and Balance Sheet Forecast, all the sales and expenditure forecast will need to be pulled together taking full account of the acceptable principles and practices of accounting.
Finally, we have now developed a number of financial planning and accounting templates that small businesses can purchase to maintain proper accounting records, as well as facilitate effective planning, monitoring and controlling of resources. We also sell reputable accounting software at a discounted price of 10% off normal retail price, so why not contact us for advice and support on this subject today. Send an email to sheila@businessservicessupport.com
Sheila Elliott is an expert in business and personal development strategies. She is the founder of Business Services Support Limited and the author of My Business Is My Business- Learn How To Earn A Fortune. For more information about are free articles visit, http://www.businessservicessupport.com and http://www.sheilaelliott.com |
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