Financial forecasting & planning Essay

Financial accounts be, quite al bingle, your project of how your course organization break perform pecuniaryly everywhere, say, the grade ahead. Preparing forecasts go show up help you to assess your likely gross revenue income, be, forther financing leases and remunerationability. Financial forecasts are essential if you hire to bone currency from a third party, such as a bank. simply they likewise provide you with the means to monitor performance on, say, a periodic basis and thereby exercise efficient monetary control arguably the second most important management function in runway a business. ObjectivesThe aim of this section is to help you to instal financial forecasts. It exit en able you toUnderstand compriseing and pricingUse break-even analytic thinking as a way of postureting gross revenue targetsUnderstand financial forecastingAssess going dandy requirements.AssignmentThe purpose of these assignments is to fancy that you are abl e to desex the necessary financial forecasts for your business. Satisf tourory completion of the set of assignments ordain demonstrate that you k now and understand how to pose and head the financial out line of works it go away be necessary to prepare. count your own personal excerption budget.Determine the funding/ corporals requirements of runnering in business. Consider how you entrusting convey and keep effective financial control of the business. Consider and invent to propagate with alternative scenarios.1. Personal budgetHow much money do you penury for yourself. Think around food, clothes, holidays, personal travel, etc. D lancinate up a personal budget. Dont skimp. You whitethorn be in business to beget fun but you need to come across money as well. Use this budget in calculating your be and values. Of course you whitethorn non give enough gross revenue at the start to be able to take that amount of money, so you should also calculate the stripped-do wn requirement that you must take from the business.2. Costing and pricingCalculate individu exclusivelyy your be and narrow a suitable determine for your product or avail. Think about your rough material requirements as part of your prospect at woo think about your likely hit bells.3. Break-evenNow that you excite measured all your cost and set a scathe, you should be in a position to prepare a break-even chart. Is your forecast of sales supra or below break-even? Do you possess a reasonable tolerance of caoutchouc? How much understand will you compensate if you achieve your sales forecast?4. Forecasting lolly and differenceYou should dumbfound all the gauges that you need to prepare a forecast of shekels and deviation. What is your anticipated gross network margin? What is your operational profit? How much money will be carry in the business?5. Cash hang up forecastingYou should score all the figures that you need to prepare a cash emanate forecast. recover to think about everything shown on the profit and loss account, expenditure items non shown on the profit and loss and, in particular, to think about time or receipts and payments. You will also need to think cautiously about your stock holding requirements and your capital expenditure. The starting line time you prepare the cash flux, ignore both investment funds or borrowing another(prenominal) than that required for capital equipment. The worst cumulative deficit will mold the minimum train of functional capital required.6. Forecasting your balance tackOnce you have completed the profit and loss and cash prey forecasts, youshould be able to prepare a balance sheet forecast. What level of operative capital requirement is suggested by the balance sheet?7. sensitivity analysisHave another brass at your profit and loss and cash flow rate forecasts. What happens if sales are 15% less than you have forecast? Do you still make a profit? What happens if raw materi al expenses go up by 25%? What does this do to your favourableness? Can you pass on such change magnitudes to your guests or will they shimmy suppliers?8. Effective financial controlYou should now be in a position to exercise control over your business. Will you practice a guileless manual book-keeping system or a computerised one? As a brief reminder, write down the key reasons for keeping effective financial control. What are the critical numbers at which to expression to ensure you retain effective financial control?Break Even synopsisBreak-even analysis identifies the tip at which your business starts to make a profit. You sens work out the break-even point using any timescale, e.g. weekly, calendar calendar monthly, yrly, etc. To calculate the break-even point you need to bang the following The score touch on costs of your business these embroil rent and rates, your drawings, impart repayments, etc The total variable costs for producing your product these ac tell apartledge labour, materials and packaging and The swaping price of your product.Once you have these figures, you post work out your break-even point using four simple calculations and plotting the findings on a represent.ExampleRon from Widgets R Us want to work out how many widgets he needs to sell in frame to break-even every month. He whole kit and caboodle his fixed costs out as followsRent 167 per monthSalary 834 per monthRates 70 per monthLoan repayment 100 per monthTotal 1,171(1 = Rs.84)(Note It is discover to round figures up rather than down, as this will increase your safety margin.)This figure fuel be plotted as followsRon and then works out his variable costs for the production of each widget Materials 9.00 case 1.00Labour 11.00Total cost 21.00 per widget(1 = Rs.84)He selects a value on the number of widgets axis (in this case, 250) and does the following calculation 250 widgets x 21.00 per widget = 5,250Ron plots this figure on the graph and draw s a straight line from it to zero.The next step is for Ron to work out his total costs. To do this, he adds his fixed costs to his variable costs 1,171 + 5,250 = 6,421 (1 = Rs.84)He plots this figure on the graph and draws a straight line from it to 1,171 on the Pounds axis.Ron now needs to work out his revenue line. To do this, he simply multiplies his products change price by the example number of widgets he chose originally (250) 32.50 x 250 = 8,125 (1 = Rs.84)He then plots this figure on the graph and draws a straight line from it to zero.Ron can now find his break-even point simply by locating the exact point where the revenue line disects the total costs line.In this case, Ron must sell 100 widgets each month if his business is to break-even. If he sells much(prenominal) than 100, he makes a profit if he sells less he makes a loss.Costing And Pricing beAlthough accountants define costs in several several(predicate) ways, there are, effectively, middling two types of cost . The first cost is that which is directly attributable to the product or aid. Direct costs include, for example, raw materials and sub-contract work. If you make desks, for example, the cost of wood will be a direct cost. Within reason, the cost will be the same for each desk, no matter how many desks you make. When you make a sale the income first has to cover the direct costs relating to that sale. Whatever is leftover is called gross profit or contribution. all in all other costs are overheads. These include, for example, staff salaries, marketing, rent, rates and insurance. They also include depreciation that is, an permitance for live and tear on capital equipment. Overheads are often called fixed costs beca exercise, generally, they are fixed for the business. Interest is often regarded as a demonstration from salary profit rather than an overhead cost. You need to include it as an overhead in your costing calculations, even though it varies with the size of your overdr aft or loan. If you are self-employed, you will take drawings from the business. Whilst, strictly speaking, drawings are an advance against profit, include them (and an allowance for income tax) as an overhead when calculating total costs.The contribution is so-called because it contributes towards covering the overhead costs. Each sale generates a contribution. When enough contributions have been made, and all the overhead costs are covered, they start to contribute to net profit. PriceThe price at which you sell your product or go intelligibly needs to exceed the total costs of providing it. But the price should also reflect what the market can stand. If you are selling a differentiated product or haveadopted a system of market focus then you whitethorn also be able to germinate a premium price. If you are pursuing a cost leadership strategy you will need to be ruthless in keeping your costs down and under control.In calculating your price you will need to follow a number of steps infer your likely sales for a period, say, one year Calculate the total direct costs and divide by the sales gaudiness to give direct costs per unit (say per product or per hour of service) Calculate your total overhead costs and divide by the sales volume to give overhead costs per unit Add direct costs per unit and overhead costs per unit to give total cost per unit and, Add a further profit margin (to allow for reinvestment, etc). If necessary, add tubful as well. You now have a first stab price. How does that compare with your competitors? Will customers buy at that price? Do you need to reduce costs? Can you achieve a high profit margin?What happens if you fail to achieve sales at the unflinching price? Remember that the overhead costs are fixed, so if sales fall the overheads will be spread over fewer items and the unit cost effectively increases. The converse is also true. Increasing the volume of sales means that the overheads are spread over more units, so the unit cost falls. This means that you can, if you choose, reduce the price. And reducing the price might increase your level of sales. Its a fine balancing act. wear and tearDepreciation is an allowance for wear and tear on the equipment used in your business. As time passes, your equipment will usually lose value, and this can be considered a cost to your business. You need to think about how long you expect your assets to last. For example, if you procure a computer system, you may forecast that in 5 age it will be obsolete. That means the depreciation rate is 20% per year. If you determine it to be 2 years, then it will be 50% per year. This does not have any effect on cash flow, just on how profits are calculated. Deprecation is an accounting cost that must be included to give a Profit & Loss account more relevance. Finance Action Planner (FAP)The Finance Action Planner (FAP) is a learning tool that will help you to Develop your all-round financial skillsLearn more about a rang e of financial issuesIdentify suitable sources of financeCreate a set of financial forecasts attempt out different financial scenariosFinancial forecastsOnce you have an belief of your likely costs and an idea of how much you need to sell to make a profit you are in a position to prepare financial forecasts. in that respect are iii basic financial statements (the profit and loss account (P&L) the cash flow statement and the balance sheet) that signalize the activities and financial state of any business. These can be prepared on a historical basis to show how a business performed during a defined period or as forecasts as estimates of how the business will perform in the future. 3 steps to forecasting1. Businesses often start by forecasting their cash flow and then aim to derive other forecasts from it. It makes more sense, however, to start by forecasting the income and expenditure of the business, which will indicate whether you will make a profit, then worry about when mo ney will be received or paid out to discover if you will have enough cash when it is needed. Income and expenditure is totald in a profit and loss account. 2. You will also need to look at your likely sales for, say, the year ahead. This needs to relate adventure to your market research and, if you are already in business, to previous performance.The direct costs can then be estimated (usually as a serving of sales) to give gross profit. 3. The next step is to estimate the likely overheads. Deducting these gives an operating profit forecast. If the net profit is too low you will any need to assess whether you can achieve high sales or whether you can reduce the overheads. When preparing your forecasts, remember to allow for increased costs, for instance, imputable to pomposity or future pay awards. If you do need a loan, then you will also need to allow an amount for loan interest. If you use equipment, remember to allow for depreciation. Whilst depreciation isnot included in the P&L, you may need to allow for the replacement or repairs of machinery, so you may wish to include a contingency.The P&L forecast will show whether you are likely to achieve your first key financial requirement making a profit.Preparing cash flow forecastsIn preparing your forecasts, you will need to think carefully about all your costs, about your price and likely sales at that price and about the timing of both(prenominal) receipts and payments.As mentioned above, the first forecast that you set out should ideally be a P&L, summarizing income and expenditure for, say, the year ahead. You might do this monthly or yearbookly. The P&L is important for demonstrating positivity over the very short term, however, the key requirement is to generate cash and know the businesss working capital requirements. This can best be done by preparing cash flow forecast which should set out all the information, month by month, regarding cash inflows and outflows. The cash flow forecast shoul d include Receipts of cash from customersPayments for raw materialsPayments for all other expensesDrawings and feeCapital expenditureCapital, loans or grants introducedLoan repayments bath receipts and payments (if tub registered) and,Tax payments.All of these items should normally be shown separately and in the month into which the money will be received, or paid by, your business.For businesses with a pocketable turnover and that demonstrate profitability in the year, it is normal only to forecast one year ahead, with a monthly cash flow. Larger businesses, specially those seeking equity investments and/or which do not show profitability in the year, may need to prepare forecastsfor two or three years. The first year cash flow is usually shown monthly, the second year quarterly and the third year just a single annual figure.It is often helpful when preparing cash flow forecasts initially to ignore any finance that is available from the bank or other lenders. The cash flow forec ast then shows the true position of the business. It can then be used to decide if the budget is viable and can be correct to reflect the true position and to assess the total funding requirement.If you do not have able money of your own, then you will need to seek loan finance or an equity investor. Most subtle businesses simply look for loan finance. Aim to match the term of the loan to the life of the asset for which it is required. It would be normal to look for a short loan, for example, to purchase equipment, or a long-term loan to purchase premises. You will also need to buy stock and pay overheads whilst awaiting payment from your customers. The money required is called working capital and is typically funded by an overdraft. When preparing your cash flow forecast, you may like initially only to include personal investment or loan finance for fixed assets and to ignore funds for working capital. The worst cumulative deficit will then give an feature of your total workin g capital requirement. Of course, the amount that you need to borrow can be reduced if you have more available to invest yourself.If you have a term loan, the capital repayments will not figure in your profit and loss account they are not a business expense although the interest portion of the repayments will be charged as an expense. However, the repayments do need to be included in your cash flow forecast.Balance sheetThe money in a business can only come from three sources capital introduced by the owner(s) loans (whether from the bank or, effectively, from creditors) and, retained earnings that is, profit which has been generated by, and retained within, the business. That money is used to finance the fixed and current assets of the business. Current liabilities includeCreditorsOverdraftsLoans due within one yearMoney owed under hire purchase agreementsAny amounts owed in bathtub or tax, etc.In larger businesses, loans falling due in more than one year are usually shown separ ately. You will, however, have a better idea of your businesss performance if you show all loans as current liabilities.Current assets less current liabilities show your working capital requirement. Since the balance sheet is merely a snapshot, however, it may be better to deduce your working capital requirement from the cash flow forecast.The net assets are always equal to the capital introduced plus reserves that is, the net finance, roughlytimes known as net worth or the equity of the business.The net finance, together with any long-term loans, is called the capital employed. All borrowing should be included when calculating capital employed.Pricing strategiesThe sterling(prenominal) danger when setting a price for the first time is to interchange it too low. Raising a price is always more unenviable than lowering one, yet there are great temptations to undercut the competition. It is clearly important to compare your prices to your competitors, but it is essential that your price covers all your costs. There are a number of possible pricing strategies from which you might choose. These include 1. Cost based pricing total costs are calculated and a mark up is added to give the required profit. 2. Skimming you charge a relatively high price to recover set up costs quickly if the product is good or new. As more competitors enter the market, you lower the price. 3. Individual you negotiate prices individually with customers based on how much they are prepared to buy. 4. Loss leaders if you wish to sell to a particular market then you might sell one product or service cheaper to gain marketentry.You balance this by selling other products or services at a higher price. This can be risky as the danger is that everything becomes a loss leader. 5. Expected price what does the customer expect to pay? If you are selling a quality product, do not under price. Often the customer expects to pay a lot as the product or service has a certain snob value and this m ay be pocket-sized if you under price. 6. Differential pricing you charge different segments of your market different prices for the same service. For example, offering discounts to certain people like pensioners or the unemployed, or charging lower rates for quiet periods. If, after working out your costs, the price you charge is much greater than your competitors then you will have to look at ways of reducing costs.Sensitivity analysisIt is important to know how sensitive your forecast is to changes. Sensitivity analysis looks at what if? scenarios. What happens to your cash position, for example, if sales fall by 10%? What happens if your main supplier increases raw material prices by 12%? Financial institutions when considering propositions for a loan particularly use sensitivity analysis. If your business is particularly susceptible to small changes, then you in all probability do not have a sufficiently large profit margin. You will thus be less likely to receive the loan required. You may find it difficult to cut costs. You may not be able simply to increase prices to improve your margins that might deter customers. are there other ways in which you can push up the margins, e.g. by increasing output?Having undertaken your sensitivity analysis, you may need to review elements of your forecast. Sensitivity analysis can help in making decisions. You may want to consider, for example, the effect of increased raw material, labour or overhead costs of reducing prices, with ceaseless volumes, to counteract competitors or reducing volumes, with constant prices, due to over optimistic forecasts. Furthermore, if you are about to spend a large sum of money on equipment, you may want to look ahead several years, if at all possible.Including a sensitivity analysis in your business plan will demonstrate thatyou have thought about some of the potential risks and that is half way to avoiding them. ad valorem tax (Value Added Tax)VAT is tax paid on the value ad ded at each point of delivery of a product or service. It is a method whereby businesses act as tax take inors for the Government. If you are registered for VAT, by submitting a VAT production you can claim back what you have paid in VAT, and overturn over what you have collected. Not all goods are taxable for example, insurance, some education and training, and postal services are exempt. If items are VAT-able, then, ignoring VAT on fuel, there are two rates standard (currently 17.5%), and zero-rated. Zero rated items are different from exempt items. It is only necessary to register if your output is taxable. If you do register, you will be able to recover VAT on your purchases including materials, capital equipment and overheads. You will, however, have to charge VAT on your sales.The difference between what you collect and what you pay out in VAT is passed on in due course to Customs & Excise. There is more paperwork involved if you are VAT registered you need tax invoices showing your VAT number, an analyzed VAT account, and VAT return forms. It may, however, be advantageous to register voluntarily if your sales are below the turnover limit, because VAT paid on purchases can be reclaimed. You may also reclaim VAT on capital equipment, raw materials and stocks bought before registration, provided the business still owns them. If you are selling to VAT registered businesses, it is likely to be more attractive for you to register. If you are selling to the general public, it probably will not be. This is, however, an area where you should seek professional advice.CASE contractBrians Book-keeping BusinessBrian runs a book-keeping service for several small businesses. His overheads are as follows Costs Per year (1 = Rs.84)Office costs5,000Advertising 1,100Insurance550Telephone650fomite running costs900Other3,000Brian works 40 hours per week. He spends 8 hours per week on administration, marketing, etc. He works 45 weeks each year allowing for holidays a nd illness. Brian draws cc out of the business each week.Brian has been asked to undertake a specific occupation and estimates he will need to spend 12 hours on it. What is the cost of providing the service?How much should he charge?SolutionWhat is the cost of providing the service?1. Total hours worked per annum = 32 hours per week x 45 = 1,440 hours 2. Total drawings = cc x 52 = 10,4003. Total fixed costs = 11,2004. Total costs = 21,6005. Costs per hour = 21,600/1,440 = 156. For a job lasting 12 hours, the cost is 180(1 = Rs.84)How much should he charge?Brian has inflexible that he should also add a further 20% profit margin in case his costs go up and to make a little extra for reinvestment. 180 + 20% = 216He is also registered for VAT and needs, therefore, to add VAT at the standard rate (17.5%)216 + 17.5% = 253.80So the price he charges to his customer is 253.80Useful tips1. Some readers of your business plan will regard the financial forecasts as the most important compone nt. It is where you summarise the anticipate income, dependent on your market research, and where you set out your expected costs. 2. The forecasts need to demonstrate that the business is viable and that there is a sufficient margin of comfort to allow for fall in demand or increase in costs. 3. Take care to prepare your financial forecasts asaccurately as you can. Then compare your actual results with your forecasts and, if necessary, take restorative action at an early stage to keep yourself on course.