Cash is King

The financial picture

All too often, financial forecasts in a business plan appear in the shape of a well-crafted profit & loss account in the expectation that this is sufficient. It most certainly is not.

Anyone who has run a business with any degree of success will understand that a profit & loss account is an accountant’s guide to how the business is doing. CASH IS KING, and if you don’t understand the difference between cash accounting and profit & loss accounting it is high time that you learned.

It can be summed up in one word: 'timing', a crucial word for the survival of every business. Therefore, creating spreadsheets, ideally simple ones that show the difference between cashflow and profit & loss is crucial to an understanding of the business and its capacity to grow without external finance. For the first year of a start-up, the business plan needs to include a monthly cashflow forecast.

What matters in the profit & loss account? Well, first of all, revenue. The majority of business plans have a very flaky approach to revenue forecasting. You need to make it more of a science and less of an art. Can we have a look at the sales pipeline to justify the forecast? Can we see the research that gives new product / service sales forecasts credibility? If what you are doing is new, can you demonstrate likely sales growth by analogy with another existing product/service?

Next, gross margins. Do you really understand the difference between gross margins and net margins and why it matters? Are you aware of the different drivers of businesses with low gross margins and high gross margins? Fixed costs do not grow in straight lines; they go up in steps, and it is important for you to understand the timing of those steps.

Be sensible about how big the financial spreadsheets become. Software tools have enabled us all to create massive quantities of data without any control over quality. Keep the business plan to the essentials, and avoid excessive detail.

Monthly figures for the coming year and quarterly figures for the following two years will be sufficient. In addition, some degree of sensitivity analysis will show you what really matters in your business (which will almost certainly be different from those in other businesses). A small drop in sales in a high margin business can be critical whereas a small drop in gross margins can be fatal to a low margin business.

While you are thinking about timing, use a simple software tool to create a balance sheet forecast that tells you something about the way the business can best be financed. Can you afford to borrow heavily and build the business with the support of the bank, factoring etc or do you need the business to be better capitalised? There are several software tools now available that make it impossible to create cash flow, profit & loss and balance sheet forecasts that are out of step with each other. Make use of them.

But it’s not the numbers themselves that matter

Don’t focus just on the numbers themselves but on the assumptions that lie behind them. Document those assumptions, test them thoroughly and ensure that your whole team has bought into them. Business plans (of which there are far too many), which have reams of meaningless spreadsheets without adequate explanation, are of little value.

If you find that there is a need for external funding, show that you understand how much is needed, in what form (eg debt or equity) is most appropriate for the business, and what it will be spent on. Then let the reader know how much money they might be able to get back, when and how. If you think it is hard to master the basic economics and accounts of a business, think again and take yourself on an appropriate course. It could save you a huge amount of time and expense, and ultimately possibly your business.