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Finance is a complex subject to navigate for small business owners. Managing cash fluctuations day-to-day, paying suppliers on time and chasing receivables can be a full-time job in itself. It's a challenge to find the time to plan your future finances, but it's even more challenging to grow consistently and profitably without careful financial planning and managing your cash flow.
That's why so many large enterprises have dedicated financial planning and analysis teams. FP&A teams spend their time forecasting, budgeting and analysing their company's finances to support the decisions that their Financial Directors take in order to achieve their company goals.
A small business doesn't necessarily have the luxury of having its own FP&A team with the owner wearing many different hats, so we're here to help. Here's an overview of what basic financial planning is and how you can implement processes in your business to make your life easier and take your business to the next level.
In short, financial planning boils down to two questions - where are you going to spend your money and where will you get that money from? In order to know where you're going to spend your money, you need to have an aim for where you want your business to be.
And in order to know where you're going to get the money from, you need to know how much you'll need, when you'll need it and how much you can afford to pay for access to the cash.
Below are a series of steps that may help you in your financial planning process. We'll use an ecommerce business called Uncle Tom's Umbrellas Ltd to put some of the steps into practical examples.
The first step in any financial planning is setting a target to aim for. Financial planning goals can be anything from breaking even to successfully selling your business to reaching an annual revenue target to hiring a certain number of people. Whatever the goal, you'll need to ensure it's SMART – that is, Specific, Measurable, Attainable, Relevant and Time-based. For financial planning, given the difficulties in predicting the future, it's good to have a finance-specific goal in the medium term (1-5 years). Beyond that, it's challenging to create definitive financial plans because of the potential for unexpected changes.
Uncle Tom would like to sell his business for £100m in 10 years but is currently selling £120k of umbrellas a year and making £12k of net profit each year, a net profit margin of 10%.
Selling his business for £100m isn't very attainable at the moment, so instead, Uncle Tom has decided to set a realistic target to increase sales from £120k/year to £1.2m a year in the next 2 years.
He'd also like his business to be more profitable, so he would like to increase his net profit margins from 10% to 20%.
Financial planning, by its very nature, is forward-looking. But in order to plan for the future, you need to know what you've got today – you'll need to assess and understand your current financial operations. To do so, it's essential to have good financial data available to you. Ideally, you'd like to understand your financial position across your 3 financial statements:
(a) Your profit & loss – this will help you understand your business's profitability. It should help uncover how you can manage costs, how sales and profitability are interlinked, gross margins, net margins etc.
(b) Your cash flow – this shows the reality of cash movements. You may sell lots of goods in December, but if you bought those goods 2 months ago and they're sold on 30-day invoicing terms, you may not receive the cash until January. Understanding the interaction between your operational transactions and the actual cash flows is key to understanding your business.
(c) Your balance sheet – the balance sheet provides a screenshot of your business at a moment in time. How much cash there is in the business, how much you owe, how much others owe and what assets it owns.
Uncle Tom has done some analysis of his business by pulling all his sales data together from his website, Amazon and eBay. He's also run some reports on his payments from his bank account, card, and payment providers and found some interesting things.
He buys and pays for his umbrellas in July but doesn't start selling until October when the rain comes, so he always faces a cash shortfall for a few months when he goes into his expensive overdraft.
He also isn't able to access money from his sales for a few weeks because it gets tied up in his merchant accounts. He never has much cash in his account and often has to wait for the money to come in to pay bills, so he can't invest in marketing as much as he'd like.
He's currently buying each umbrella for £5 from his supplier, which feels too expensive. He wonders if he'd be able to reduce his buying price by placing bigger orders but has no way of placing bigger orders right now because of his cash constraints.
Once you've worked out where you want to be and where you are, you can begin adding in the bare bones of what you'll need to get there. It's best to start breaking down your business goals into smaller, manageable chunks. Going from £10k of sales to £20k a month is much easier to plan for than going from £10k to £100k.
Break down big financial numbers into more manageable figures – what would your business need to look like to sell for £10m in 2 years time? You might find that a £10m valuation of an ecommerce business would need £10m in annual sales or £2m in net profit. Breaking that down into monthly figures will then allow you to establish the operational infrastructure you'd need in place in order to service such levels.
This is where we're adding financial meat to the business plan bones so you can bring your business goals to life.
Remember to factor in things like seasonality of costs and sales. It's highly unlikely that costs and revenues will come simultaneously or that revenues will fall evenly through the year. Think about when you'll be receiving cash and when you'll need to spend it. Most businesses usually have to spend cash before they receive it, so they have lots of money tied up in the business – this is called working capital.
Most importantly, remember to build in some contingency cash too. Managing cash flow is one of any business's biggest challenges, and we can never predict the future. Supplies may be delayed, or customers may pay late. It's always sensible to factor in a buffer in case something unexpected arises.
Uncle Tom decides he can take out a card which will give him 45 days of credit terms on his day-to-day spending. That will allow him to manage his monthly cash flows much better by paying off one single bill at the end of the month instead of daily outflows. It'll also free up some cash to increase his marketing spend by 20%, which should also lead to a 20% increase in sales.
Uncle Tom's current warehouse is working to capacity, so he realises he'll need a bigger warehouse which will cost more in rent and in staff costs. At the same time, he'll be able to order more umbrellas and bring down his purchase price from £5/umbrella to £3/umbrella. Given his sales price is £10, that would improve his gross margin from 50% to 70%.
Once he's worked out the costs for his infrastructure, his umbrellas and marketing, he'll be able to plot a path towards his goal of £1.2m of sales in the next 2 years whilst also working out where his funding shortfalls may be. He might need to put some of his own money in or take out a loan. It's also possible that the increased sales at a higher margin will improve his cash flow, so he won't need any more money.
You have a plan. Now it's time to put the wheels in motion. However, as with any plan, things will almost certainly never go exactly as you expect. Whether it's covid, a financial downturn, a storm delaying a shipment or a fire at a warehouse – you'll face many bumps in the road. It's essential to keep your plan alive. Keep reviewing it, keep updating it with new information, and you'll always be one step ahead.
It's much easier to deal with a £100k working capital shortfall when you've already factored in a £90k shortfall than when you haven't planned for anything at all.
In the first year of his plan, September is particularly rainy, and Uncle Tom sells more umbrellas than he'd expected. He needs to quickly adapt his financial plan to account for buying more stock and selling it.
He'll need another warehouse, more staff and more marketing, so he has to quickly update his plan and reallocate cash from other areas he was planning to spend it.
It can be a daunting task to start financial planning for a business, but it's much easier if you break it down into smaller steps. Taking the time to build a financial plan is worthwhile no matter what stage your business is at. If you'd like to make it easier to manage your finances, check out Juni, the financial platform made for digital entrepreneurs, which will give you a full picture of your business.
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Juni is the financial platform built for ecommerce. We give you a unified view of your finances, with cards, mulitcurrency accounts, and banking, accounting and advertising integrations - all in one place. We can even help boost your cash flow with working capital, cashback and more.
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