Creating a budget is fine, and if you have one for 2015, great! This is a good first step.
However, to actually improve your cash operating results, your business requires a complete set of projected financial statements that show you where you’ll be each month.
If all you have is a budget, then all you’ve really done is project out the income statement—whether you’ll have a profit or loss at year’s end. But it won’t help you answer the three questions that keep many business owners awake at night.
- How much cash—not sales, but actual available cash—will my business need?
- When will we need it?
- Where will it come from?
The most important result of financial planning is improved management of your company’s cash flow, so that you can keep the lights on. This cannot be accomplished by only focusing on top-line revenues and bottom-line net income.
Instead, you must forecast out the income statement and the balance sheet and the cash flow statement.
Income Statement Forecast
The income statement forecast is the first step. It’s your estimate of how your projected revenue will compare to projected expenses—and whether you’ll end up with a profit or a loss.
When you do this, it’s a good idea to get specific.
Let’s assume you have growth goals for your business—if you’re an entrepreneur, you almost certainly do. Decide what your detailed goals are for the coming year, and then break them down into monthly increments. (If you want to generate $1.2 million in sales, you’ll need to sell at least $100,000 each month.) Look at your company’s history to determine any seasonal fluctuations. And, of course, factor in the cost of any major initiatives you have planned.
Really dig in and understand the direct costs associated with each sale. Doing so will probably provide some real insight into how you can improve profit margins. Figure out the expected revenue and the direct variable costs for each type of sale—whether that’s by product, by service type, by customer type, by location, whatever makes the most sense for your business.
This means you will need to break your revenue goals into the different types, analyze your costs, and forecast out the next 12 months.
Now analyze every single overhead expense. Each one should be justified by either improving your customers’ experience or improving your employees’ experience and their ability to deliver exceptional service to your customers.
Where You May Need Help
To project out the balance sheet and your cash flows, you probably will need some business budgeting software and possibly the help of a CPA. This process is simply too complex, and there’s too much room for error if you try to build this in Excel. We use PlanGuru.
Even with the software, you’re going to need some data on your operations to date.
In order to project how balance sheet accounts are going to impact cash flow, you’ll need some historical information on accounts receivable. What’s the average age of your receivables—how many days do you have to wait until you’re paid on a sale? What’s the average age of your payables, and how long does it take to turn over your inventory?
You’ll also want to factor in notes payable, how much principal you need to pay down on loans, and your goals for paying down lines of credit, credit card balances or any other debt. All line items on the balance sheet need to be factored in as each can potentially impact cash flow, such as major equipment purchases or changes in ownership capital.
The software will then allow you to view a forecasted statement of cash flows—how much money you’ll have on hand each month—which should be reviewed in detail and in tandem with the forecasted income statement and balance sheet.
Monitor and Compare
Once you have these projections, you should monitor and compare your actual financial results against the forecast on a monthly basis.
We believe that forecasting out monthly for 12 months is enough detail for most business owners. You may want to forecast your annual results up to three years out, just to give you some perspective on your long-term goals, but for detailed monthly planning and comparison, 12 months is enough.
Doing this each month also allows you to regularly adjust your operations to unforeseen “curves in the road.”
