If you open a business or if you want to develop the company's activity, you need to pay attention to the investment that this entails: from options to costs to be covered in the future, related to the investment.
If you are at the beginning of your journey and have chosen to develop your business or want to estimate how your business could evolve during the following years, you will need to draw up a financial forecast, which must include an income and expenditure budget and a cash flow report.
Income and expenditure budget versus cash flow
Here are the differences between them:
Income and expenditure budget
it is drawn up on the basis of the estimated income from the current activity (sales, services) and the expenses generated by its operation.
The income is recorded in the accounting records when a product is sold and an invoice is issued, even if this income will be collected in the future (for example: today I sold 1 ton of flour and I offered an invoice payment term of 30 days ). Therefore, the income is not collected when the invoice is issued. Simultaneously with the income, the related expense is also recorded (that is, the release from inventory of the quantity of goods that was sold).
The cash flow of the company
It refers to the actual amounts that are collected (related to the invoiced revenues), and the amounts that must be paid (related to the registered expenses) respectively.
What must be taken into account is that although at the end of the period under review the company may be making a profit, it may happen that along the way the expenses exceed the income and the company may not be able to honor the payments on time.
How financial projections help
Financial projections have the role of highlighting the peak periods (of collections, but especially of payments), so that you can decide when and especially if it is necessary to turn to funding. For a clearer picture, you can find below a generic model for documenting a monthly cash flow.
Cashflow record table
Download the document and add your own financial data
A sale ends when the money is collected, not when the invoice is issued.
Cash flow = proceeds - payments
Let's start from the equation above.
Since the most common source of funding to ensure liquidities during the peak periods is bank loans, a different approach is necessary from the perspective of the requested funding, respectively:
short-term working capital funding to support the current business
medium or long term investment funding.
We will briefly explore both.
Financial forecasts in terms of the working capital funding
Regardless of the form of such funding (credit lines, working capital, factoring), it is recommended for you to be able to answer the following questions to the point:
Is the requested amount justified for the company's funding needs?
Will the new funding generate sufficient revenue and cash flows to ensure the company's ability to repay the credit facility?
Are sales margins high enough to cover the funding costs?
Financial forecasts in terms of investment funding
A funding of an investment project is expected to result in an increase in income, and in an improvement in the operating profit respectively (the profit obtained directly from the activity carried out, before deducting the financial expenses, budget taxes and expenses with the gradual recovery of the value of the company's assets, also called depreciation).
You have to consider the type of your investment and implicitly its influence on the subsequent activity of the company, which is why we distinguish between several types of development:
replacement investments, with the main purpose of maintaining profitability, with a lower risk or
expansion investments, the main purpose of which is to increase the turnover, with a higher risk
How do you make future projections when you want to make an expansion investment (purchase of machinery, cars, expansion of the production space, etc.) which has an impact on the increase in the production/delivery capacity and, implicitly, on the sales?
Main topics to consider:
How much will sales increase after the implementation of the new investment?
What expenses will the new investment bring about? Will the profit earned from the development of the activity cover at least the funding cost (interest and bank loans)?
It is also very important to correlate the service life of the equipment with the repayment period of the funding source (loan), so that the repayment source is generated by the object of the loan itself.
It is not (economically) efficient to resort to a short-term loan for funding an immovable asset (e.g.: real estate property, equipment, car, which are used for the business), because such a measure will result in an imbalance on short term.
The new investment will also entail various costs (some of which quite major), such as:
increase in the number of employees who will use/manage the respective goods;
increase in the amount of raw material purchased, increase in operating expenses (utilities, rent);
For example, if you have a transport company and purchase 2 new trucks, you will need to:
employ at least 4 drivers (who work in shifts);
purchase fuel for the new vehicles;
pay road taxes, road tolls, insurance, new taxes, spare parts, etc.;
If the profit earned with these vehicle exceeds the interest paid to the bank, then it is a profitable investment.
Therefore, the financial projections take into account:
the revenues earned in the following period and the identification of ways to increase them;
forecasting the expenditure of the following period and trying to optimize them by making the activity more efficient;
establishing the profit that must register an increase after the implementation of the investment project.