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  • BUDGETS AND CASH FLOW? BORING, BUT ESSENTIAL FOR STARTUPS

There are numerous costs to take into consideration prior to establishing a business, and without the appropriate research, many items can be left out inadvertently. Prior to receiving funding for a loan from a bank or investor, it's common for parties that are interested in investing or loaning money to you and your new business to request an itemised list of income and expenses during an initial period.

start-up budget is an itemised list of income and expenses for a new business, which often covers the period up to commencing operations and perhaps a small amount of time after operations have commenced.

The point is, having an educated idea about startup costs can benefit your business more than not having a plan at all, and facing more unforeseen surprises. The key is to look at your business expenses as individual components.

You can calculate starting costs by making three simple lists, a few educated guesses and then adding them all up.

 

List spending on assets. Your business assets are the things you need to use in your business over the long term. For example, if you're starting a brick-and-mortar store, that might include items such as shelves, tables, a cash register and so on. A graphic artist might need specialised printers and a drafting board, among other things.

If you're either making or selling products, think about the inventory you'll need to have at the start. The simplest examples are the books a bookstore needs to stock its shelves, or the raw materials a manufacturer might need to start assembling a product. If you're starting a service business, meaning you don't make or sell products, then don't worry about inventory. You can skip this step.

All of these items make up your starting assets. While you might also think the money you have in the bank is an asset to list here, we're going to save that for another list later on.

For every item on this list, make an educated guess of what the amount of the expense will be. If you can't estimate the price for an item off the top of your head then do some research. For instance, call real estate agents to inquire about rental space and prices. Contact insurance brokers to ask about insurance plans and prices or go direct to get more cost effective options.

List spending on expenses. Not everything you purchase is an asset. You also spend money on expenses. For example, it costs money to set up a legal company and to establish the legal obligations. The money you spend to build your website, the costs of fixing up your office and the salaries you pay employees to help you set up are also examples of expenses.

Now, add up your starting assets and your starting expenses to calculate most of your starting costs.

Determine how much money you'll need to get started. The final piece of the puzzle is knowing how much cash you'll need to have in the bank for the early months while your startup is ramping up and not generating enough sales to cover costs and expenses. This is also known as your “runway”, the amount of time you have before you run out of cash to burn.

There are a number of theories on how to do this. Some people say you need enough to cover six months worth of expenses, others say a year, but essentially you need enough cash to fund operations until the company generates enough cash to fund operations by itself.

A suggestion is to estimate your first 12 months of sales, costs of those sales and expenses. What you should end up with is a list of 12 months with estimated sales, costs and expenses for each month. Subtract the costs and expenses from the sales for each month, and the result should show you whether you're short of cash. You'll be able to tell from that spreadsheet how many months it takes to start breaking even and how much money you're missing. That's essentially what you need to have as starting cash.

The basis of this budget plan is the sales plan so that you can establish a more accurate startup budget. 

Your sales forecast is the backbone of your business plan. People measure a business and its growth by sales, and your sales forecast sets the standard for expenses, profits and growth.

When it comes to forecasting sales, don't fall for the trap that says forecasting takes training, mathematics or advanced degrees. Forecasting is mainly educated guessing. So don't expect to perfect it; just make it reasonable. Business owners are qualified to forecast sales, without needing a business degree or accountant's certification. What you need is common sense, sound research of the factors you have to take into consideration, and motivation to make an educated guess.

Your sales forecast in a business plan should show sales by month for the next 12 months and then by year for the following two to five years. Three years, total, is generally enough for most business plans.

If you have more than one line of sales, show each line of sales separately and add them up. If you have more than ten lines of sales, summarise them and consolidate. Remember, this is business planning, not accounting, so it has to be reasonable, but it doesn't need too much detail. Here are some tips to get you started:

  • Develop a unit sales projection. Where you can, start by forecasting unit sales per month. Not all businesses sell by units, but most do, and it's easier to forecast by breaking things down into their component parts. Product-oriented businesses obviously sell in units, but so do a lot of service businesses. For example, accountants and attorneys sell hours, taxis sell rides, and restaurants sell meals.
  • Use past data if you have it. Whenever you have past sales data, your best forecasting aid is the most recent past. Some statistical analysis techniques take past data and project it forward into the future. You can get just about the same results by projecting your two most recent years of sales by month on a line chart and then visually tracking it forward along the same line. Statistical tools are a nice addition, but they're rarely as valuable in a business plan as common sense, particularly if it's guided by analysis.
  • Use factors for a new product. Having a new product is no excuse for not having a sales forecast. Of course you don't know what's going to happen, but that's no excuse for not drafting a sales projection. Nobody who plans a new product knows the future; you simply make educated guesses. So break it down by finding important decision factors or components of sales. If you have a completely new product with no history, find an existing product to use as a guide. For example, if you have the next great computer game, base your forecast on sales of a similar computer game. If you have a new auto accessory, look at sales of other auto accessories. Analysts projected sales of fax machines before they were released to the market by looking at typewriters and copiers.
  • Break the purchase down into factors. For example, you can forecast sales in a restaurant by looking at a reasonable number of tables occupied at different hours of the day and then multiplying the percent of tables occupied by the average estimated revenue per table. Some people project sales in certain kinds of retail businesses by investigating the average sales per square metre in similar businesses.
  • Be sure to project prices. You've projected unit sales monthly for 12 months and then annually, so you must also project your prices. Think of this as a simple spreadsheet that adds the units of different sales items in one section, and then sets the estimated prices in a second section. A third section then multiplies units times price to calculate sales. The math is simple, the hard part is making that estimated guess of unit sales. A fourth section of your projected prices will set the average costs per unit. You want to set costs because a lot of financial analysis focuses on gross margin, which is sales less cost of sales. For financial reasons, cost of sales, also known as costs of goods sold and direct costs, are different from the other expenses that come out of profits.

The cost of sales isn't what you pay salespeople or for advertising. It's the amount you pay to buy what you sell. This is usually easy to understand. In any retail store, for example, the cost of goods sold is what the store pays for the products it sells. In service businesses, the costs of sales can be less obvious, but it can still be estimated.

Finally, in a fifth and final section, you will multiply unit sales with the average cost per unit to calculate your cost of sales. This gives you a sales forecast that you can use for the rest of your financial projections. The first place you'll use it is at the beginning of your profit and loss statement, which normally starts with sales and cost of sales.

Of course, not all businesses fit easily into the unit sales model. Some business plans will have sales forecasts that project sales only, by line of sales, and then direct costs, by other factors. For example, a taxi business might simply estimate total fares as its sales forecast and fuel, maintenance and other items as its cost of sales. A graphic artist might stick with the simple Rand-value sales forecast and project cost of sales as photocopies, colour proofs, etc. In the end, it's always your plan, so you have to make the decisions that are best for you.

There are plenty of free examples available on the internet, here is but one example: http://www.entrepreneur.com/formnet/form/368

To summarise:
  • Monthly budget is a budget of your projected monthly turnover and expenditure
  • When just starting your business it is difficult to compile exact numbers
  • Do at least an estimated turnover and expenses list
  • As you begin trading, the turnover and expenses can be updated with actuals
  • This is a great learning experience to improve on estimations

If you have done your initial planning well, you would have underestimated income and overestimated expenses!

Understanding cash flow forecasting:
  • Cash flow is indicative of how the money flows through your business
  • Cash flow is not just the money you receive from your clients, it is all the money you have access to, such as:
    • Overdraft
    • Shareholder loans
    • Standard loans
    • Debtors
  • You can prepare a cash flow forecast to ensure you have sufficient funds available

If you planned correctly you would have sufficient funds to meet monthly commitments and put enough aside for unexpected expenses.