Operating a small business is like a hike in the woods where the observed nature is mostly familiar, but sometimes referring to a compass is very important. The entrepreneur’s compass is the financial forecast. These projections guide you in the course you want to take. And when the path twists you in a different direction, the forecast shows where you’re off track and how to get your bearings back.
Projections set goals and milestones. More importantly, they permit you to measure progress toward your objectives. Many entrepreneurs eschew making financial forecasts because the process entails a lot of numbers, which seem cumbersome to calculate. But forecasting is a simple process when it’s constructed on a spreadsheet from identification of a few basic factors you’re certain to already know.
Direct Costs
The top line in your financial forecast is sales revenue. But determination of this figure is embodied in an initial step of identifying your available resources. These elements are cash and time. Assess available funds for inventory and other costs that must be paid before you collect from customers. The money on hand for these things represents a curb on how much you can sell. In addition, your revenue is limited by the time you have to contribute to business. Selling more than you can deliver individually means adding staff. And that brings you again to a cash need.
Start by considering all direct costs, such as inventory or materials. Labor cost is also commonly a major direct factor in generating sales. For solo-operated service providers, the only direct cost is typically the entrepreneur’s time. The key dynamics are how much output the individual can accomplish every month and the amount of personal income desired for the effort. That owner compensation target is the major direct cost in many basic business models.
Sales Revenue
When your direct costs are identified, sales revenue is projected as a multiple of those expenditures. All you need is your ratio of direct costs to sales revenue. This may be calculated using historical data. Or you might simply identify a markup you aim to achieve. For example, you might have prices that are twice your direct costs – yielding a ratio of 0.5 or 50%.
Divide your forecasted costs by the ratio. The product is your sales revenue forecast. Subtracting direct costs from sales revenue results in an amount for gross profit.
Overhead Expenses
Every business has general overhead expenses. Even the plain solo entrepreneur working from home has at the least a cost for internet and cell phone. Larger organizations of course incur expenses for rent and office administration. Don’t forget costs for advertising and marketing, even if that’s only website development and maintenance.
All of these overhead items are measures where you have flexibility to reduce cost. Subtract them from your gross profit to obtain net profit. Exclude from overhead costs all capital expenditures for machinery, equipment, and leasehold improvements. Rather, subtract these costs from your net profit forecast at the irregular intervals when you expect to incur them. With the passage of time, update the financial forecast. Although poor results will necessitate cutting overhead and capital expenditures, beating expectations gives you extra funds for expansion.
The Finance Writer 