I was talking to a business owner a few days ago and he was bemoaning the fact that despite that he had a reasonable turnover and a reasonable profit he is never seems to be in a position to make investments in his business and didn’t know what he expected his profit was going to be at the end of the year. His comment, which I have heard many times, was “I never know what profit I made until my accountant files my accounts for the previous year”. He then admitted that often he doesn’t really understand how the accountant reached the final figures!
I hear this sort of thing often and am sure you know of business owners like this? Of course a major issue with this is that often there is a tax bill then to be paid that has not been planned for, or is completely different to what was expected! Worse than that, how do you decide if you can afford the new piece of kit you need, or whether you can hire another member of staff? How do you decide if you can afford to pay yourself this month?
How do you know which way you need to go when you don’t know where the starting point is? It’s a bit like trying to keep to the speed limit when the speedometer tells you what speed you were doing on the last journey, not this one. Hardly surprising then that you get a ticket you didn’t expect!
Normally when you buy anything substantial, be it a house, car, or even a TV set, you know whether you can afford it. If need be, you’ll put some sort of estimate together of what your monthly disposable income will be, taking into account your income and your outgoings, and then establish if there is sufficient to cover the expenses. So why is it in a business that owners often don’t plan their cash flow (or even know what it is), and manage their business off their bank balance and leave hugely important decisions to chance?
For startup businesses the failure rate is of the order or 5% in the first year of operation, and then 15% per year for the next four years. Less than 50% of businesses last for more than 5 years and why is this? You may have heard the statement…. Turnover is vanity, profit is sanity, but cash flow is reality. More businesses fail due to poor financial planning than any other reason, yet it is an easy problem to solve.
So, what are the key things you need to make an effective financial plan?
1) A budget for at least the next 12 months which should include:
• your expected sales on a monthly basis from existing clients (allowing for client losses) and new client and/or product sales
• your monthly direct costs (those costs directly proportionate to sales)
• your expected monthly costs broken down into key areas (salaries, rent, rates, travel, etc) This will then allow you to see projected profitability for your business
2) A monthly set of reports that includes:
• Profit and Loss
• Aged Debtors
• Aged Creditors
• Aged stock and/or work in progress
• Short term (8 week) rolling cash flow forecast
3) A standard process to review these reports each month, so you decide what action to take to address any issues or opportunities
Managing your financial plan is an easy and quick job when you know the true facts and have a simple process which allows you to be confident that you are making the right decisions for your business. It will also make sure you avoid any nasty surprises like unexpected losses, large tax bills and so on……
If you’d like to understand better how the finances of your business fit together, ask us for a free Financial Review of your business.