Effective budgeting and forecasting are essential to the success of your business start up. You’ll need to know how to produce key financial records and statements in order to gain initial investment for your venture, this can be difficult without any historical data.
Why are Financial Records Important?
Financial budgets and forecasts are techniques used to aid the decision-making process and are a crucial part of your business plan. They provide you with evidence to prove to potential investors that your business will be profitable in the future. Budgeting and forecasting ensures that you are on track when making important financial decisions for your business, and helps you to avoid over spending.
A financial budget uses estimate figures to predict where a company wants to be financially by a certain date. It uses estimated revenues and expenses to create a baseline to compare actual results to in the future. For this reason, a financial budget can be used a performance measure.
A financial forecast is a more definite projection of what a business will have achieved by a specific point. Rather than a statement of where a business wants to be, it provides a clear prediction of where a business will be, financially. Forecasts estimate future financial outcomes by using historical data and are used to determine how future budgets are allocated within the business.
Gathering Financial Information
It can be difficult to create financial documents without having any historical data to use as a baseline. Despite this, creating records and statements is crucial if you are to gain investment for your business.
There are many ways that you can gain the information needed to make financial predictions without having any historical data. Previous experience in the industry in which you are launching your new venture is useful. You will more than likely have a good understanding of sales figures, customer numbers and pricing strategies that you can use as guidelines.
If you have no experience you can seek advice from industry professionals. Accountants that specialise in small businesses or those within your industry can provide more reliable financial predictions. Researching other businesses that are similar to yours and using the market research that you have previously collected for your business plan will also provide helpful financial information.
Cash Flow Forecast
Creating your cash flow forecast is difficult as a start up business as you’ll need to do a lot of estimating. A good way of tackling it is to underestimate your income and overestimate your expenses. This helps you to plan for the worst case scenario.
Your cash flow forecast will show lenders and investors how much capital that you expect make and, how much you’ll spend. It also proves to them that you can stick to a budget without over spending.
A cash flow forecast will include the bills that your business incurs including utilities and rent, and how much money you will need to pay this while your business is just starting out. Typically the forecast should project your income and expenses for 3 years. This proves to your lender or investor that you can continue to survive. For the first year, you should show a monthly breakdown of your incoming and outgoing finances, this should change to quarterly figures for years 2 and 3.
Your break-even analysis follows on from your cash flow forecast and is the point at which your profits are equal to your costs, anything above the break-even point is profit. The break-even analysis lets your investors know when you predict that you will break even, giving them an estimation of when they will start to see a return on their investment.
As well as the initial start up break-even analysis, this model can be used to work out the profitability of new products, differing sales volumes and changes to prices.
Your balance sheet shows what you own, what you owe and the value of your overall investment in the business. It shows a ‘snapshot’ of a companies financial position at a particular point in time, this could be a particular month, during start up or when the business ceases trading.
A balance sheet consists of 3 components:
- Assets – things that the company owns
- Liabilities – things that the company owes
- Owners’/Stockholders Equity
It is shown in two columns, assets to the left and liabilities and owners’ equity on the right. The total assets must equal the total liabilities plus the owners’ equity for it to balance.
Profit and Loss Account
After completing your cash flow forecast, you should be able to draw up a profit and loss account. Free Agent refer to the profit and loss account as an “accounting term for the story of your business’s trading during a given period”. It shows the businesses incomes minus the expenses to work out the profit for the year.
Financial and Legal Responsibilities
Businesses and their directors have legal and financial responsibilities and liabilities. In Element 4, we discussed choosing the right legal structure for your business, this will affect the legal and financial responsibilities that you as a company director will have.
Company directors are morally and legally required to carry out a number of obligations. These obligations differ depending on the legal structure of the company. In a partnership, one director cannot make decisions without consulting the others, whereas, in a sole trader business, one director holds the power.
Directors do not automatically have executive powers within a business, however, most are employed by the company and will have specific powers delegated to them. The powers assigned to directors will depend on their role within the business. The managing director of a company will make day to day decision whereas area specific directors (sales, marketing, finance etc.) will only have powers to make decisions within their departments.
No matter what their role, all directors have a duty to the company that they work for.
Companies Act 2006 lists the 7 general duties of a director:
- Act within powers
- Promote company’s success
- Exercise independent judgement
- Exercise reasonable care, skill and diligence
- Avoid conflicts of interest
- Accept no benefits from third parties
- Declare any interest in a proposed transaction or arrangement
The proceeds from any business activity will attract tax. No matter which industry your business operates in, what your product is or how many people that you employ, you will pay some kind of tax.
Similarly to legislations and regulations, the tax that you pay is dependent on the type of legal structure within your business, however, the 5 most common types of tax are:
- Income tax – tax paid on profits, salary and dividends
- National Insurance – tax paid by workers and employers towards the cost of certain state benefits
- Corporation tax – tax paid by limited companies on profits from doing business
- VAT – Value added tax, paid if a company’s taxable supplies are greater than £83,000 in a 12-month period. The standard VAT rate is 20%
- Business rates – paid by all businesses with a premise, similar to council tax
Depending on where you operate, your business may also be liable to pay federal, state or local taxes.
If anything about your business changes, this could affect the taxes or amount of tax that you pay. If you change premises, buy new property or employ more staff, you’ll need to notify HMRC.
Preparing Financial Documents to Inform the Business Plan
Financial documents should be the last part of your business plan that you write. The more time that you spend researching your start up business, building and defining your idea and, planning your marketing and operations, the more you will learn. Use this knowledge to make the most informed and realistic financial predictions for your start up.
When preparing your sales forecast, another name for cash flow forecast, there are 2 approaches that can be used.
- Minimal investment
- Fast business cycle to quickly grow sales and profits
- Minimal cash investment
- More risk of short-term financial problems
- Plenty of cash in the bank and stock in the warehouse
- Payables all up to date
- Less risk of short-term cash shortages
- Long term profitability could be effective
Using elements from both the aggressive and conservative approach to sales forecasting creates a well-balanced forecast. Use conservative elements for making key management decisions and more aggressive elements to stay focused.
It is important not to be too optimistic with your forecasting, over anticipating can lead to debt and you risk letting your expenses get too high. Combining this with elements of an aggressive approach ensures that you stay motivated to achieve your goals.
Start Up Budget
A start up budget is the initial financial plan used by a business to gain the essential funding needed to commence trading. It must include all essential items needed for the business to be able to function including any machinery and labour. The start up budget should also provide the business with an action plan for allocating its resources and ensuring that goals are met.
In Element 4 you should have identified the initial costs associated with setting up your business. The costs that you identified should now be refined using further research and any additional costs should be accounted for. You should now have predicted yet accurate start up costs that can be used within your business plan.
Potential Sources of Finance
Before you can start your business, you’ll need a way of financing it. There are many methods available, research each method to find one that is most suitable for your business’ needs.
It’s important to be realistic about your options when it comes to funding your start up. Since the economic downturn in 2008, banks have become less likely to loan money to new businesses. Dr Stuart Fraser of Warwick Business School stated in his report for the Department for Business innovation and Skills that there is a “higher likelihood of loan rejection due to a lack of collateral”.
Finance falls into two categories; equity finance and debt finance.
Equity finance: raising capital through the sale of shares
Debt finance: borrowing money without giving up any ownership
If you choose to fund your company using equity financing, you are choosing to give away part of the ownership. Using this method of finance lets you set up your business without the need for big loans and the burden of having a debt to repay. There are however negative points to consider. As an investor owns a part of your company, they will expect a share of your profits and will also want to ensure that you are acting in their best interests which can lengthen and complicate the decision-making process.
There are several types of equity financing available to you including;
- Own Money – You’ll find it difficult to raise any money for your start up if you don’t invest some of your own. Investing in your own business shows that you are confident in your idea and encourages others to follow
- Friends and Family – Friends and family are likely to be supporting of your venture and are therefore more likely to invest their money into your business
- Angel Investors – Wealth individuals or groups who have an interest in supporting new start up businesses and want to make a high return on their investments
- Venture Capital – A firm that invests money from investment companies, pension funds, large businesses and wealthy individuals into high-risk, high-return start up businesses
If you do not want to give up any ownership of your company, debt financing is the option for you. With this form of financing, you keep all of the profits that you make and you do not have to answer to anybody else when making decisions for the business. Large loan repayments, however, can be hard to keep on top of and for some new businesses, you may be required to pledge any personal assets before your loan application is accepted.
There are different types of debt finance that may suit your company:
- Trade Credit – Negotiating ‘buy now pay later’ deals with suppliers
- Term Loans – The most well-known type of debt financing however they can be difficult for start up’s to attain due to the lack of collateral and credit history
- Family and Friend Loans – Loans from family and friends often have the most flexible, affordable repayments methods and don’t require you to give up any ownership of the business
- Overdraft – An amount is decided between you and the bank, allowing you to withdraw up to that limit even if you have insufficient funds. Overdrafts notoriously have high-interest rates.
Before choosing a finance method, first list the pro’s and cons of equity and debt finance. After deciding which route best suits your needs, research each method of payment in detail.
The operating budget is the projection of estimated income and expenses, based on sales revenue forecasts, over a given period. It is common for a business to have multiple operating budgets for different areas of the business such as sales, production and manufacturing.
In order to draw up your operating budget, you need to know the daily costs associated with running your business. Operating costs can include:
- Office supplies
- Utility expenses
- Salaries and wages
- Travel expenses
- Accounting and legal fees
Your start up’s operating budget can include both fixed and variable costs. Fixed costs include rent and do not change depending on a company’s levels of production. Variable costs fluctuate and vary with a business’s output. Variable costs are often associated with one particular project and include direct marketing and labour costs.
Maintaining Accounting Records
As well as being a legal requirement, good record keeping is an important and valuable part of running a business. Having a record of past finances allows you to make informed decisions based on real life data in the future. You can also compare specific periods of time to see how your business has been performing. Without records, you’d have no way of measuring your performance.
Good record keeping can get you out of any sticky situations that you may find yourself in. If a customer or supplier has an issue with an invoice, you’ll be able to quickly find the original to settle the dispute. Paying your taxes can be a complicated task, make life easier for yourself with organised paperwork. Ensuring that your records are orderly and up-to-date reduces the stress when it comes to paying your business taxes.
Hiring accountants is a necessary yet costly process. Keeping up to date with your own accounting records saves your external accountants time, saving you money on their expensive fees.
You’re now equipped with the knowledge that you need to plan the budget for your start up business. You should be able to produce crucial financial documents including cash flow forecasts and balance sheets and should understand the importance of these records to gain investment.
There’s now only one stage left to starting up your own business! In Element 6 we focus on creating your business plan and pitch. This is needed to attract investment before you launch your new venture.
If you’re still in need of some help with starting your own business, our ABE Level 3 Certificate in Business Start Up is the answer. For a comprehensive guide to starting your own business venture enrol today or, contact one of our advisors for more information.