If you can accurately forecast business income and expenses, you can plan for the least costly source of capital or avoid spending that depletes cash at the wrong time.
Brian and Jennifer England had a personal habit of living within their means before starting British American Auto Care Inc. in Columbia, Maryland, in 1976. To do that, they had to know what their means were going to be. They carried that mind-set into business.
“I just presumed everyone had a budget at home,” Brian says. “If you can’t handle your day-to-day expenses how are you going to do it at your business?”
The Englands carefully listed each personal and business expense, including Brian’s salary. Then they calculated how many hours of auto repair work British American Auto Care would have to do to break even. In 1976 it was 35 hours.
“We sell hours. Labor costs so much per hour, hours become money. [Sale of] parts are icing,” Brian explains. “We started business with $10,000, which would meet all our expenses for six months. If we had no work, we could survive [in business] six months. Every day we had work, that was one more day the business would survive: six months and one day, six months and two days.”
Brian was doing the simplest form of financial forecasting. Figure all your expenses and sources of income. If they aren’t at least equal, you shouldn’t even start the business. Forecasting needs to be a routine part of managing a business in order to maximize resources. If you fail to forecast the amount of capital needed, you may run out of cash. The choice then may be between unplanned borrowing at a high interest rate or unfavorable terms and panic selling of assets that brings less than top dollar. Inaccurate forecasts may lead to borrowing that the company can’t afford or excess inventory that ties up capital and is expensive to handle and store.
Forecasting is difficult for the start-up because it is an educated guess, based on research of similar types of businesses and assumptions about costs and revenue. “You have to be honest with yourself about your forecast numbers,” Brian says. Many entrepreneurs underestimate the time and money they need to start and grow their ventures. Financial forecasting, especially in the early years of business, should include three calculations: the worst-case scenario, the everything-goes-as-planned scenario, and the beyond-your-wildest-dreams scenario. As the owner monitors actual business performance week by week or month by month, he adjusts each track. Companies are considered good financial forecasters if they are 85 percent accurate. You might think lenders and investors would be delighted if you wildly underestimate financial performance, but they prefer business owners who understand their businesses and industries so well that they hit their forecasts precisely.
Many small businesses encounter seasonal fluctuations. For a farmer or Christmas tree salesman, such fluctuations are easy to predict. But some industries are less obvious, such as midsummer slowdowns for business services or early April ebbs for seminar planners. Such trends become more predictable the longer a business is open if the owner is tracking financial data, and that knowledge will help plan for seasonal financing that best suits the company.
For British American Auto Care, the fluctuations are less tied to seasons of the year than to company growth over time, Brian says. From the initial 35 work hours to cover expenses, the company now needs 282 work hours. “Unless we expand, the number stays remarkably the same year after year. You can find complicated forecasting models and software, but itt gets down to basics. I prefer to keep it simple.”
Brandon is a finance consultant and part time blogger who has written this article for Mr. Tabber Benedict a M&A attorney and businessman with substantial securities.