Do you agree that having a financial plan with forecast is a
good thing to do for your small business? If you do, do you have one? My guess
is not many small business owners devote their busy schedule to work on a
financial plan. One of the reasons of not having a financial plan is about a
perception, that it’s time-consuming and boring. Additionally, many small
business owners might not know how to do it. In this article, I would like to
offer a simple explanation and an easy way to do a financial plan.
Why is it important for small business owners to have a
financial plan? Put simply, a good plan would tell you your current financial
status and your future business trend, financial wise. A plan doesn’t have to
be complicated. It only requires that you spend a few minutes to read and
understand this article and you develop some sort of discipline to track your
revenue and your expenses, you are good to go. There are two simple concepts
that you need to know for your financial plan – one is business
cash flow, and the other is a concept of time value of money.
Let deep into these 2 concepts.
Let start with the
cash flow. Your cash flow is simply the movement
of cash of your business. The major goal of the cash flow management is you
need to ensure that you have enough cash to pay all of obligations that keep
your business running. You also have to understand that being profitable is not
the same thing as having a good cash flow management. This is because even
though you are profitable, you may not have enough cash in a particular month
to pay suppliers if you don’t plan well. What you should be doing is to create
a discipline of recording or tracking your revenue and expenses. The first step
is to record all “current” in and out of your cash. It will help you understand
your financial status. Then, you have to do a “forecast” of your cash flow.
It’s the same practice of having a budget for big corporations. You
can use this template to record your cash flow.
I don’t have to explain much why knowing your cash flow
situation – the past, the present, and the future – is very important to your
business. You certainly need to know what your spent and whether those expenses
were absolutely necessary. You also need to ensure that you have enough cash to
fulfil your current and incoming commitments. And, most importantly, having an
idea of your future cash flow helps you do business more effectively. The next
concept that you should know is “time value of money”.
What is time value of money (let call it TVOM)? It doesn’t
sound like fun. I think it’s a good concept for you to know even though you may
not have to actually do the calculation like banks or investors. Why? The
concept of TVOM tells you that the same amount of money your receive today is
worth more than the same amount in the future. This is because the amount in
hand today can be invested to turn into more money in the future. The key
difference between the today’s and the future’s money is “interest or rate of
return”. Suppose that a customer offers to pay you $1,000 today or $1,100 one
year from today. This promise comes from the customer that you trust very much,
and thus you do not believe there is any risk that you will not be paid. Which
option would you choose?
It all depends on the return you can earn on this amount. If
you can earn 6% on your money, for instance, then you should accept the $1,000
today. If invested for one year, it would grow to $1,060, beating the option of
receiving $1,050 one year from now. However, if you can only earn a 4% return
on your money, you should accept the offer of $1,050 paid one year from now. If
you accept the $1,000 and invest it at a 4% return, it will only grow to $1,040
in one year, compared to receiving $1,050 after one year from this customer. I
cannot talk about the TVOM concept without showing you the formula (sorry).
The basic formula for the time value of money is as follows:
PV = FV ÷ (1+I)^N, where:
PV is the present value
FV is the future value
I is the required return
N is the number of time periods
before receiving the money
The good news is you don’t have to do the calculation
yourself. When I was studying, I had to do a manual calculation myself and it
wasn’t fun. There are a number of websites that offer a TVOM calculator. I suggest
this one because it’s simple and straight forward.
I can’t stress enough why being on top of your business’ financial is super important. If you feel like this is not your forte, you can always seek help. However, I would encourage you to at least start small with a good record keeping for your revenue and expenses. Once you have a very good tracking system, the rest is super easy.