Why you need projections and forecasts!

Sometimes, new business start ups wonder why they need projections and forecasts. After all, they’re only a “guess” aren’t they??

Well, yes, to an extent, they’re a guess, as you never know for certain what your sales and expenses will be. However, they are more than that and vitally important to highlight trends, patterns, “pinch points”, etc.

More importantly, they make the new business owner think about how the financial side of things will work out.

I often think that the process of preparing the forecasts is more important that the end result!

Take, for example, a small cafe. Now, the owner could just make an estimate of their average daily takings, their average costs of food ingredients, estimates of overheads, etc. But none of that is much use if they’ve just plucked figures from thin air.

Our approach would be two pronged.

We’d start by setting up an income spreadsheet based on number of tables/covers, average customer spend, average occupancy rates, etc to “build up” what a typical working day may look like. We could use an “average” day or tweak it for busier/quieter days, etc. That then feeds into what food ingredients and consumables need to be bought to meet those sales. Again, we could use average percentage cost of ingredients, or we could drill down into more detail if there are different margins on different product ranges, i.e. drinks, full meals, breakfast buns, etc. By having that kind of detail, it’s easy to perform “what if” analyses, i.e. what if they sell more breakfast buns and less soups, etc.

Once we’d got some figures for sales and costs of sales, we’d move on to overheads, identify which are fixed (i.e. rent, rates, etc) and which are variable (i.e. staffing, power, etc) and for the variables, whether they’re variable according to level of turnover, level of profit, level of opening hours, etc., etc.

Then, we’d build in the differences between cash flow and profit & loss, i.e. where perhaps same customers have trade accounts and pay monthly in arrears, or some suppliers have credit accounts where the business pays monthly in arrears, which overheads are on fixed monthly standing orders, which are paid monthly according to activity, etc. We’d also build in the effects of VAT, i.e. the quarter payment pattern, the payment pattern of payroll deductions such as income tax, NIC and workplace pensions, annual business tax payments, monthly loan repayments, etc etc. That will show the “pinch points” such as when multiple irregular payments happen at the same time, such as a quarterly rent bill, at the same time as the VAT payment, at the same time as annual tax payments due, etc. It also highlights working capital requirements, such as whether an overdraft is needed, whether the business is likely to be able to finance owner’s drawings, etc.

We’d then end up with an integrated set of balance sheets, profit and loss accounts and cash flow forecasts, all of which change automatically when any variable changes. That’s when the fun begins, i.e. you can see the impact on cash flow on, say, a 5% increase in selling prices, or a 5% increase in raw material or power costs, or a change in the breakdown of sales between hot or cold foods, or effects on increasing occupancy rates.

Forecasts also show whether the business is even viable, i.e. whether the small cafe has enough tables to make a profit given the overheads it will have to pay, or whether it can pay enough staff hours wages to cover the opening hours.

The same principle can be applied to all different types of businesses. One type of business that we find particularly interesting are car dealerships where you have the workshop time and parts linked to numbers of new and used car sales not only as at date of sale, but also at servicing intervals, so the sale of an extra new car will filter through to workshop time and parts sales right throughout the warranty period (with dealer estimates of how many car owners come back and how many don’t) and even into the post warranty period when, obviously, smaller numbers of owners continue coming back for each service. By using the dealerships own data (and other data often provided by the manufacturer) the forecasts can be really quite accurate.

It goes without saying that factors outside the businesses’ control may have a massive impact, but that doesn’t mean that forecasts and projections aren’t useful, especially as they often “force” the business owner to really think about how the financials are going to work, and with a bit of “tweaking” the forecasts can show the impacts of, say, higher inflation or higher interest rates, increasing or reducing demand, etc.