Financial Forecasts and Projections
A long term overview of your company's finances is necessary to plan effectively.
OVERVIEW
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One of the biggest mistakes business owners make is managing their business’s finances solely from their bank account. Managing your business in this way does not account for VAT that is due next month or the provisional tax on the horizon in three months’ time. It also doesn’t consider the fact that you might need to replace a large asset in six months’ time. These can all have a significant impact on the profitability of your business.
Managing your business through your personal bank account restricts you from making informed decisions about the financial future of your company.
Remember that for any SME, cash is king. If you are in the dark about what your cash balances will look like in six months’ time, the decisions you make today could put your business at risk resulting in cash flow issues and even closure.
WHAT’S INCLUDED
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Budget and cash flow forecast
The most effective way to understand your business’s future cash flow is to prepare a budget and a cash flow forecast.
A budget is a spending plan for your business based on your income and expenses and is a prediction of your expected profitability for the year ahead. It can be broken down into individual months – especially if sales or costs are inconsistent or ad hoc.
A cash flow forecast is normally a monthly representation of your expected cash flow balance for the next 12 months. It uses the cash inputs from your budget and is adjusted for other cash flow items which could include: loan payments, asset purchases, tax payments, expected funding to be received, etc.
More about budgets and setting a budget
Detailed budgets are the sharpest tool in your financial arsenal.
Setting a budget also allows you to benchmark your cash flow. How do you know whether your business has done well if you cannot compare your actual performance to the goals you’ve set for the year? It is also helpful to create different budgets and forecasts for different expected scenarios, for example, a good vs bad sales year.
A well-constructed budget can break down the exact detail of each sale along with cost drivers for your business. For example:
- A better handle on the future sales based on the number of units you expect to sell every month for the next 12 months, multiplied by the expected selling price.
- The impact of salary expenses can be better understood by dissecting the number of employees x their salaries.
- Electricity cost can be broken down into the number of kilowatt-hours that you expect to use (based on historical usage) multiplied by the cost per kilowatt-hour set by your municipality.
Improving cash flow with a cash flow forecast
A cash flow forecast gives you a handle on any underlying issues affecting profitability.
Preparing a cash flow forecast will enable you to predict your expected cash balance at the end of every month. When you see your expected cash balance is below your minimum requirement for a particular month, you are able to take action to mitigate risk and make the necessary changes to avoid going into the negative.
Here are some ways in which you can avoid a negative financial outlook:
- Increasing selling prices
- Negotiating with suppliers to reduce stock costs
- Negotiating with customers to reduce payment days
- Lowering spending on discretionary expenses such as marketing, advertising or travel
- Exploring additional types of working capital finance to fund your expenses
Implementing strategic changes
Once you have prepared your cash flow forecast, you are able to make informed decisions about the future of your business.
Although budgets are prepared on an annual basis, they can be reassessed on a quarterly or half-yearly basis, depending on the size of your business. Cash flow forecasts should, at minimum, be prepared every six months (preferably every quarter) – especially when dealing with large ad hoc cash flow items like loans or asset purchases.
Make sure you have the right tools in place to accurately understand where your business is, and what direction it is going. If there is still a level of uncertainty, seek expert advice.
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