D Compare projected figures with previous years to see where performance is improving or deteriorating. Also compare figures for projected margins and growth with those of other companies, or across different parts of business.
E Sensitivity analyses help to see how different outcomes affect performance
Profit and Loss Forecast
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Complete the spreadsheet with estimated sales by month. Allow for seasonality and a build up of sales (related to marketing promotions) from start-up.
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On the basis of operating plan (volume of production/service, purchasing plan etc) , having identified direct variable costs - completed budgeted direct costs.
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Calculate gross profit (sales-direct costs)
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Overheads (fixed and semi-variable costs) vary little in relation to output or level of business activity in the short term. If the business expands fixed overheads may grow (e.g. bigger premises, another telephone). Estimates the annual cost of each overhead item and calculate the monthly average spend. Identify items, which will be paid quarterly or as one payment. Be clear about when these have to be paid as they will affect cash flow considerably. The profit and loss statement merely reflects a budget for them.
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Monthly gross profit less total monthly overheads gives the trading profit or loss. In the initial trading period - the losses will be apparent and frightening unless your forecasts are sound and you know that you are on course for breaking even by the planned date.
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Include depreciation (of plant and equipment) in your profit and loss forecast. You may seek to rent or hire rather than buy capital assets outright
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Include interest payable on any loans/overdraft.
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Calculate net profit before tax (trading profit less depreciation and interest)
Cash Flow Forecast
As you trade, cash flows in and out. The cash flow forecast predicts the effect of the business operation on the bank balance. You and your investors need to anticipate how and if your creditors can be paid, when you will be flushed with cash or desperately short of it. Will you be able to pay your bills when they are due? If not you will the bank extend your overdraft, can you dip into reserves. If not then you are illiquid - legally unable to trade. You may have to file for bankruptcy or place your company into receivership. Cash flow is thus something, which you cannot ignore. The cash flow spreadsheet includes budgeted and actual columns so that as you trade you can update the budgeted figures (as you get nearer the receipt/payment dates your ability to predict becomes more accurate) and then enter the actual figures to compare the variances.
The forecast covers the following
Receipts
- Predict the peaks, troughs and seasonality of your sales. The sales figures should be inclusive of VAT that has been charged. VAT is an important element in cash flow - you have to pay the VAT collectors.
- The cash sales figures (if most of your customers have paid in cash) will be similar to the profit and loss data.
Note the "cash from debtors" row in the spreadsheet. Debt management will be a key part of your cash flow operations. Where sales are on credit terms build in a factor (say 12%) to cover sales, which might become bad debts. This % of course will vary. You cannot assume that all your debtors will pay promptly. You will despair of chasing bad debts. You will become hardened to the problems of credit sales and bad risk customers. Some large firms are the worst - their arrogance in delaying payments may bring you to your knees.
Payments
- Predict all expenses that business will incur. Many of suppliers will offer credit times e.g. 30 days to pay. Their goods and services have been used of free until the due payment date. But then it must paid. The cash flow forecast keeps an eye on payments by month. It will also need to monitor individual outgoing payments by due date - if you cannot cover a payment bankruptcy or receivership may loom large.
- Will receipt of a payment from a customer cover outgoing payments on a due date? What if the inflow does not materialise (bad debt) - will the supplier accept your excuses? Will your bank manager?
Wages
- Most items are as per the P & L statement.
- Include PAYE and National Insurance payments made for employees. Roughly it is about £27 000 per year.
- As a sole trader or partner, the salary/wage takes from the business are "drawings" against the business rather than wage/salary.
- Implement a monthly direct debt system for payments to minimise unexpected quarterly bills.
Interest and VAT Payments
- These rows cover monthly or quarterly interest on loans and your overdraft. Remember the bank will deduct this straight from your business account. Anticipate the payment in relation to all other out flowing payments to suppliers.
- If your sales exceed £45,000 you need to be registered for VAT. There is the VAT charged to customers and VAT paid to suppliers. If VAT charged to customers is greeted than VAT paid to suppliers then you owe the surplus to HM Customers and Excise. If you pay more VAT to suppliers than you charge to customers then you can claim VAT back from the VAT office. These monthly or quarterly payments/receipts must feature in your cash flow forecast.
- For example I start to sell in November at the end of January I should pay VAT. It means sales in three month mines materials ((100 000+130 000+125 000)-(10 000+25 000+30 000))*17.5%. And so on each quarter.
- Total repayment in capital budget includes interest rate (annual – 9%) plus repayment of loan. I used a formula: Loan 200 000 * (1+0.007)^10*12 / ((1+0.007)^10*12-1), monthly interest = 9%/12=0.007%
Net Cash Flow before Tax
- Subtract total monthly payments from total monthly receipts. Note the minus figures and work out how you are going to cope with these!
- Add a positive net cash flow to the opening bank balance figure to give your closing balance (vice versa for negative net cash flow).
"Cash flow" management refers to the need to have cash come in -- flow in -- at the right times, so that it is available to flow out as needed. Everyone knows that if an organisation has more expenses than income, sooner or later it will find itself in trouble. However, even if income matches or exceeds expenses in a given year, the cash from the income may not arrive in time to pay the bills as they come due. A cash shortage can be very disruptive to your ability to carry out your mission. To avoid disruptions of business or to take advantage of temporary cash surpluses, cash flow can and should be projected, monitored, and controlled.
Projecting Cash Flow
Projections of receipts and expenditures, which comprise cash flow, are typically developed as part of the budget process, so that you can anticipate and develop strategies for funding the shortages or investing the surpluses. (Many of these strategies are described later in this response sheet.) Cash flow projections follow a format similar to your budgets. For each month, anticipate how much money you will receive and how much you will spend in each category.
To try this for the first time, you must look at your organisation’s prior year's chequebook as a basis for your cash flow projection for the coming year, adjusting for any anticipated changes that will affect the timing and amount of payments and deposits. These changes might include when your programs are offered, what programs are offered, new funding sources or expiration of previous funding, increases or reductions in interest rates, etc. While your new cash flow projection will largely correspond to your budget, some cash flow may come in from receivable from the prior year, cash may go out for payments made for last year's bills, and some income and expenses for the current year will be delayed until next year and, therefore, would not be included in the current year's cash flow budget.
As the year progresses, cash flow projections can be updated. By comparing budgeted cash flows to actual deposits and expenditures, and understanding the nature of any variances, you can strengthen your ability to accurately anticipate cash flow in the future.
Consequences of Incorrect Forecasting
- Overforecasting (forecasting too much demand) results in overproduction, which has consequences of excessive inventory, which is harmful
- Underforecasting (not forecasting enough demand) results in underproduction, which has consequences of not meeting customer demand, and subsequently, the possibility of losing their business to competitors
