It’s not about the destination it’s about the journey, right? This absolute truth in life applies to business planning as well, and it’s this philosophy that will serve you best when preparing and using business plans. Hopefully, we can help you get past thinking about a “budget” (a dirty word in our office) as a simple expense reduction effort and start thinking in terms of financial planning to improve profits and increase cash flow.
Example: If you were to plan a two week trip across the country, you wouldn’t do all the planning and then put it away in hopes you remember the route, planned stops, timing, and accommodations at a later date? No, you would continually be referring to the plan, comparing to where you actually are, and adapting if necessary. The same is true of your business financial planning.
For starters, do not think about business financial planning simply as preparing a budget – budgets are for households.
You’re running a business, and to have any real insight and impact on improving your operating results, a business requires a complete set of forecasted financial statements. In our opinion, the most important result of financial planning is cash flow management and improvement. This cannot be accomplished by focusing only on top line revenues and bottom line net income improvement with a simple Profit & Loss Statement budget.
The P & L budget does not help you answer the cash flow questions – How much cash will the business need, when will it need it, and where will it come from. The only way to do that is by forecasting out the income statement, and the balance sheet and the cash flow statement. Each of the three financial reports is tied to the other, and going through the forecasting process will help you understand how they are tied together and why managing cash flow is more difficult than simply managing expenses. So there is some complexity here but let us help you get started by summarizing the broad objectives for the income statement forecast.
The income statement forecast is the first step and its purpose is to help you manage and improve profits. Think in terms of detail goal setting. Let’s assume you have growth goals (if you’re an entrepreneur you do!). Come up with what your growth goals are for the coming year, and then break that down into monthly increments. Look at your history to determine any monthly seasonality and of course factor in any major initiatives you have planned. Now analyze your historic gross profit margins – commonly referred to revenue less cost-of-goods-sold, maybe more easily understood as sales minus direct costs of producing the product or service.
Gross profit is key area that can have a huge impact on your company, so really dig into this to understand the direct costs associated with each and every sale – it will probably provide some real insight into how you can improve profit margins. Break it down into revenue and direct variable costs for each type of sale – 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 twelve months. Fill in the rest of the Profit and Loss forecast by analyze every single overhead expense line item. Each overhead expense should be justified either improving your customers experience or improving your team’s experience and their ability to deliver exceptional service to your customers.
Now for the hard part, forecasting out the balance sheet. The best advice here is that you will need some business budgeting software as it’s simply too complex and too much room for error trying to build this with formulas in excel. We use Plan Guru. Some areas that need historical analysis (these are areas that can provide insights into potential cash flow improvements) are accounts receivable average aging days (days sales in receivables), inventory turnover, and accounts payable average aging.
You’ll also want to factor in notes payable amortization, and your goals for paying down any 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 which should be reviewed in detail and in tandem with the forecasted income statement and balance sheet to ensure no surprises. You’ll probably want the help of your CPA to put some of this together and help you conceptualize how all three statements tie together.
Remember, the objective of business financial planning is to help you visualize the financial impact of your profit and cash flow goals. Like planning anything, you have to first understand where you are today and where you want to get to. There’s value in the planning, but the real value is in measuring against the plan. Returning to our example of “planning a two week journey across country,” you wouldn’t simply make the plans and hope everything works out. You have to continually monitor progress and adapt along the way.
In business you should be monitoring and comparing actual financial results against forecasted results on a monthly basis. Our opinion is that forecasting out monthly for twelve months is enough detail for most 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. But for detailed monthly planning and comparing actual to planned results, twelve months is enough.
And remember, the real value of planning is to return to it every month comparing actual to plan. Then roll forward at least once a quarter so you always refreshing your twelve month view, continually adapting to unpredicted curves in the road.