Planning and Obtaining Finance

This section covers Planning and Obtaining Finance covering, Relevance of a Business Plan in Obtaining Finance, Interpretation of a Simple Cash-Flow Forecast and Calculations Based on Changes in the Cash-Flow Variables and the Use and Limitations of a Cash-Flow Forecast.

In order to raise finance, businesses must demonstrate their financial viability and future plans to potential investors, banks, or other financial institutions. This is where effective planning plays a crucial role. Two key components of planning in the context of raising finance are the business plan and cash-flow forecasts. This guide will explore the relevance of a business plan in obtaining finance, how to interpret a simple cash-flow forecast, and the use and limitations of cash-flow forecasting.

Relevance of a Business Plan in Obtaining Finance

A business plan is a comprehensive document that outlines the objectives, strategies, and financial projections of a business. It serves as a blueprint for the company’s operations, providing a roadmap for growth and development. In the context of obtaining finance, a well-prepared business plan is essential for convincing potential lenders, investors, or partners that the business is a worthwhile investment.

Relevance of a Business Plan:

• Shows the viability of the business: A business plan provides an outline of the business idea, the market it operates in, the competitive landscape, and the management team’s qualifications. This helps demonstrate that the business has the potential to succeed and generate returns.
• Details of financial projections: Potential financiers will want to understand the financial health and future cash flow of the business. A business plan includes financial forecasts, including income statements, profit and loss projections, and cash-flow forecasts, which help establish the business’s financial needs.
• Provides evidence of planning and strategy: A business plan shows that the business owners have considered various aspects of running the business, from marketing strategies to operational challenges. This can increase confidence among investors or lenders that the business is well-organised and has a clear path for growth.
• Helps secure investment or loans: By demonstrating thorough planning and an understanding of the market, a business plan can be a powerful tool in convincing lenders to provide a loan or investors to offer capital. It shows that the business is more than just an idea; it’s a well-thought-out plan with a solid strategy for success.
• Acts as a benchmark: A business plan can be used internally to measure progress and track the success of the business against its financial and operational goals.

Interpretation of a Simple Cash-Flow Forecast and Calculations Based on Changes in the Cash-Flow Variables

A cash-flow forecast is a financial tool that shows the expected inflows and outflows of cash for a business over a specific period, typically on a monthly basis. It is essential for managing day-to-day operations, as it helps ensure the business has enough cash to meet its financial obligations. A cash-flow forecast allows businesses to anticipate cash shortages and plan accordingly.

Interpreting a Simple Cash-Flow Forecast:

A simple cash-flow forecast typically includes the following elements:

• Cash inflows: The expected cash that will be received by the business, such as sales revenue, loans, or investments.
• Cash outflows: The expected cash that the business will pay out, including operating expenses, wages, supplier payments, rent, and interest on loans.
• Net cash flow: This is calculated by subtracting the total cash outflows from the total cash inflows. If the result is positive, the business is generating more cash than it is spending. If negative, the business may face liquidity issues and require external financing or cost-cutting measures.

Calculating Changes in Cash Flow Variables: In practice, businesses often need to adjust their cash-flow forecasts based on changes in certain variables. Let’s explore how these changes affect the forecast:

Changes in Sales Revenue (Cash Inflows):

• If a business expects an increase in sales (e.g., due to a new product launch or increased marketing), cash inflows will rise, improving the cash balance.
• Conversely, a decrease in sales or delayed payments from customers will reduce cash inflows and potentially cause cash shortages.

Calculation Example:

• If monthly sales revenue is forecasted to be £50,000, but due to a marketing campaign, sales are expected to increase by 10%, the new forecasted sales would be £55,000.

Changes in Expenses (Cash Outflows):

• An increase in expenses, such as higher raw material costs or rent increases, will lead to higher cash outflows. This reduces the amount of cash available for other expenses or investments.
• A decrease in expenses (e.g., through cost-cutting or negotiating better supplier terms) can help improve cash flow.

Calculation Example:

• If monthly operating expenses are forecasted at £30,000 but rise by 5% due to inflation, the new expenses would be £31,500.

Delays in Receivables (Cash Inflows):

• If the business experiences delays in receiving payments from customers, this can lead to cash-flow problems, as the business may have to wait longer to convert sales into cash.
• Businesses may need to revise their cash-flow forecasts to account for these delays and plan accordingly, perhaps by seeking short-term finance.

Calculation Example:

• If the business expects to receive £40,000 in customer payments, but due to customer delays, only £30,000 is received, the forecasted cash inflow will need to be adjusted downwards.

Changes in Loan Repayments (Cash Outflows):

• If the business takes out a loan or line of credit, the cash-flow forecast will need to include the expected loan repayments. Any changes in interest rates or repayment schedules will affect cash outflows.

Calculation Example:

• If monthly loan repayments are forecasted at £5,000, but the loan agreement is renegotiated to £4,500, the new cash-flow forecast will reflect this reduction in outflows.

Example Calculation of Net Cash Flow:

• Opening Cash Balance: £10,000

Cash Inflows:

• Sales Revenue: £55,000
• Loan Received: £20,000

Cash Outflows:

• Operating Expenses: £31,500
• Loan Repayment: £4,500

Net Cash Flow = (£55,000 + £20,000) - (£31,500 + £4,500) = £75,000 - £36,000 = £39,000

Closing Cash Balance = Opening Balance + Net Cash Flow = £10,000 + £39,000 = £49,000

Use and Limitations of a Cash-Flow Forecast

Use of a Cash-Flow Forecast:

• Planning and Budgeting: A cash-flow forecast helps businesses plan their finances by predicting future cash inflows and outflows. It allows businesses to budget for upcoming expenses and determine if they need to raise additional finance.
• Monitoring Liquidity: A key use of a cash-flow forecast is to monitor the business’s liquidity position. It ensures that the business has enough cash to meet its day-to-day financial obligations, such as paying suppliers, employees, and creditors.
• Identifying Potential Cash Shortages: A cash-flow forecast can help a business identify periods when it might experience a cash shortfall, allowing it to take proactive steps to address the situation (e.g., securing a short-term loan, adjusting payment terms with suppliers).
• Decision Making: The forecast provides business owners with critical data to make informed decisions about expansion, cost-cutting, and other strategic choices.
• Attracting Investors or Lenders: A well-prepared cash-flow forecast demonstrates to potential investors or lenders that the business is financially prudent and has considered potential cash-flow issues, making it more likely that they will provide financing.

Limitations of a Cash-Flow Forecast:

• Reliability of Assumptions: Cash-flow forecasts are based on assumptions about future sales, expenses, and external factors. If these assumptions are inaccurate or if unforeseen events occur, the forecast may not be reliable.
• Changing Market Conditions: Economic conditions, competition, or regulatory changes can impact cash flow in ways that are difficult to predict. For example, if a major supplier increases prices unexpectedly, it may affect the forecast.
• External Factors: Factors such as changes in interest rates, fluctuations in foreign exchange rates, or changes in consumer behaviour can significantly affect cash flows but may be difficult to anticipate.
• Over-Optimism or Over-Pessimism: Businesses may be overly optimistic in their sales forecasts or overly cautious in predicting expenses, leading to inaccurate projections. This can result in poor decision-making based on unrealistic expectations.

Summary

A business plan and cash-flow forecast are fundamental tools for raising finance and ensuring the financial health of a business. The business plan provides a detailed overview of the business, its goals, and how it intends to achieve them, making it crucial for securing investment or loans. A cash-flow forecast is equally important, as it helps businesses manage their day-to-day finances, plan for future needs, and identify potential liquidity issues. However, while cash-flow forecasts are invaluable tools, they have limitations, as they are based on assumptions and predictions that may not always be accurate. Careful planning, regular updates, and adjustments are necessary to ensure that a business remains financially stable.