Financial control is a vital part of any business. If you lose control it will almost certainly result in your business spiraling into bankruptcy. A wise way to avoid this is to simply record your past cash flows, your current patterns and use the information to construct documents I will explain in detail. These can all be made simply by keeping the required information. Do not forget that all of the information from each document cannot tell you exactly how your company will perform in the future, but it can give you a good guide. I will also include relevant pictures to show what these documents should look like.
Cash Flow Forecasts
Cash flow forecasts are a great way to estimate how your company will perform in the future. They are the standard way to find where your business will peak and trough in its revenues. It is also a handy way to see how much money your business has recently if it is up to date, since it lists closing balances. You can also check your trading profit (Sales capital minus costs) and revenue, (Capital from sales) whilst also having your capital from last month and costs from the current month easily displayed. These are helpful for a business because they are quick and relatively easy to make. They can be flawed sometimes because people can sometimes not make realistic estimates or consider all factors, which can result in the company being too optimistic or pessimistic in spending and sales.
This could hinder your company more than help it. For this reason, you should wait until it is sensible to make a cash flow forecast. Benefits of accurate cash flow forecasts include detecting overdrafts early on and finding problems, the ability to review your costs and pricing to suit your disposition and being able to renegotiate terms with others, such as banks or creditors. It is also a great document to show to people that may be interested in your business, such as shareholder, (Potential) investors, creditors and lenders. Since it can be helpful to show to a creditor, it is also a helpful way to clear up issues surrounding a company’s liquidity. It is also good to show shareholders and investors since it will give them an easy way to compare with other competing firms.
Break Even Charts
Break even charts are a method of identifying what prices you will have to set to break even in certain situations, among other things. Although they can sometimes be tricky to get exactly right, knowing what your break even point can sometimes be a big help. Microsoft Excel also has a feature where you can make a break even chart on the computer, which can have less human error in comparison to hand drawn charts. Advantages of break even charts include being able to check many situations before you decide a strategy, to be able to have a visual way to identify your costs and revenues. This will be able to let you put ‘cost-based pricing’ in place, which essentially means that you can price your products around your costs, so you can work out the best way to receive maximum profit.
These charts are limited though, since they can only predict. Sometimes you have to check that the situation is feasible, since the break even charts may give you an impossible situation where you cannot sell the amount you need to break even. Also do not forget more variables are always around, so leave a margin of error and do not leave break even charts as your only source of advice. On the chart below, we can clearly see where the blue and red line cross, with the red line being costs and blue being revenue. The break even point is the exact point where they cross. Some people can even choose to draw a line directly downward just to check where it touches on the x axis, which can reduce human error so the data is more accurate.
Profit and Loss Statements
Since by law, you will be required to create financial statements each year on behalf of your company, you will most likely need to create a profit and loss statement. In Layman’s terms, a profit and loss statement will help you document what happens when your revenue is turned into profit. The costs will be the main focus of this document because, not only does it help the government and banks involved when they ask for it, it will also help you find out where your revenue is being spent, similarly to one of the uses of a cash flow forecast. It can be as simple as writing down the revenue minus costs, which will equal your profits, but most documents should be more detailed.
You need to expand upon where your costs have come from, who the recipient is and what the specific amounts are. Since this can be used to forecast your sales and costs, you can estimate these values sensibly but they will not be an official document unless they are real figures. A theoretical profit and loss statement is only for the businesses use. Advantages of profit and loss statements include being a simple way of seeing past and present situations for the business, including theoretical ones, being an easy document to write and read, and providing vital information to internal and external sources. They are, meanwhile, limited to the information they supply and they will almost always need to be backed up with more information as proof, since the document is so short.
Other Financial Recording Systems
Most financial recording systems will help you find sources of financial problems, allow you to control your credit and predicting situations where cash is vital so you can leave a margin of safety (For example, you must make sure you have enough money to start up your business otherwise you will be in the red instantly, which will have a bad effect from the start). Other financial recording systems include the balance sheet, which helps the company show its financial position at any time. This can be helpful if the business needs to find information at a single point in time. It is the only one of the documents mentioned that can do this.
All financial recording systems will generally benefit your company if you construct them correctly, since most are a good way of predicting what is to come for your business and how you can prepare.