I cannot forecast what I don’t know (Finance, Part 2/5)
The saying goes, “if you don’t have a plan, you are planning to fail”. In the first part of this series, the reason for having a plan, or a forecast, was touched upon. Without a plan you have nothing to compare what you thought would happen, against what happened. Many small businesses do not track the variances between the plan (as they don’t really have one) and what in fact is occurring as they go along. So, at the end of a year, assuming they don’t run out of cash in the meanwhile, their accountant simply reconciles the income against the out goings and works out how much tax is to be paid. The accountant might casually make some observations, “Oh, you spent a lot on entertaining”, or “you have not made much profit on XYZ this year”. If this is the case, you are missing an opportunity to reconcile as you go along and to make adjustments, so you are continuously improving which will avoid any nasty surprises at the end of the year. So how do you go about drawing up a plan?
Step 1. Gather information.
There are somethings which you can work out accurately, for example the insurance costs, software applications and so on. As a business develops the fixed costs will get larger e.g. there may be premises, equipment, loan repayments and so on. Generally, on the cost side, the fixed costs of running the business, i.e. the cost you would incur if it had no work, can be calculated fairly easily. These costs must be covered by the activities of the business.
As a business grows, there will be information on the previous year’s sales and cost of delivery. The forecast can be based upon these. By building on what you know and making so educated assumptions the income and cost of activities can be derived.
Step 2. Making assumptions.
Some assumptions are based upon research and others on experience. Each year it is worth stepping back and reviewing the environment you are operating in. Are there new technologies, new competitors in the market, how is your customers doing or changes to legislation which will impact upon your forecast? Retailers are having to consider the impact of online sales on their activities. Some changes present a threat, others an opportunity. Be aware of what is going on and factor in as much as you can. Record your assumptions, as if they prove to be wrong you can always make an adjustment to the forecast and then take appropriate action to avoid an issue or take advantage of a situation. Be realistic with your forecast. Most businesses have a seasonal factor, so factor it in.
Step 3. Review and update.
So, you now have a plan. Break it down into manageable bits. The manageable bits can become targets for the staff and can be used to incentivise them if you want. Keep the plan under review. The review process allows you to predict what is going with better accuracy and opens up the discussion on what should be done. It can also be used to carry out “what if” scenarios e.g. If we secure that order, will we have enough cash to buy the materials to deliver it? The forecast is a just that, it’s no more than an educated guess. But if you don’t make some assumptions and plan, you have nothing to monitor against and you run the risk of some nasty surprises along the way.
If you need to reset how you monitor your business performance, get in touch with me, for a no obligation discussion on creating a plan. http://ow.ly/SyPn30j0MUY
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