Financial forecasts are, quite simply, your forecast of how your business will perform financially over, say, the year ahead. Preparing forecasts will help you to assess your likely sales income, costs, external financing needs and profitability. Financial forecasts are essential if you need to raise money from a third party, such as a bank. But they also provide you with the means to monitor performance on, say, a monthly basis and thereby exercise effective financial control - arguably the second most important management function in running a business. Objectives
The aim of this section is to help you to prepare financial forecasts. It will enable you to: •
Understand costing and pricing;
Use break-even analysis as a way of setting sales targets; •
Understand financial forecasting; and,
Assess working capital requirements.
The purpose of these assignments is to ensure that you are able to prepare the necessary financial forecasts for your business. Satisfactory completion of the set of assignments will demonstrate that you know and understand how to: •
Identify and calculate the financial outlines it will be necessary to prepare. •
Calculate your own personal survival budget.
Determine the funding/materials requirements of starting in business. •
Consider how you will take and keep effective financial control of the business. •
Consider and plan to deal with alternative scenarios.
1. Personal budget
How much money do you need for yourself. Think about food, clothes, holidays, personal travel, etc. Draw up a personal budget. Don’t skimp. You may be in business to have fun – but you need to make money as well. Use this budget in calculating your costs and prices. Of course you may not have enough sales at the start to be able to take that amount of money, so you should also calculate the minimum requirement that you must take from the business.
2. Costing and pricing
Calculate all your costs and determine a suitable price for your product or service. Think about your raw material requirements as part of your direct costs; think about your likely overhead costs.
Now that you have calculated all your costs and set a price, you should be in a position to prepare a break-even chart. Is your forecast of sales above or below break-even? Do you have a reasonable margin of safety? How much profit will you make if you achieve your sales forecast?
4. Forecasting profit and loss
You should have all the figures that you need to prepare a forecast of profit and loss. What is your anticipated gross profit margin? What is your operating profit? How much money will be retained in the business?
5. Cash flow forecasting
You should have all the figures that you need to prepare a cash flow forecast. Remember to think about everything shown on the profit and loss account, expenditure items not shown on the profit and loss and, in particular, to think about timing or receipts and payments. You will also need to think carefully about your stock holding requirements and your capital expenditure. The first time you prepare the cash flow, ignore any investment or borrowing other than that required for capital equipment. The worst cumulative deficit will indicate the minimum level of working capital required.
6. Forecasting your balance sheet
Once you have completed the profit and loss and cash flow forecasts, you should be able to prepare a balance sheet forecast. What level of working capital requirement is suggested by the balance sheet? 7. Sensitivity analysis
Have another look at your profit and loss and cash flow forecasts. What happens if sales are 15% less than you have forecast? Do you still make a profit? What happens if raw material prices go up by 25%? What does this do to your profitability? Can you pass on such increases to your customers or will they switch suppliers?
8. Effective financial control
You should now be in a...
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