My last two blogs "Determining your sales budget to be included in your annual budget" and "What expenditure needs to be included in the annual budget?" showed what needed to be included in the profit and loss account to calculate the profitability of the business.

To calculate the profitability we took:

Sales - Cost of sales = Gross profit - Expenditure = EBITDA

EBITDA = Earnings Before Interest, Tax, Depreciation and Amortisation. 

Please note that as the profit and loss account is being compiled remember to list the assumptions used to calculate the figures at the same time as they may have to be referred to.

To start building up the trade debtors, trade creditors and stock in the balance sheet we now have to feed figures into the balance sheet from the profit and loss account.

VAT is added to the sales from the profit and loss account and sales + VAT are put into the balance sheet as trade debtors. If the customers' terms are 30 days then the trade debtor is translated to cash in the next month and the trade debtor is removed from the balance sheet.

Cost of sales where there is no stock and expenditure with the exception of salaries (to be discussed later) will be treated in a similar way. VAT is added to the expenditure from the profit and loss account and expenditure + VAT is put into the balance sheet as trade creditors.  If trade creditors are paid on 30 days terms then the trade creditor is removed from the balance sheet in the next month.

Stock is included in the balance sheet net of VAT. To calculate stock purchases:

Closing stock + Cost of sales (profit and loss account) - Opening stock = Stock purchases

NB You will need to determine what the level of closing stock should be.

The purchases are treated in the same was as expenditure as discussed above by adding VAT and including them in trade creditors.  

So far I have shown how to calculate the trade debtors, trade creditors and stock on your balance sheet.  There are other areas of the balance sheet which still need to be looked at and these will be discussed later.

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Previously I talked about how to determine your sales and cost of sales figures for your annual budget and calculate your gross profit. However in order to complete the profit and loss account and calculate the profit or loss for the business for the year you must include all your expenditure for the coming year.

This may include plans for expansion or closure and these would include costs for:

• moving
• refurbishment of the premises
• rent, rates, service charges, light and heat, insurance etc
• new furniture and machinery (not treated as capital)
• rental break costs from the old premises (if any)
• dilapidation costs for the old premises (if any)
• contingency costs as some incidental costs will arise

For most companies salary costs account for about 50% of expenditure and so it is important to include all the new staff you are likely to recruit over the next year. You will need to determine the costs associated with each new employee which not only includes their gross salary and employers NIC but also:

• any benefits
• recruitment costs
• training
• new computer
• new desk

Other costs to be considered to build up the complete cost base include:

• Marketing costs - will you be attending any exhibitions?
• Travel costs - which members of staff travel and how frequently?
• Research and development costs - allocate these to individual projects.
• Distribution and logistics costs - if relevant.
• Facilities costs - include all items from rent and rates down to the tea and coffee for the employees.
• Office costs - this will capture costs not included elsewhere such as communications and IT.
• Corporate costs - legal, audit, accountancy and tax fees and directors' fees.
• Interest costs.

Remember to include all expenditure including expenditure associated with any planned changes to the business. Even though many costs will be estimates this will give you a good picture of the profit or loss for the business for the coming year.

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One of the most time consuming and important parts of the budget will be the sales budget. The sales budget sets a target for the coming year for the sales people and it will help determine the expenditure and cash flow in the budget.

With a start up business you will need to look at the potential markets for your product, the number of units expected to be sold (over the products lifetime) and the sales price of the product. By this point you should know if you are manufacturing / buying the product or licensing your technology to a third party and receiving royalties.  In both cases you need to document your assumptions to determine your sales for the coming year. If you are manufacturing / buying in your product for resale will you be able to order / buy enough units to reach your sales targets or will you need alternative manufacturers? Have you calculated the cost of your product and do you know whether the product will have a profitable gross margin? If your gross margin is negative is this product ever going to be profitable?

For businesses with established product ranges you need to calculate the gross margins for each product and if any of these are found to be unprofitable then you should consider whether these products should be discontinued. This can happen when a product reaches the end of its life and the sales price drops below the cost. Also with more established businesses the sales budget should be analysed by customer as there may be the potential to make more sales, likewise the budget can be analysed by geographic sectors as emerging markets may have more demand for a product when sales are starting to drop in established markets.

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Most businesses dread the time when people start to mention the words "annual budget".  It means having to think about the next financial year when you have not even completed the one you are currently working in. Annual budgets are usually started three to four months prior to the year end and can take quite a lot of management time, so why do we need to prepare an annual budget?

What the budget does is to help management identify their plans for the next financial year and the budget helps to crystallise these plans by documenting them and working out how much they will cost. It means that a business is not standing still and it is looking to the future to improve its profitability, cash flow and net worth.

So what does the budget include? The budget is usually split into twelve months (it can be weekly) and it should include:

• a profit and loss account;
• a balance sheet;
• a cash flow forecast; and
• a list of assumptions.

All departments should give their input and the budget should be agreed by the management team and signed off by the board of directors, so that everyone buys into it.  So if you want to crystallise your plans for your business for the next financial year and you want everyone to buy into your plans do you think a budget would help you?

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The last few blog entries have shown you what needs to be included in a rolling three month cash flow forecast.  As mentioned previously the cash flow forecast will show you if you have a cash shortfall or cash surplus over the next three months and I have described some of the short term measures you might use to improve your cash situation.

A cash flow forecast helps you to be proactive in your business so you can start to plan your short term cash requirements, as the forecast is a rolling three month forecast. The forecast needs to be updated each week with the actual transactions which have been cleared by the bank and then the forecast is extended for another week to keep the three month forecast.  Once the cash flow forecast is up and running it does not take much time to update it each week as long as it is kept up to date. In addition CEOs like to see the weekly cash position so they can plan for the short term so what is stopping you from setting up a weekly cash flow forecast?

So if you want a tool where you can forecast your cash balance for the next three months on a rolling basis and you want to be proactive when it comes to your cash situation rather then being reactive why not set up a weekly cash flow forecast. If you need any help or advice on this then please let me know.

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Having entered all the known and expected receipts onto our cash flow forecast and all the known and expected payments you now have an overall picture of what the cash position is for the next 13 weeks for your business. You can see where there are likely to be cash shortfalls and surpluses. With this information you can be proactive and plan your way out of the shortfall rather than being reactive and making bad short term decisions. You have time to make decisions.

So how do you rectify the situation? Does the forecast show you that you need to be chasing your customers for payment on a regular basis as they are not paying on time? If you offer a small cash discount might the customers pay quicker? Do you need to renegotiate your credit terms and try and extend your credit terms with your major suppliers? These may help or do you need external help?

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I mentioned previously that your weekly cash flow forecast should include all your sales/receivables from your customers and therefore to complete the picture you must include all your payments. There will be more categories of payments and the format you choose depends on how much detail you want to show in your cash flow forecast. Payments include amounts due to be paid to suppliers, expenses to be paid to employees, rent, rates, payroll, PAYE/NIC, VAT, intellectual property fees, professional fees, loan repayments, loan interest, bank interest, bank charges and whatever other payments you need to make. For each of these payments you need to work out when they are due to be paid and allocate them to the appropriate week. If the payments are not made according to the cash flow forecast then they need to be moved to the following weeks.

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Every cash flow forecast must include all your sales invoices from your sales/receivables ledger which are due to be paid by your customers. The amounts due should be inserted into the week corresponding to the due date of the invoice. If the customer pays on time then this is good news as the cash is yours and is included in your cash balance. However if the customer does not pay on time the sales invoice has to moved to a later week in the forecast which impacts your current cash balance. The cash flow highlights if you are having a problem with customers paying on time and you need to ask, does your customer have cash flow problems or are they taking extended credit terms without asking for them? Either way this needs to be resolved as you need to collect what is due. How quickly are your customers paying and is this affecting your current cash position? 

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Hello,

All companies need a weekly cash flow forecast which shows all the forecasted receipts and payments of the business for the coming 13 weeks / 3 months to show whether there will be a cash shortfall or surplus over that period.

Lynn

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