You may not have the need for a complete financial forecast, but it's just a shame to run a business without managing a simple sales forecast, expense budget, and -- if and only if you're planning a startup -- an estimate of startup costs. These are all relatively simple estimates, with relatively simple math, that anybody who is smart enough to run a business can handle.
After all, a lot of the real value of the plan-as-you-go business plan is the tracking, following up, seeing what was different between what actually happened and what was planned. That's much more likely to happen if you have numbers, like sales and expenses, that you can track.
Furthermore, you really should also be aware of the very important cash traps that can kill your business even if it's growing and profitable. These traps are avoidable.
So in this section what I want is to get you into the basic numbers that can run your business. There is so much benefit from tracking the difference between sales forecasts and actual sales; this is where you really get into planning process and managing your business better.
Don't worry, this isn't (yet) a full-blown financial forecast. Don't call your local accountant or management consultant. The math is simple, and although the educated guessing isn't, you can do it, and you are uniquely qualified. Here's what we're going to look at:
- A sales forecast. How to do it, why to do it, what to look for, how much to do.
- Your spending budget. You need to know -- and track changes in -- the money flowing out of your business. This is related to burn rate, fixed and variable costs, and milestones. It's real management. This ought to include just a few of the most important parts of spending:
- costs of sales
- a simple expense budget
- starting costs (this is only if you're planning a startup. If so, you have expenses that will get deducted from future income, and you'll have assets that you'll have to buy. You want to have a good idea of what it takes to get started, before you get halfway there.)
- Cash flow traps. Just so you know, we're going to leave the full-blown financial forecast, with its standard formats, and balances, and accrual accounting and definitions and all, for the following chapter about dressing the plan as needed. But we can't pretend we have you in good shape with numbers if we aren't anticipating the cash-flow traps that can kill even profitable and growing businesses.
Your sales forecast is the backbone of your business plan. People measure a business and its growth by sales, and your sales forecast sets the standard for expenses, profits and growth. The sales forecast is almost always going to be the first set of numbers you'll track for plan vs. actual use. This is what you'll do even if you do no other numbers.
When it comes to forecasting sales, don't fall for the trap that says forecasting takes training, mathematics or advanced degrees. Forecasting is mainly educated guessing. So don't expect to get it perfect; just make it reasonable. There's no business owner who isn't qualified to forecast sales -- you don't need a business degree or accountant's certification. What you need is common sense, research of the factors, and motivation to make an educated guess.
Your sales forecast in a business plan should show sales by month for the next 12 months -- at least -- and then by year for the following two to five years. Three years, total, is generally enough for most business plans.
If you have more than one line of sales, show each line separately and add them up. If you have more than ten or so lines of sales, summarize them and consolidate. Remember, this is business planning, not accounting, so it has to be reasonable, but it doesn't need too much detail. Here's an example, from a sales forecast for a local computer retail store.
It's a simple example. You should recognize the arrangement of rows and columns. I'm just showing you a portion of the spreadsheet, because it has to fit on the page.
Notice the predictable structure. First you have units, then prices, then you multiply price times units to get sales. It's simple math, but breaking it up like that makes things easier later on, when you look at what went wrong (and remember, something will go wrong; business plans are always wrong).
Even if you've never done a spreadsheet, you can do this one. The hard part is remembering that you can estimate, you are qualified, and nobody else can do it better. Just take a deep breath, calm down, and make an estimate.
Or, if you prefer, read on. Let's talk about working from past data, estimating entirely new products, your data analysis qualifications, and some other factors. Then you can make your forecast.
You probably know this already, but I'll go over it just in case. I recommend using Business Plan Pro software so you don't have to do this, but it's good to know anyhow, and you can certainly do everything in this book without that software. So here's a bit about spreadsheets.
Spreadsheets are normally arranged in rows and columns, with rows numbered from 1 to whatever, and columns labeled from A to whatever. Simple mathematical formulas refer to the cells that are identified by row and column. For example:
So what we see here is a simple formula that adds the 34 in cell B2 to the 45 in cell C2 to get the sum of those two, which is 79. That number is in cell D2, so you see the formula showing at the top when you click on D2. Also the number in the upper left corner indicates which cell the displayed formula belongs to.
Here's another simple example:
In this case the cell named B5 is highlighted, and its formula says to sum up all the cells from B2 to B4. That's three cells, and the numbers they contain sum up to 128.
There are lots of books and websites and different instructions and tutorials available for spreadsheets. This is enough for now, so you can understand my simple forecast examples.
So you make a sale. When you deliver the goods, you record it as a sale. If the customer didn't pay you immediately, you record the accrued amount as Accounts Receivable.
You order some goods. When you receive them, you don't pay for them. Instead, you record the accrued amount as Accounts Payable.
At the end of the tax year you have some expenses outstanding, like professional services you know you'll be billed for but you haven't been billed yet. You accrue those expenses into the current tax year. They are deductible against income.
In so-called cash basis accounting, the opposite of accrual accounting, you don't put the sale or the purchase onto your books until the money changes hands. With business-to-business sales, the norm is the money changes hands later. So accrual accounting is better. It gives your books a more accurate picture of your financial flow and financial position.
Why does this matter here? Because timing of sales, costs, and expenses makes a difference. Start your forecasts correctly so the can be part of a more formal financial forecast when you finally need one.
Just a quick note. I hope it's obvious. With examples in this book I'm not showing you the full columns of the spreadsheets, because that would be awkward. Numbers would have to be very small and difficult to read. I use my spreadsheets for sales forecasting and other normal monthly projections with a standard layout.
I base my tables on the standard spreadsheet layout as used in Microsoft Excel, Lotus 1-2-3, AppleWorks, Quattro Pro, and even the true pioneer, VisiCalc, the first spreadsheet, from 30 years ago. The rows are labeled from 1 to whatever, and the columns are labeled from A to whatever. When you get past the 26 letters of the alphabet you start over again, with AA, AB, AC, etc.
|Labels in Column A
||Special uses for Column B
||12 Months Monthly in Columns C-N
||Annual Columns as Needed.
|I run the labels along the lefthand side. These might be Sales, Expenses, Profits, etc.
||I keep column B open for variables like growth rates and such. This is convenient for starting balances too.
||My months go off toward the right, one by one, in 12 columns.
||The first year's totals of the numbers from the previous 12 months. Then come the additional years as needed.
Don't reinvent wheels. Please. As you do your sales forecast, be aware that accountants and financial analysts have definite meanings for timing of sales. If you don't deal with this their way, then when you do eventually incorporate the work you've already done on the sales forecast into more formal financial projections, you'll have it wrong. It will look bad.
|So What's Accrual Accounting and Why Does it Matter?
|So you make a sale. When you deliver the goods, you record it as a sale. If the customer didn't pay you immediately, you record the accrued amount as accounts receivable.Then you order some goods. When you receive them, you don't pay for them. Instead, you record the accrued amount as accounts payable.
At the end of the tax year you have some expenses outstanding, like professional services you know you'll be billed for in the future. You accrue those expenses into the current tax year. They are deductible against income.
In so-called cash basis accounting, the opposite of accrual accounting, you don't put the sale or the purchase onto your books until the money changes hands. With business-to-business sales, the norm is that the money changes hands later. So accrual accounting is better. It gives your books a more accurate picture of your financial flow and financial position.
Why does this matter here? Because timing of sales, costs, and expenses makes a difference. Start your forecasts correctly so they can be part of a more formal financial forecast when you finally need one.
Timing of Sales
Your sales are supposed to refer to when the ownership changes hands (for products) or when the service is performed (for services). It isn't a sale when it is ordered, or promised, or even when it's contracted. With proper accrual accounting, it is a sale even if it hasn't been paid for. With so-called cash-based accounting, by the way, it isn't a sale until it's paid for. Accrual is better because it gives you a more accurate picture, unless you're very small and do all your business, both buying and selling, with cash only.
I know that seems simple, but it's surprising how many people decide to do something different. And the penalty of doing things differently is that then you don't match the standard, and the bankers, analysts, and investors can't tell what you meant.
Timing of Costs
Costs of sales or direct costs or costs of goods sold are supposed to be timed to match the sale.
For example, when you buy a book from a bookstore, whatever that book cost the store to purchase was an amount added to inventory until you purchased it, and only then, with the purchase, it became an amount added to cost of goods sold.
Notice the timing. It sits in inventory for as long as it takes, but it doesn't get out of inventory and turn into cost of sales until it gets sold.
Messing that up can mess up your financial projections. When sales for the month are $25,000 and cost of goods sold are $10,000, you want the $10,000 to be the costs it took to buy whatever was sold for $25,000. If this month's costs are for things sold last month, or things sold next month, you get bad information.
It's harder to keep track of this sometimes with services. The cost of sales for a taxi ride should be the gas, the maintenance, and the driver's compensation. But accountants would go crazy trying to match the exact gasoline costs to the exact trip, so they estimate a lot. They are always trying to match the months though; costs should be recorded in the same months as the corresponding sales.
Timing of Expenses
Expenses are supposed to show up in the month that they happen. Ideally, travel expenses are attributed to the month you travel, even if you paid the airfare two months earlier. Ideally, advertising expenses are recorded for the month that the ad appears in print, rather than the month when you submitted the ad. And they certainly should not appear in the month in which you pay for the ad, which often is two or three months later. You want the timing to match.
"But I have a new product, how can I forecast for that. There's no history."
Join the club. Lots of people start new businesses, or new groups or divisions or products or territories within existing businesses, and can't turn to existing data to use for forecasting the future.
You're still going to forecast, and don't worry so much about it, because although you'll do it for the next 12 months, you're only going to be grossly inaccurate for the first month. By the second month, you'll have data to use to revise your forecast.
Think of journalists covering a free election. They don't want to wait for the formal official results to be published, so they ask people coming out of polling places how they voted. Maybe those people tell the truth, and maybe not, but there's information to be gathered. They call this exit polls. And if the exit polls surprise people -- they thought Jones was going to win by a landslide but the exit polls indicate Smith is winning -- then the reporters investigate further. Are these early results coming from just one kind of voter (rich, poor, rural, urban, early voter, whatever) and does that one kind of voter favor Smith more than the rest of the voters? Time to apply common sense.
You do the same thing with your forecast that journalists do with elections. You can get what data is available and apply common sense to it, human judgment, and then make your educated guesses. As more information becomes available -- like the first month's sales, for example, then you add that into the mix, and revise or not, depending on how well it matches your expectations.
It's not a one-time forecast that you have to live with as the months go by. It's all part of the plan-as-you-go process.
One of the more powerful drags on business planning in general is what I call fear of forecasting. Lots of people have it.
"How could I possibly know?" is one of the more popular complaints. After all, who can predict the future? How can you know what's going to happen in the market, with the competition, or with new technologies. Isn't it just wasting your time to try to guess?
No, it isn't just wasting your time, because one thing harder to do than forecasting is running a company without a forecast. The real question isn't, How can I possibly know what's going to happen? but, rather, How can I possibly know whether what actually does happen is good or bad or better than expected if I don't know what I thought would happen?
Confusing? Think of it this way: although you forecast for at least a year, you actually go out on a limb only for the next month. In a month, you're going to review that forecast. You're going to see what is different from the forecast, and revise the forecast. Your year doesn't stay static after the first month if results of the first month cast doubt on the whole year.
So don't worry so much; get started with your forecast, and you'll be revising.