Helping you to understand Business Accounts and Financial Projections – Part 2 ‘Common Mistakes and Misconceptions’
Chris Roberts - Director, Franchise Finance Ltd
Understanding the difference between ‘Profit’ and ‘Cash’ will help you to avoid problems when considering financial projections. The issue is best explained by looking at a business that gives one month credit when it makes a sale. If the invoice for a large profitable sale is projected to be issued in June then the invoice amount will be included in the P&L sales in June and a ‘profit’ will be shown in that month. However the actual money is not expected to be received until July so it is shown in the CFF in July. Unfortunately if the business needs to pay say wages at the end of June, it may not have enough money until the funds from the sales invoice are received in July. So even though the business has made a ‘Profit’ it has a serious ‘cash-flow’ problem. The technical term for this problem is a ‘lack of working capital’ .
By producing both a projected P&L and a separate cashflow forecast the problem can be identified and extra working capital can be arranged in advance.
At this stage it is worth emphasising that the projected P&L incorporates trading expenses i.e. things like rent, fuel, insurance and wages, all of which reduce your profits (or increase your loss). They are distinguishable because once these payments or ‘overheads’ are paid they are ‘gone’ and nothing individually is left. However, projected payments for assets such as vehicles, fixtures and fittings and equipment are not set against profits when they are purchased because they remain within the business to help you continue trading. They need to be included in the cashflow forecast because you will pay money away when you buy them and recorded in the balance sheet as an asset because your business will own them.
You will see here how there are two entries to make. This in fact applies to every business transaction that you project. For example wages will be shown in the P&L (as mentioned above) and also in the cashflow forecast. This is called ‘double entry book-keeping’ and as I will explain in subsequent articles, why ‘Balance Sheets’ should actually ‘balance’.
Another common mistake is to either forget about or incorrectly deal with VAT in the projections. Many businesses will quote their costs to you excluding VAT so you will need to add it on, where applicable. This is a highly technical subject but for the purposes of this introductory article and assuming your franchise is (or will be) registered for VAT, then you need to know that you exclude VAT in the P&L and include it in the CFF. The reason for this is that you are simply acting as a VAT collector for the Tax Authorities. The money does not belong to you so it does not form part of your profits. However, it does pass in and out of your bank account so it does need to be shown in the CFF.
And finally for now ‘Depreciation’. We all know that a vehicle purchased at the beginning of a year will be worth less at the end of the year. This is accounted for by charging a percentage of its value (say 20% – but this varies depending on the expected usable life of the asset) to the P&L account and reducing the value in the balance sheet by the same amount. The year-end balance sheet then gives the true value of the asset, but bear in mind ‘depreciation’ is a ‘book-entry’ and the system does not store up cash to buy a new van!
Chris Roberts runs a series of one to one and group courses and Franchise Finance also prepare full business plans and/or financial projections for their clients.
Helping you to understand Business Accounts and Financial Projections – Part 1 ‘The Basics’
Chris Roberts - Director, Franchise Finance Ltd
Do you fall into one of the following categories when it comes to accounts and financial projections?
- Don’t understand them (but maybe pretend sometimes that you do!)
- Find you’re scared of them or just see a jumble of numbers.
- Can’t see the need for them or simply rely on other people to understand them for you.
If you can say yes to any one of the above then you are taking a big risk with your new or existing franchise business.
This first article from me on this subject is split into two parts. The first sets the scene and provides a simple introduction, in layman’s terms, to some of the key things you need to know. The second part describes some common mistakes and misconceptions. I will then follow this up with some further detail over the coming weeks in order for you to better understand the financial aspects of your business so that you remain in control and ‘get where you want to go’.
So, to begin with, I suggest writing down your ‘Business Objectives’ i.e. what you are trying to achieve. It helps to look at this in three steps, the short term, the medium term and the longer term. (For the purpose of this article we are going to focus on the short to medium term). You then need to think about what resources you are going to need over that period to achieve those objectives.
The next step is to transfer all these ‘hopes and aspirations’ into £’s and pence, to see how well it will work in practice. The biggest mistake, however, is to try and do this on one spreadsheet or one piece of paper. If you do, you are likely to start making some serious mistakes. You need three, otherwise you will get the concept of ‘profit’ mixed up with the realities of ‘cash’ and also not deal properly with your assets and liabilities. The three separate parts to your financial projections are:
- The Profit and Loss Account (Your sales less trading costs which give you a profit or a loss)
- The Cashflow Forecast (A mirror image of what your bank account should look like)
- The Balance Sheet (A list of your business assets and liabilities)
In layman’s terms, and to help differentiate between the three, the 1st shows what you hope to do (and whether it is worthwhile doing it!), the 2nd shows how much money you will need to do it (or turning this on its head it shows you ‘if you can afford to do it!) and the 3rd shows what your business will look like at a particular time in the future. This should be of interest to you and will be needed by your bank if you want to borrow money.
The profit and loss account (P&L) and the cashflow forecast (CFF) are normally prepared on a corresponding monthly basis for the period of a year and the related balance sheet (which can be described as a ‘snapshot’ in time) shows the assets and the liabilities on the last day of that year.
I will expand on all of this in Part Two of this Article.
Chris Roberts runs a series of one to one and group courses and Franchise Finance also prepare full business plans and/or financial projections for their clients.
The Big Question: Self Employment or Franchise Business: Part 2
Joel Caws - Technical Director, Select Your Franchise
In my last posting: The Big Question: Self Employment or Franchise, we looked at the main pros and cons of both self-employment and franchising. Today I want to look at what type of person is the best fit for both options. It’s meant as a general guide only and its not to say that a person more suited to a franchise opportunity couldn’t go it alone in self-employment. It’s all a matter of determination, commitment and available resources at the end of the day.
A potential Self-Employed person might think:
“I want to work completely on my own. I don’t need any support and backup as I have the business experience required to cover the bases or know where to get it. I have a great business idea and I know how to sell and market properly. I’m confident that I will work hard and dedicate myself as I know its going to be hard and probably require long hours at first. Everything in life is a risk but I’m confident I can make a go of it.”
If your thinking runs something along those lines then Self-Employment may by the choice for you. Draw up a business plan, run it past a few trusted friends and take it to your bank manager to get some valuable outside feedback.
A potential Franchisee person might think:
“I don’t really have any of my own ideas I’d be confident would actually work in practice, however, I’m a hard worker… give me a job and I can get it done! I’d like to build my own business so that I can have something I can call my own. I can work independently, be motivated and determined but I’d like to know theres some support and backing there if I need to talk to someone. I know theres no guarantees but I’d like the best possible chance of succeeding whilst building my own business.”
If thats your kind of thinking you are probably looking at franchising as your best way forward. Theres alot of franchise opportunities out there so make sure you do your background research properly for any that you are interested in, get feedback from existing franchisees and preferably talk to a franchise legal expert.
Whichever option you consider, remember there are no guarantees. Both options come with their risks and it will be up to you to plan and be diligent enough before taking the leap that you have taken steps to give you the best chance of success. At the end of the day, its YOU that will decide whether the business succeeds or fails, whether its self-employment or franchise business. Both require hard work, determination, dedication and motivation in order to succeed.
