As owners, we make decisions on a daily basis about where to spend our cash, and we all know, there is no shortage of shiny objects to entice us! Two things are important to keep in mind when you are spending cash on the way to growing your company: Immediate Need and Value Over Time.
Quick Lesson: Assets vs Expenses
Assets provide a future benefit to your business. Assets are either purchased to provide a working return on investment for your business, such as operating equipment, computers, warehouse building, delivery vehicle, or can be a by-product of the operations of your business, such as cash on hand, accounts receivable, inventory on hand. Assets can be used as collateral during expansion, sold during lean times, and help produce a healthy balance sheet.
Expenses or costs are put into two general classifications, either Cost of Goods Sold, or Operating Expense. Cost of goods sold (COGS) are directly related to producing the product or service you sell, such as the cost of the inventory you just sold, or the cost of the labor to generate the revenue producing services. Operating expenses are all the other admin, marketing & selling, and general overhead expenses that it takes to run your business. It’s important to distinguish between these direct and indirect costs/expenses when developing a business financial plan, as well as determining break-even points and making pricing decisions.
What can you spend today?
There is sacrifice in business just as there is sacrifice with everything else in life… we want to have what we want, when we want it, but what price are we willing to pay in the long run for immediate gratification? When it comes to immediate need, think about your current situation… and think about your cash flow plan. Without a financial plan to guide you, frankly, you’re just guessing about whether or not the company can afford it. There’s no point in buying company custom logo clothing if you can barely make payroll to pay the people who wear it!
Developing your company’s financial plan requires that you analyze and understand every line item on your financial statements. It’s during this process that we’ve seen so many entrepreneurs make great decisions about the ROI (return on investment) for each of the assets, direct costs and indirect costs we discussed above. And we’re not just talking about cutting unnecessary expenses, We’ve also seen great decisions made on purchasing more effective tools & equipment (assets) for their team so they can work better and more efficiently, or making better direct costs buying decisions to improve profitability, having a huge impact on bottom line.
What do you need long-term?
Budgeting and business financial planning are key. What you spend today comes down to planning for tomorrow, and it’s always smart to think about how your purchases will hold their value over time. All business assets have value, but each type of business asset is valued differently and value can change, based on the circumstances.
The key benefit of a business financial plan is that it allows you to create a focus for the direction you want your business to go, providing clear targets that will help guide future spending. The financial plan for your business constitutes more than just a Profit & Loss statement budget, it should also include a fully projected balance sheet. The projected balance sheet is necessary in order to show the effect of non-P & L items on cash flow, such as inventory and receivables turn over, capital asset purchases, debt reductions, or seasonal Line of Credit needs.
If you have a 12-month budget in place, you can monitor and compare what’s happening today against forecasted results on a monthly basis. If you have planned for future purchases or have foresight into the stress growth will put on cash flow, the weight doesn’t feel so heavy when it actually comes time to buy or borrow short term because it was already part of the plan. Everything comes down to what you plan for, so if you haven’t planned for growth, it’s going to be very difficult to actually grow.
Forecasting out monthly for twelve months is usually enough detail for most small business owners. Beyond the next twelve months, you may want to forecast out annual results up to three years to give you some broad range perspective on long-term goals.
And remember, the real value of planning is to return to the plan every month comparing actual to plan. Then roll forward at least once a quarter so you’re always refreshing your twelve-month view, continually adapting the based on actual experience and new strategic initiatives adopted by your company.
If you first understand where you are today, and then make a plan for where you want to be three years from now, that will become your guide for day to day purchasing behavior and will keep you on track for future growth.
Virtual BeanCounters serves entrepreneurs with an empowering finance division so they can focus on innovation and creating value for their clients. We believe you can accomplish the business of your dreams a lot easier with a professional accountant on your team! Contact us by phone at (913) 649-1040 or click here to visit our Contact page.