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Financial Forecast – Plan for the Future
Custom Accounting Serviceswww.customaccountingweb.com
[email protected] 702 - 4962
Two Basic Ways of Developing Your Cash Management Plan
Using historical data
Developing the numbers one at a time (getting behind the numbers)
Historical Data
Easiest to developHistory is a good prediction of the futureExpenses remain relatively constant
Management not fully aware what makes a business expenseHistory is not always a good predictor of the futureOutside economic forces make past obsoleteLacks accountability
STRENGTHS
WEAKNESSES
Getting Behind the Numbers
More accuratePinpoints accountability
More time consuming to develop
STRENGTHS
WEAKNESSES
Step 1 – Sales Forecast
ALTERNATIVE 1:ALTERNATIVE 1: Take previous year’s dollar volume, add to it the current year’s expected price increases and anticipated volume increases. Referred to as a “reasonable guess”.
Two methods to help predict coming year’s sales:
Example: Previous year’s sales $1,580,000Estimated price increases at 7-1/2% 18,500
1,698,500Volume increases at 10% 169,850Expected sales $1,868,350Use (rounded) $1,870,000
ALTERNATIVE 2: ALTERNATIVE 2: Begin with units of product sold during the year, convert units sold to a dollar value. A more precise method.
Example: Unit Sales This Year* Total Unit**Prior Year Increase Units Price Total
Product A 50,000 10,000 60,000 11.50 $690,000Product B 35,000 17,000 117,000 3.75 438,750
Expected sales $1,868,750Use (rounded) $1,870,000* more reasonable guessing
** include price increases
Step 2 – Monthly Sales:
After determining the dollar amount for your expected sales, project how the sales will be produced month-by-month. This step gives tight financial control. Two possible methods:
ALTERNATIVE 1:ALTERNATIVE 1: Predict each month’s sales and use the result. Simple to use and can be of great value if enough data is gathered to predict with accuracy.
The second method lacks some accuracy, but is simple to use . . .
Month-By-Month Analysis
ALTERNATIVE 2:ALTERNATIVE 2: Assume relationship of each month’s sales to be same as last year. Review prior year’s sales, month-by-month, to determine the relationship of each month’s sales in budget to annual sales.
Example: Prior Year Current YearMonthly % of Projected Projected % ofSales Year’s Total Monthly Year’s
Month $ Total Sales Sales TotalJanuary $100,000 6.9% X $1,870,000 $129,030 6.9%February 100,000 6.9 X 1,870,000 129,030 6.9March 100,000 6.9 X 1,870,000 129,030 6.9April 100,000 6.9 X 1,870,000 129,030 6.9May 150,000 10.3 X 1,870,000 192,610 10.3June 150,000 10.3 X 1,870,000 192,610 10.3July 125,000 8.7 X 1,870,000 162,690 8.7August 100,000 6.9 X 1,870,000 129,030 6.9September 150,000 10.3 X 1,870,000 192,610 10.3October 100,000 6.9 X 1,870,000 129,030 6.9November 125,000 8.7 X 1,870,000 162,690 8.7December 150,000 10.3 X 1,870,000 192,610 10.3TOTAL $1,450,000 100.0% $1,870,000 100.0%
Step 3 – Cost of Goods Sold
Next in your plan, determine how much you will pay for what you sell—cost of goods sold. There are two basic methods, use the one you find simplest.
ALTERNATIVE 1:ALTERNATIVE 1: The Percentage Method.Assuming over the years your business has been operating on a consistent cost of goods sold percentage and you would like to continue that level for the coming year. Simply multiply that percentage by each month’s sales for cost of sales for each month.This may prove the simplest method but you need be sure the historical percentage is accurate.
ALTERNATIVE 2:ALTERNATIVE 2: For a more precise method of determining cost of goods sold budget, begin with the number of units of a product you anticipate selling and price the units to be sold. Do this for each product line of sales.
Example: Units Anticipated Cost ofto be Cost of GoodsSold Each Unit Sold
Product A 50,000 $7.80 $390,000Product B 35,000 12.75 446,250Product C 100,000 1.25 125,000Cost of Goods Sold $961,250
Step 4 – Expenses
A partial list of expense items generally found on financial statements.
AdvertisingAdvertisingAutomobile ExpenseAutomobile ExpenseBad DebtsBad DebtsBusiness PromotionBusiness PromotionCollection CostsCollection CostsContinuing EducationContinuing EducationDepreciationDepreciationDonationsDonationsDues and SubscriptionsDues and SubscriptionsInsurance Insurance –– GeneralGeneralInsurance Insurance –– GroupGroup
Insurance Insurance –– LifeLifeInterest ExpenseInterest ExpenseLegal and AccountingLegal and AccountingOffice Supplies and PostageOffice Supplies and PostageRentRentRepairs and MaintenanceRepairs and MaintenanceSalariesSalariesTaxes and LicensesTaxes and LicensesTelephone and UtilitiesTelephone and UtilitiesTravelTravel
To predict expenses, approach each expense category individually. Depending on the nature of the expense, use either historical Percentage of Sales method described earlier or predict each month’s expense and use the result. Can be of great value if enough data is gathered to predict with accuracy.
Step 4 – Expenses
Advertising: If advertising is not a major expenditure, compute your plan amount by using the prior year’s advertising expense percentage of sales to the current year’s predicted sales. This percentage should be applied to each month. If advertising is a significant expense, consider establishing your financial plan in conjunction with your ad agency .Automobile expense: Estimate a reasonable cost for operating a car during the year and multiply that cost by the number of company cars. This will give you your annual expenditures. o arrive art the monthly expenditure, divide this number by 12.Bad debts: Review historical data to track bad debts as a percentage of sales. Take your historical percentage and apply it to the sales for each month in your financial plan. If you believe the percentage is excessive, a reduced planned percentage may be in order. However, try to berealistic; now may be the time to review credit policies, put some delinquent accounts on a cash-only basis and cut off others completely. Develop a consistent policy and stick to it.Collection costs: Because accounts receivable are getting tougher to collect, you should
consider planning some additional dollars for collections during the year.The best way to determine the amount would be to review what percentage of sales the collection costs have been running historically and apply that percentage to each month’s sales. You may want to plan for additional costs if you plan on taking a hard-line approach to collections.Continuing education: This is an area where few small companies spend significant dollars. To determine your financial plan, review the people in your organization and see which ones might benefit from continuing education. Multiply the number of people by the dollars decided for each. This will be your annual expense. For simplification in applying the dollar amounts to the monthly plans, just divide the total allocation by 12.
Donations: This, too, should be in the financial plan. Decide on your annual amount, stick to it and, if you think you may want to add an extra amount for unanticipated causes, by all means do so, but do it in the beginning of the plan year. For your monthly financial plan, divide by 12 and apply the amount to each month of the plan.Dues and subscriptions: Now is the time to make certain that all those organizations you’ve joined and publications you subscribe to are of benefit to your company. Then, look at the previous year and add for increased costs. If you are anticipating some additional expenditure in this area, you should plan them at this time. Apply 1/12 to each month of the financial plan.Insurance: General insurance is the cost of insuring equipment, liability, etc. Call your insurance agent to find out exactly what you should anticipate in insurance premiums for the year. Use this amount for your plan. Or, if you are consistently paying the same amount from year to year, look at the prior year’s financial statements and use that number plus some percentage increase. To do this for your monthly plan, divide by 12 and apply the amount to each month of the plan.Interest expense: This item depends on what you are going to be borrowing and what the interest rates are going to be in the future. It is best to anticipate high when it comes to interest; therefore, when you review your cash requirements, project high. One-twelfth a month of the total will give you a reasonable financial plan.Legal and accounting: To determine your financial plan for legal and accounting, ask your lawyer and accountant what they anticipate your costs will be during the year. If you feel that their anticipated fees are high, negotiations may be in order.
Office supplies and postage: Sometimes this can be a tough category to anticipate. Go back and look at what the annual percentage has been running for the past few years; apply that percentage on a month-by-month basis to your financial plan. Also consider whether the percentage has been reasonable in the past and whether you feel you may be able to reduce it. Generally, historical percentage is the best method for budgeting this item.Rent: This number is easy. Just use your monthly rent figure for each month of the financial plan. Don’t forget any cost of living increases or property tax and expense escalations.Repairs and maintenance: Review the annual percentage over the past few years and apply that percentage on a month-by-month basis to each month’s sales. Don’t forget to include contracts for preventative maintenance. Now may be the time to consider whether to upgrade and improve equipment that requires constant maintenance.Salaries: This item is not difficult to plan if you prepare for it by thinking through your plansfor each employee for the next 12 months. Literally count the number of employees you anticipate each month. Add up each employee’s anticipated monthly salary and you have your plan for the yearTaxes and licenses: Determine the historical percentage and apply that factor to the current year. Check the appropriate city, state and federal sources for potential increases. Divide by 12 and apply it to each month of the financial plan.Taxes, payroll: This should be planned by taking a percentage – anywhere from 10 to 15 percent – of the gross payroll cost as your monthly financial plan.
Telephone and utilities: Check prior years’ records to get a rough estimate of the percentage of sales. Apply this percentage to each month. Another method is to take the prior year’s dollars, add 10 to 15 percent and divide by 12 to determine each month’s expense.
Travel: Increasing travel costs make it necessary to plan realistically and early. If you anticipate extensive travel, this is the time to sit down and decide what trips will be taken, where you will be traveling and who will be going. Develop a written travel policy. This could save many dollars in travel costs.
If your company’s travel plans are modest, take the total annual dollars and divide by 12 to determine your monthly financial plan. If you project extensive traveling, calculate each month separately by the actual anticipated trips for each given month
BREAK-EVEN ANALYSIS
• Break-even:the process used to determine profitability of various units of sale
• Break-even Point or Break-even Quantity: • The quantity at which revenue from sales equals
total costs
• Total costs equal total fixed costs plus total variable costs
BREAK-EVEN ANALYSIS• Example:
• A bakery that sells cakes has total fixed costs (TFC) of $5000 per month
• Cakes sell for $10 each
• Variable costs are $5 per cake
• Question: How many cakes per month must the bakery sell to break-even? To earn a profit?
• Answer: The bakery must sell 1000 cakes per month to cover its fixed costs. It must sell 1001 to earn a profit.
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