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Planning for The Future

J. Tol Broome Jr. -- Gifts and Dec, 5/1/2001 12:00:00 AM

For many gift retailers, the process of financial planning doesn't extend beyond meeting the next week's payroll. Often there are so many financial fires to put out in a given week that one just can't find the time to do any long-term planning. But, by failing to plan financially, you may be unknowingly planning to fail.

Business budgeting is one of the most powerful financial tools available to small business owners. The most effective financial budgets include both a short-range, month-to-month plan that extends for at least a calendar year, and a quarter-to-quarter long-range budget that covers at least three years. It's true that no one can predict the future, and no financial plan ever turns out right on the money. However, a good budget can allow you to plan ahead for capital expenditures, revenue growth, increased supplier prices, economic changes, and other contingencies.

Why Budget?

The primary reason to create a budget is to gain financial control, which will enable you to better accomplish both day-to-day financial objectives and important big-picture goals. You'll be able to:

Manage your business proactively.
Share your budget with your banker, and thus get loans more easily.
Provide financial planning information for investors.
Maintain working capital needs more efficiently.
Set sales goals.
Price your goods and services more effectively.
Perform tax planning.
Plan ahead for employee benefits.

When Do You Budget?

Your short-range budget should cover a fiscal year that coincides with the year-end you use for your financial statement reporting. This part of the budget should be prepared during the two months preceding the fiscal year-end, so that you will have ample time to gather information.

Your long-range plan should cover a period of at least three years on a quarterly basis, or even on an annual basis. The long-term part of the budget should be updated each year when you prepare the short-range plan.

While some owners prefer to leave the one-year budget unchanged during the year for which it provides projections, many owners adjust the budget over the course of the year, so that it takes into account financial occurrences like unplanned inventory purchases or unexpected upward sales trends. Using the budget as an ongoing planning tool during the year is certainly recommended. However, a word to the wise: Financial planning is vital, but it is important to avoid getting so caught up in the budget process that you forget to keep doing business.

What Do You Budget?

It is important to include both an income statement and a balance sheet in your budget. This will enable you to consider potential cash flow needs for your entire operation, instead of just needs that pertain to income and expense items. For instance, if you are adding four new lines, you'll need to consider the impact of these inventory purchases on your cash flow.

Your financial plan should include the following:

An income statement, detailing sales, the cost of goods sold, gross profit, operating expenses, operating profit, other income, other expenses, income taxes, net income before taxes, and net income after taxes
A balance sheet, detailing cash holdings, accounts receivable, inventory, real estate and other fixed assets, total assets, short-term notes payable, current maturities on long-term debts, accounts payable, accrued expenses, taxes payable, deferred taxes, long-term debt, and total liabilities
A rundown of cash flow, detailing net income after taxes, depreciation and amortization, increase or decrease in accounts receivable, increase or decrease in inventory, increase or decrease in accounts payable, loan proceeds, total cash available, owner's draw, capital expenditures, total disbursements, and cumulative cash flow

While this may seem like a lot of information to compile and forecast, the procedure is not as cumbersome as it appears.

How Do You Budget?

Once you have your accountant-prepared financial statement in hand, the battle is half over. You will also need historical monthly financial statements, which can be prepared by either you or your accountant.

Next, you'll need a personal computer with spreadsheet capability. If you are reasonably proficient with computers, you can build your own budget spreadsheets with software programs such as Lotus or Microsoft Excel. Another option is to purchase a budget software package like Quicken.

The first step is to set up a plan for the following year on a month-to-month basis. Starting with the first month, establish specific budgeted dollar levels for each category of the budget. Break each category into subcategories. For instance, for sales, budget each line you sell separately. Do the same breakdown for cost of goods sold. For operating expenses, consider line items such as advertising, auto expenses, depreciation, insurance, etc.

On the balance sheet, break down inventory according to type. Consider each item of your fixed assets and then break the assets out into real estate, equipment, investments, etc. On the liability side, break down each bank loan separately.

Do this for each of the first 12 months. Then prepare the quarter-to-quarter budgets for years two and three. When preparing the first year's budget, you will want to consider seasonal factors. For most gift and decorative accessories businesses, the months October through December produce far more revenue than other months, and this results in wide-ranging changes in cash flow needs. For this reason, you should factor seasonality into the budget instead of taking your projected sales level for the year and dividing by 12.

Prepare the income statement budget first, then the balance sheet budget, then the cash flow budget. You will need to know the net income figure before you can prepare a pro forma balance sheet, because the profit number must be plugged into the retained earnings. And you will need both income statement numbers and balance sheet numbers for the cash flow projection.

When preparing the pro formas, use your historical performance as the starting point for your predictions. Look at your operation's numbers for the previous three years. For example, if your sales have grown an average of 10 percent over the past three years, you should start with a projected revenue growth for the next year of 10 percent. But you will have to factor in other considerations, such as:

Expense-cutting plans
Store renovation costs
Price increases
Competitive factors
Changes in supplier prices
Changes in tax rates
Changes in lease expenses

Sensitivity Analysis

Another nice benefit of creating a financial plan is that it allows you to perform sensitivity analysis. Once you have a plan in place, you can make adjustments to it to account for the potential effects of certain variables on your operation. All you have to do is plug in the changes and see how they affect your store's financial performance.

Here's how it works. Let's say you've budgeted a 10 percent sales growth level for the coming year. You can easily adjust the sales growth number to 5 percent or 15 percent to see how it will affect the performance of your business. You can undertake sensitivity analysis for any of the financial variables, such as cost of goods sold, operating expenses, or accounts payable or receivable on hand.

It's a good idea for your accountant to be involved in the financial planning process, whether that means drawing up the plan or simply acting as an advisor. His input will provide an independent review of your short-term and long-term budgets.

While financial planning takes a considerable amount of time and effort, the benefits will far outweigh the sacrifices. A well designed budget will have a positive impact on the financial performance of your business.

J. Tol Broome Jr. is a regional loan administrator for BB&T bank in Winston-Salem, North Carolina. His freelance writing credits include Start Your Own Business, an Entrepreneur Magazine publication.

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Planning for The Future

May 1, 2001

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