As we have seen, the books and records allow the preparation of annual financial accounts for a business. However, by the time they are prepared it is often too late for crucial management decisions to be taken . There are therefore several things that the small business (or indeed any business) should do to monitor trade throughout the year.

CONTROLLING THE CASH POSITION

Profit does not necessarily mean cash

There is often a lack of appreciation that profits do not necessarily mean cash in the bank. Without close control the additional profits quickly become locked into non-cash forms: more stock is held, debtors increase, and possibly the profit gets tied up in capital equipment (see Figure 41). Such common problems have led to the winding-up of many a small business.

The cash flow statement

In order to overcome this problem a simple cash flow statement (forecast) should be prepared. An example of this is shown in Figure 42. You can draft it on a piece of plain paper or get a preprinted form from your local bank if you prefer.

• Decide on the length of time that the forecast is to cover; for example, one year. The nature of the business may mean using a shorter or longer period, particularly if it is highly seasonal.
• Next, decide on the length of the individual periods to be forecast. Normally this would be months, but again depending on the business it might be better to prepare the statement by weeks or calendar quarters.
• Write in your initial (opening) cash or bank balance.
• Then forecast the cash receipts for each of the periods. Remember, if you sell goods on credit the cash may not come in for one, two or even three months after the date of the sale. Thus if you sell goods in the first month of the cash flow statement you should enter the cash received for those goods in the month of probable receipt (e.g. in the case of customers taking an average of 60 days credit, then the entry should be in month 3).
• Then forecast your cash outgoings. Remember to include such items as the purchase of capital equipment, the payment of PAYE and any other tax, and any drawings taken out by yourself. Remember, too, that you may be able to get credit on goods that you purchase. Thus goods delivered to you in month 1 may be paid in months 2 or 3 and the entry on the cash flow statement should therefore be in the relevant month. (Depreciation, as we have seen, is not a cash item, and so you don’t need to include it in your cash flow.)
• Next the boring part! – Add through the statement as follows:
  • (a)Add up the total receipts for each period.
  • (b)Add up the total payments for each period.
  • (c)Deduct the total payments from the total receipts to arrive at the cash increase or decrease for the period.
  • (d)Add the cash increase (or deduct the decrease) from the opening balance to arrive at the new cash balance at the end of the period. If the figure becomes minus you need to get an overdraft, or cut expenditure.
  • (e)The closing cash balance becomes the opening cash balance for the next period.

By reviewing the closing balance each month you will be able to estimate the cash needs of the business. If, for example, your business has a seasonal Christmas trade you might need overdraft facilities to help you to buy stock in October and November before the cash comes in from the sales in December.

You can also add the actual expenditure to this statement each month in order to monitor the trading results. You might be surprised (? horrified) at how the actuals compare with your estimates. But you should get more accurate with experience.

Controlling the credit

In business your main income will be from your customers, but this only materialises into cash when they actually pay up! Until the customer pays, you are financing their business.

Suppose you are owed £1,000 by one of your customers who helps themself to an extra four months beyond the agreed credit period. The cost to your firm in interest charges will be £27 (based on an interest rate of 8%). This is not only expensive, but lack of cash could jeopardise your whole business if you are already stretched to the limit on your borrowing facilities. And problems, like the proverbial number 7 bus, have a nasty habit of showing up all at once!

You can keep bad debts and the level of accounts receivable to a minimum by careful credit control procedures. Always check the credit-worthiness of major new customers, either through a banker’s reference or by using a credit-rating agency.

You should also monitor the time taken by your customers to pay. You can do this by preparing an aged debtors list. On page 73 it was suggested that you should list the amounts owing to you by your customers. The aged debtors list as shown in Figure 43 is a development of this idea. Beside the total column are added, say, 5 extra columns, these being headed Current, 1 month, 2 months, 3 months and over 3 months. You then enter each of the debts not only in the total column but also into the column for its appropriate ‘age’. You can then see at a glance which customers are taking ages to pay. Remember, the longer an account is outstanding, the less chance there is that you’ll ever get paid.

Don’t be afraid of taking legal action to recover debts that are becoming old. Often, the threat of legal action against a financially unsound customer (who doesn’t want his other creditors to be aware of his situation) will bring a positive response and your account will jump to the head of the queue for payment.

Don’t worry about upsetting customers who are bad payers. They tend to be thick-skinned and know full well that you are only trying to run your business. If you do manage to upset them remember that, with the additional problems they are causing, you are probably better off without them.

Finally, whilst on the subject, it is worth mentioning that good credit management will almost literally pay dividends. On an annual turnover of £100,000, if your customers take an extra month’s credit it is going to cost you around £667 per annum in finance costs (assuming interest at 8%).

MANAGING A BUDGET

What is a budget? Someone once defined it this way: ‘A statement of a financial position for a definite period of time, based on estimates of expenditure and proposals for financing them’. This sounds a bit grand, but it’s really quite a simple idea and one that every schoolboy uses. The schoolboy only sets his budget for a short period, say the afternoon. He has 37p in his pocket and plans how he will spend it. He can buy a comic at 18p and a chocolate bar at 19p, or a packet of crisps at 14p and an icecream for 23p. He will plan his budget for the afternoon and make his decisions accordingly. If when he gets to the ice-cream shop he finds that the ice-cream is on special offer and is only 20p then there will be a variation from the budget resulting in a budget surplus of 3p.

How does budgeting apply in business?

A good budget can be a very powerful tool for management. It will normally be set for a year in advance, but be subdivided into monthly periods.

The cornerstone for the budget will be your anticipated sales volume and revenue for the forecast period. This is not always easy to forecast: you will have to take into account such factors as past performances, new products, advertising campaigns, competition, and seasonal factors. And remember that when you split it into 12 months it may not just be a question of dividing all the figures by 12. You know the pattern of your trading best.

As well as sales income your budget should forecast all the expenses of the business.

Preparing a budget can be a chore, involving a fair amount of detail. But you’ll know more about your business as a result, have a useful tool for the efficient management of your business, and know what level of profit (and liquidity) to expect.

Monitoring progress

The budget statement can also be used to monitor the progress of your business. If you work out a simple monthly operating summary, like that in Figure 44, you can see how your actual results compare with the budget you set. A monthly management profit and loss account such as this will differ from the cash flow forecast because it takes no account of the timing differences on making payments; it will also make the necessary

adjustments for changes in stock levels and depreciation (non-cash expenses).

If you find that actual results differ markedly from your budget, you should be able to identify the reasons and think about what action to take. You may, of course, need to modify your budget, but either way it will give you a better insight into the way your business finances actually work.

Performance ratios

There are several key ratios which you can use to measure and monitor the financial health of your business. Unfortunately, because there are so many different types of business one can’t give any general guidance on what ratios to expect: they vary so much from one trade to another.

Some of the key ratios to look for are given below and you may wish to monitor these figures for your business. You could check them monthly, quarterly, and certainly at the end of each year when you have your annual accounts, and you’ll be able to tell (as will your bank manager!) where you are going right and where you may be going wrong.

Gross profit rate	=	gross profit ______________ sales turnover	x 100 per cent
Net profit rate	=	net profit ______________ sales turnover	x 100 per cent
Return on capital	=	net profit ______________ capital employed	x 100 per cent
Outstanding accounts receivable expressed in days’ billings	=	outstanding accounts ______________ accounts sales	x 365 days
Stock turnover	=	materials used per annum ______________ average stock held	per annum

SUMMARY

You should now be able to:

• Prepare a cash flow statement and use it to forecast finance requirements.
• Prepare a budgeted profit and loss account statement.
• Monitor the actual progress of the business against the budgeted profit and loss account and the cash flow statement and make necessary amendments to your trading plan.
• Operate a good system of credit control and chase up the old debts.
• Calculate the performance ratios: check to see if these are improving compared with prior years and try to obtain details from others in the same trade in order to see how your business compares.