15.4. The Financial Plan

Making financial projections

Setting clear business objectives involves more than just producing words in a business plan. Business managers must translate their objectives into figures or targets expressed in money terms. Financial plans are needed to focus a firm on its targets and to help provide the entrepreneur with the answers to key questions once the business is trading, for example:

• What is the cash position of the business?

• What profit is being made?

• What are the business overheads?

• What are the variable costs?

• How much does the firm owe?

• How much is owed to the firm?

• How much working capital does the business have?

The financial plan should answer the questions that an entrepreneur would be asked by a bank when starting up a new business venture. The purpose of these questions is to establish how much money the firm will need to spend on its major cost items, including freehold or leasehold premises and rates, as well as plant, machinery, and equipment. Set against this are any assets which the entrepreneur can make available to the lender as security, and any capital to be provided by the entrepreneur. At the bottom of the plan is the amount to be raised externally.

In order to answer these questions, firms typically produce cashflow forecasts, balance sheets, and profit and loss accounts on a regular, sometimes monthly, basis.

An example of a financial plan questionnaire

BUSINESS:	name of business business address type of business principal activities of business date business commenced
KEY PERSONNEL:	names positions held salaries details of any additions to management team necessary for the growth of the business
COST OF PREMISES:	Freehold: value (give basis and date) mortgage outstanding monthly repayment figure	Leasehold: term of lease period outstanding options to renew (YES/NO) present rent per annum frequency of payment next rent review		Rates: amount (half-yearly) date due (half-yearly)
PLANT AND MACHNERY, EQUIPMENT AND VEHICLES (EXISTING):	description life expectancy value capital expenditure anticipated during the next 12 months
PRODUCT OR SERVICE AND THE MARKET PLACE:	brief details of the product or service market size and potential (quote sources of information) major competitors and their existing market share has the product or service been market tested (give details) marketing and sales methods including costs involved
ASSETS AVAILABLE AS SECURITY:	business assets (description) and their value (with basis and date) personal assets (description) and their value (with basis and date)
FINANCIAL REQUIREMENTS:	Total cost of project: own resources grants other sources (please specify)		Bank requirements: overdraft (as per cashflow) loans and terms ( ___ years) other (please specify) total bank requirements		Total:

The cashflow forecast

Cashflow refers to the money which flows into and out of a business over a period of time, usually one year. A cashflow forecast should be constructed for the first year of trading (some lenders ask to see forecasts for the first three years. A cashflow forecast gives the estimated sum of cash inflows into a business, minus the sum of cash outflows. Inflows of cash can arise from cash sales, debtors paying cash, interest received, and sales of any assets. Cash outflows may be caused by cash purchases of stock, purchases of materials or of assets, or by settling debts owed to creditors. The cashflow forecast shows the net effect of cash inflows and outflows each month, and the impact of these on the firm’s bank balance.

The advantage of cashflow forecasting is that it allows the business to spot in advance any shortfalls in cash during particular months, and to take appropriate action. If a deficit is anticipated, the firm can attempt either to reduce cash outflows in advance, or to raise cash inflows. Failing this, it can attempt to arrange an overdraft to cover the deficit. The cashflow forecast also allows the firm to identify where cash surpluses are likely to be made, and to plan to use these efficiently, for example, by investing the surplus or holding it over to meet a future deficit.

An example of a blank cashflow forecast statement is given below. The forecast contains columns for both predicted and actual cashflow. By comparing the two, it is possible to identify differences or variances from the plan, and to investigate these as they happen.

A cashflow forecast proforma

PERIOD (E.G. 4 WEEKS/MONTHS/ QUARTER)
	Budget	Actual	Budget	Actual
Orders: Net of VAT
Sales
Receipts Cash Sales From Debtors Other Revenue Sources
Total Receipt (A)
Purchases
Payments Cash Purchases To Creditors Wages/Salaries/PAYE Rent/Rate/Insurance Light/Heat/Power Transport/Packing Repairs/Renewals VAT – Net HP Payments/Leasing Charges Bank/Finance charge/Interest Sundry Expenses Tax Dividends Drawings/Fees Loan Repayments Capital Expenditure/Inflows Total Payments (B)
A – B = C or Cr B – A = - C or Dr
Bank balance at end of Cr D previous period brought fwd… Dr
Bank balance at end of period Cr
carried fwd to aggregate (C+D) Dr
Agreed overdraft facility

A projected balance sheet

A potential lender will also require information about:

• The total capital (money) needed by a business

• What the business intends to do with its capital

• How much of the owner’s money is being put into the firm

• Where the rest of the capital is to be raised from

This information is usually shown in the form of an opening balance sheet. A balance sheet is a statement of an organization’s assets and liabilities at a particular point in time. Assets will include premises, machinery, and equipment owned by the firm, and holdings of cash, bank deposits, or sales on credit. Liabilities refers to money owed by the business to other people and organizations, for example, bank loans, hire purchase, leasing agreements, or purchases made on credit.

Opening and projected balance sheet

	OPENING BALANCE	PROJECTED BALANCE
	Sheet 1.6.06 ₤	Sheet 31.5.07 ₤
Fixed assets Machinery Vehicles	2,000 2,500	(less 20% depreciation) 1,600 (less 20% depreciation) 2,000
(A)	4.500	3,600
Current assets Stocks Debtors Cash	2,000 0 1,500	2,500 500 2,000
(B)	3,500	5,000
Less Current liabilities (C) Bank overdraft Trade creditors	2,000 500	1,600 250
(C)	2,500	1,850
Working capital (D = B – C)	1,000	3,150
Net assets (A+D)	5,500	6,750
Financed by Bank loan Overdraft facility Owners’ savings	4,500 0 1,000	4,500 1,000 0
Net profit	0 ______	1,250 ______
	5,500	6,750

In the case of a new business, the balance sheet statement is likely to be drawn up for the first day of trading. It is common practice to include in a business plan both an opening balance sheet and a projected balance sheet for the end of the first year of trading.

A table above shows an opening balance sheet for a new business and the balance sheet for the same business one year later.

The opening balance sheet shows the capital requirements of the firm, and what it intends to do with this capital in terms of distributing it between fixed and current assets. The balance sheet also shows, in the ‘Financed by’ section, how the business intends to raise its finance – in this case, by taking out a bank loan, and from the owners’ savings. In this way, a start-up balance sheet can provide a great deal of useful information to a potential lender.

The projected balance sheet for the end of the first year shows the assets and liabilities the business expects to hold by 31 May 2007. By the end of the year, fixed assets such as machines and vehicles will have reduced in value because of depreciation. At the same time, the values for current assets and liabilities will change from their opening position, due to business trading.

In order to produce the end-of-year balance sheet forecast, the values of some of the balance sheet figures, such as stocks and cash, can be estimated from the cashflow forecast for the year. The firm will have some money owed from sales to debtors by the end of the year, and in this example, will have recorded its first retained profit, a predicted sum of ₤1,250.

The projected year-end balance sheet allows potential lenders to see the likely value of the business one year from starting trading, and so gives them an idea of the likelihood of the business being able to repay its loan.

The projected profit and loss statement

A table below provides an example of a projected profit and loss statement for a business.

Trading and profit and loss statement as at 31.5.07

	£	£
Turnover		45,000
Opening stock (1.6.06)	4,500
Add Purchases	12,000
	16,500
Less Closing stock (31.5.07)	2,500
		14,000
Gross profit		31,000
Less Rent	4,000
Rates	500
Light/heat	450
Telephone/Post	150
Insurance	250
Hire Purchase	400
Advertising	400
Loan repayments	500
Provisions for bad debts	300
Depreciation	400
Drawings	4,000
Other expenses	750
Total expenses	12,100	______
Net profit		18,900

The profit and loss statement shows the profit made by a business during a particular trading period. It is calculated as total sales revenue minus total costs. Unlike a balance sheet, which gives a picture at a particular moment in time, the profit and loss statement shows profit made over a period of time.

If a profit is projected after tax and other expenses, the business owners can then decide how much to retain in the business and how much to pay out to themselves. If a loss is projected, the owners can plan in advance how to raise the finance necessary to pay for the loss.

New firms are usually required to produce a projected profit and loss statement for their first year of trading in order to give potential lenders an estimate of how well the firm is likely to do. Once the business has started, managers are likely to produce a profit and loss statement every one to three months in order to monitor business performance.

Monitoring and reviewing business performance

Once a new business is up and running, managers will want to monitor its financial performance very closely in order to be in a position to take immediate corrective action when required. Potential lenders will look for evidence that the business is going to be run according to principles sound financial management, and will expect to see details of how this is going to happen in the business plan.

The main means of monitoring used by small firms are as follows:

• Regular monitoring of cash inflows and outflows against the cashflow forecast.

• Comparing actual sales and purchases against operating budget plans. A comparison of plans with outturn can be made using variance analysis. It is important for an organization to keep its costs as low as possible, and within budget.

• Producing monthly or three-monthly profit and loss statements and balance sheets. These accounts can reveal a great deal about business performance. Financial performance can be monitored using ratio analysis, for example, measuring profit margins, return on capital employed, and liquidity ratios.

• Monitoring aged creditors lists and aged debtors lists. This will tell a business how much is owed to suppliers and when payments have to be made, and how much is owed to the business for sales made on credit. Chasing up late payers may be required to keep cashflow projections on target and to provide funds, so that creditors can be paid on time.