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Financial Management

What do I need to know about budgeting?

How to begin putting together your budget.

Entrepreneur

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Budgets and planning is the core of financial management. Let this become one of your strongest and most valuable skills as an entrepreneur.

Budget Terms

What are operating expenses?

Although different businesses have different costs associated with them, the main operating expenses of most businesses include:

  1. Rent. Under many lease agreements, you’ll be expected to provide the first month’s rent plus a security deposit. Many lessors also require the last month’s rent.
  2. Phone and utilities.
  3. Equipment. Equipment costs vary from one business to another. At a minimum, most businesses need office equipment, signage and security systems. To determine your costs, list all the equipment you must have to efficiently operate your business.
  4. Fixtures. This broad category includes partitions, panelling, signage, storage cabinets, lighting, check-out counters, and all shelves, table stands, wall systems, showcases and related hardware for product display. The cost of fixtures depends on your business location, the size and condition of your facility, the type of business you’re in, what kind of image you want it to project, and whether you’re purchasing new or used fixtures.
  5. Inventory. Like equipment, inventory requirements vary from business to business. Some businesses, such as retail stores, are inventory-intensive, whereas others, such as personal shopping services, don’t require any inventory at all except office supplies.
  6. Leasehold improvements. These non-removable installations, either original or the result of remodelling, include carpeting and other floorings, insulation, electrical wiring and plumbing, bathrooms, lighting, wall partitions, windows, ceiling tiles, sprinkler systems, security systems, some elements of interior design and sometimes heating and/or air-conditioning systems. Because the cost of improvements can vary tremendously, get several estimates from reputable contractors.
  7. Licences and tax deposits. Most cities require business operators to obtain various licences or permits to show compliance with local regulations. Licensing costs vary from business to business, depending on the requirements of your particular location.
  8. Marketing budgets. Most companies determine their first year’s advertising budget as a percentage of projected gross sales, typically two to five percent.
  9. Professional services. Generally, this refers to your lawyer and accountant. Their fees will range according to their expertise, and the location and size of their practices.
  10. Payroll. Salaries and fees paid to full time and part time employees, directors and/or consultants.
  11. Insurance. A word of caution when estimating these costs: if there’s ever a time to be conservative, it’s now. Err on the high side when you project expenses and on the low side when you project revenue. And don’t forget to add a “rainy day” or contingency fund to cover the costs of unforeseen expenses – somewhere around five percent of your budget is a typical amount to set aside. This financial cushion will help you and your investors to avoid panic in case you’re faced with an expense you hadn’t budgeted for

What does the term Overheads refer to?

Overhead refers to all non-labour expenses required to operate your business. These expenses are either fixed or variable:

1. Fixed expenses

No matter what your sales volume is, fixed costs must be met every month. Fixed expenses include rent or mortgage payments, depreciation on fixed assets (such as cars and office equipment), salaries and associated payroll costs, liability and other insurance, utilities, membership dues and subscriptions (which can sometimes be affected by sales volume), and legal and accounting costs. These expenses don’t change, regardless of whether a company’s revenue goes up or down.

2. Variable expenses

Most so-called variable expenses are really semi-variable expenses that fluctuate from month to month in relation to sales and other factors, such as promotional efforts, change of season, and variations in the prices of supplies and services. Fitting into this category are expenses for telephone, office supplies (the more business, the greater the use of these items), printing, packaging, mailing, advertising and promotion. When estimating variable expenses, use an average figure based on an estimate of the yearly total.

Capital Requirements

How to determine how much capital is needed for a start-up?

To determine how much you’ll need for start-up, account for all opening expenses along with your initial operating expenses. Although different businesses have different costs associated with them, the main start-up costs include these:

  1. Rent. Under many lease agreements, you’ll be expected to provide the first month’s rent plus a security deposit. Many lessors also require the last month’s rent.
  2. Phone and utilities. Some telephone and utility companies require deposits, while others do not. A deposit may not be required if you own real estate or have a previously established payment record with the company. Telephone deposits are determined by the number of phones and the type of service required. Unless you need a large number of phones and lines, the deposit won’t be too costly. Deposits for petrol and electricity (when required) will vary according to your projected usage, so get accurate information and carefully project your numbers.
  3. Equipment. Equipment costs vary from one business to another. At a minimum, most businesses need office equipment, signage and security systems. To determine your costs, list all the equipment you must have to efficiently operate your business. Next, price those items by obtaining quotes or bids from at least three vendors. Use the quotes you receive to estimate your start-up equipment costs.
  4. Fixtures. This broad category includes partitions, panelling, signage, storage cabinets, lighting, check-out counters, and all shelves, table stands, wall systems, showcases and related hardware for product display. The cost of fixtures depends on your business location, the size and condition of your facility, the type of business you’re in, what kind of image you want it to project, and whether you’re purchasing new or used fixtures.
  5. Inventory. Like equipment, inventory requirements vary from business to business. Some businesses, such as retail stores, are inventory intensive, whereas others, such as personal shopping services, don’t require any inventory at all except office supplies.
  6. Leasehold improvements. These non-removable installations, either original or the result of remodelling, include carpeting and other floorings, insulation, electrical wiring and plumbing, bathrooms, lighting, wall partitions, windows, ceiling tiles, sprinkler systems, security systems, some elements of interior design, and sometimes heating and/or air-conditioning systems. Because the cost of improvements can vary tremendously, get several estimates from reputable contractors.
  7. Licences and tax deposits. Most cities require business operators to obtain various licences or permits to show compliance with local regulations. Licensing costs vary from business to business, depending on the requirements of your particular location. In addition to these fees, you’ll also need start-up capital for tax deposits if yours is a retail business. Many states require a deposit against future taxes to be collected.
  8. Marketing budgets. Most companies determine their first year’s advertising budget as a percentage of projected gross sales, typically two to five percent.
  9. Professional services. Before you officially open your business, get help from a knowledgeable lawyer and accountant who work with small business owners to make sure you meet your legal and tax obligations. Their fees will range according to their expertise, and the location and size of their practices.
  10. Pre-opening payroll. If your business is going to be a full-time venture, set aside a salary for yourself in addition to a three-month reserve, just to play it safe. This rule of thumb also applies to any employees you might hire during this phase of business start-up.

How conservative should a business person be when estimating my start-up capital requirements?

If there’s ever a time to be conservative, it’s now. Err on the high side when you project expenses and on the low side when you project revenue. And don’t forget to add a “rainy day” or contingency fund to cover the costs of unforeseen expenses – somewhere around five percent of your budget is a typical amount to set aside. This financial cushion will help you and your investors avoid panic in case you’re faced with an expense you hadn’t budgeted for.

What is undercapitalisation?

Undercapitalisation is the condition that exists when a company doesn’t have enough cash to carry on its business and pay its creditors.

When you’re launching a business or starting out as the new owner of an existing business, proper planning and research are absolutely necessary. Undercapitalisation can be a major problem, one that may lead you right out of business.You don’t necessarily need piles of money to start a business.

Apple Computer was started in a garage by Steve Wozniak and Steven Jobs. Yahoo! was founded by a pair of Stanford University graduate students, Jerry Yang and David Filo, to help their fellow students locate cool websites. There is nothing wrong with this approach if you’re willing to invest a great amount of time and energy into making the business work. But keep in mind that undercapitalisation is the number one killer of start-up businesses. Don’t skimp on getting enough money to start your business right.

What is required when asked to substantiate and motivate sales projections?

The heart of any new business concept is the monthly sales forecast. Sales usually climb more slowly than business owners expect, and the expenses pile up faster. For start-up companies, the initial business plan should include a month-by-month projection for the first year, followed by annual projections going out a minimum of three years.

All projections should be broken down into months, especially when it comes to the first year. To prepare the sales projections you have to do a great deal of thorough research. Remember sales forecasting takes into account the economic climate, current sales trends, and capacity for production, company policy and market research.

You have to collect this information by doing research and then analysing it in a way that makes it possible to estimate what your sales will be. Do extensive research to establish the total number of potential customers that you believe that the company can realistically count on. There are many sources of information to assist with your sales forecast. Some key suggestions are:

  • Competitors
  • Trade suppliers
  • Chambers of Commerce and business associations
  •  Trade publications
  • Networking groups

Determine current trends by talking to suppliers about what is selling well and what is not. Get out on the street and study your competitors. Visit shops, business, websites and locations where their product is offered. Analyse the location, customer volumes, traffic patterns, hours of operation, busy periods, prices, quality of their goods and services, product lines carried, promotional techniques etc.

In any sales projection, you will have to make some basic assumptions about the customers in your target market.

Experienced business people will tell you that a good rule of thumb is that 20% of customers account for 80% of sales. Use this research to estimate your sales on a monthly basis for your first year.

There are various types of financial projections that you will need. The first is a month-by-month projection for the first year.

First Year:

This is the main planning and monitoring vehicle and the forecast must be updated monthly. The initial capital costs depend on the kind of business you are starting. These costs could include décor, lighting, equipment, tools, office furniture, telephones and internet installation. Other costs include registering the business, drawing up of agreements (legal fees), stationery such as business cards, a logo, web site design and maintenance.

Long-range plan

The long-term forecast must show the strategic plans for the business. Start-ups have to plan for various ongoing costs such as rent and salaries and the cost of having staff on site. If you run the business with a sales team, work out the number of calls each one can make, the number of calls and average length of time expected to close a sale, average close rate per sales person.

The incentive structure will also have an impact on the projected forecast depending on how the staff is rewarded. You will also have to include production costs, tax, telephone, electricity, water, insurance and if you have taken a loan to fund the start-up, you must include the interest on your loan.

Cash Forecast

The purpose of the cash forecast is to break down the budget ever further. Don’t forget that the focus must be on cash flow rather than accounting profit. A cash flow projection shows the amounts of money your business expects to receive and pay out each month in a rolling six- or 12-month period. This forecast takes into account the lag time between billing your clients and getting paid; incurring an expense and paying for it; and paying tax. Don’t forget to consider any seasonality associated with buyer behavior.

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Financial Management

What do I keep in mind for financial planning in a business?

In the startup phase of any new business, the profits will usually be quite low. It is therefore important to be wise with every cent in these early stages.

Peter Gossman

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When doing financial planning for the first few months of my new business, what sort of things should I bear in mind?

Below are some financial considerations for the first few months of your new business.

1. Your Personal Salary

In this startup phase, the owner’s personal salary and the business viability will be strongly related. If you are solely reliant on your business to meet your needs, then you may need to reduce your lifestyle to ensure that your business will still break-even, while paying you enough to meet your essential needs.

Related: 6 Steps Of Financial Planning

Don’t start your business hoping to draw a large salary. This may come later, but seldom in the startup phase. Initially, you may have to personally contribute money to the business just to keep it afloat. If possible, work and save up as much as you can before starting your business. The startup phase will often require personal sacrifice.

Consider working a second job in the early months of your business. Your goal in the startup phase should be to take as little as possible from the profits, so that your business can grow as quickly as possible.

Reduce your personal lifestyle and expenses as much as you can. Carefully develop a personal monthly budget. Monitor this budget regularly and ensure that you adhere to it.

2. Separate business finances from personal finances

It is important to have a very clear separation between business transactions and personal expenses. Some owners use business funds for personal costs, often using cash from business sales to buy personal items, then declaring these as business expenses.

Any money taken from business profits for personal use cannot be expended to the business, nor should personal transactions be done through your business accounts. Also avoid business trading using your personal bank account. The only personal cost through your business accounts should be the salary that is paid to you.

3. Startup capital

In most businesses, you will need to invest money, (for stock, machinery, equipment, etc.) before you can trade. When determining your required startup capital, it is wise to start small and gradually scale up.

Avoid debt as much as possible. Focus on sales and begin selling as soon as you can. You don’t need a fancy office with billboards and business cards to start trading. Avoid large rental costs – initially try to work from home. Should you need a loan, try to get low-interest loans from friends and family before approaching institutions.

4. Cash flow forecast for your business

Plan a cash flow forecast for at least 12 months. Take time to realistically list the anticipated monthly cash flowing into your business (Sales, Loans, Investments), and out from your business (Salaries, Suppliers, Loan repayments, Rent, etc.).  Regularly review this forecast.

5. Accurately record all income and expenditure – personal and business

In order to draw up a realistic Personal Budget and Business Cash Flow Forecast you will need accurate historical information of all your business and personal transactions for the previous months. Start today: record all income and expenditure, especially cash transactions that do not leave a document trail.

Remember to keep personal records separate from your business records. Develop an effective filing system for all source documents.

6. Don’t give up

Starting a new business is tough, and the financial rewards are seldom seen in the startup phase. You may be tempted many times to just give up. Remember, every large tree started as a small seed and took a long time to grow.

If you give your small “business seed” the care and attention it needs, it will eventually grow and develop into a great tree and bear much fruit.

Related: How to Become a Millionaire by Age 30

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Financial Management

How should I calculate if a project is worth it?

Our turnover is great, but our profits are not. How do I calculate if a project is worth it? We excited by the deal, but I think they end up costing us more than they’re worth.

Louw Barnardt

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How should I calculate if a project is worth it?

If you’re an entrepreneur without a strong financial background, one of the biggest business challenges you might face is the evaluation of a project’s financial implication. Often new projects are enthusiastically undertaken without proper consideration of the real profit the company stands to make.

A new project or contract always means more revenue, but often it does not end up being profitable in total.

If your business has been growing its revenue, but profit has been going sideways or down, your company is actually only spinning its wheels in terms of bottom line profit.

It might be time to implement a basic financial analysis before a project or contract is accepted.

Considering net present value

Before you roll out that new line of business or accept that project, take the time to consider its net present value. Sure, it generates income and keeps your team busy, but after prudently taking into account all costs and the effect of your cost of capital over time, is it still making you money?

The process to undertake can be broken down as follows:

  • First, understand your company’s cost of capital
  • Plot your project’s cash flows over its life span
  • Calculate the project’s net present value using your cost of capital.

Cost of capital

Cost of capital means the cost of the equity (the owners’ own money) and debt (borrowed funds) of the company. It is calculated as the cost of equity times the weighting of equity in the capital structure, plus the cost of debt times the weight of debt in the capital structure.

Cost of Capital = (cost of debt x weight of debt) + (cost of equity x weight of equity)

A basic example to simplify this mouth-full:

Financial decision making

Peter’s company is half-funded by himself, and half by a loan. The weight of equity is therefore 50%, and so is the weight of debt.

The interest on the borrowed funds is 12% per annum. Because the interest is tax deductible, we use the after tax cost of interest. The cost of debt is therefore 12% x 0.72 = 8.64%.

Peter’s expected return on the money that he put in is 30% to compensate for the risk that he is taking in putting money into his business.

Let’s keep it as simple as this for our example. Applying our formula, Peter’s cost of capital can be calculated as:

Cost of Capital = (cost of debt x weight of debt) + (cost of equity x weight of equity)

= (8.64%x50%) + (30%x50%)

= 19.32%

Peter now knows that his company will need to generate returns of at least 19.32% in order for him to adequately cover his cost of capital.

Plotting your project’s cash flows

Peter’s financial decision is whether or not to purchase a new line of software with a five year licence for his design company. The new software will enable a new stream of income, as well as add to existing income streams and will cost him R200 000. He has plotted the project income and expenses over five years as follows:

Basic NPV model

On face value, it looks like the total net inflow for the project over five years coming in at a positive R328 400 is a definite must. But in order to properly analyse this, we need to compute the project’s net present value.

Net present value

The net present value of a project is the current value of all the project’s future cash flows, discounted at the company’s cost of capital.

In basic terms, the R21 200 profit of year one, discounted at the cost of capital rate of 19.32%, is worth only R17 767 at the beginning of that year. Likewise we discount each year’s profit back to its current (year zero) value to get the present value thereof.

The sum of these discounted amounts then make up the net present value:

Net Present Value

The project’s NPV comes out negative at -R14 407. As the NPV is smaller than zero, Peter should not accept the project as it will generate less present value profit than the cost of the funds employed in making that profit. Not the same answer as that of the first look at the project’s profit.

Likewise, doing a basic cost of capital calculation for your company and a NPV calculation for each new project, entrepreneurs can make better financial decisions that will drive bottom line profits instead of just spinning the wheels in one place.

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Financial Management

Which comes first, accounting software or HR software?

Start with accounting software and grow from there.

Peter S. Cohan

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Which do I need more for my small business – accounting software or payroll software? I can’t afford to buy both. And how do I choose between the plethora of options available?

Generally you should start with an accounting package and then add on others as you need them. That said, businesses are like fingerprints: Each one is unique, and has its own set of needs. You may need accounting or payroll or both.

It depends on details like how many staff you employ, how complex your finances are, and how many companies you’re running.

Choose the right software for your business

In my opinion this is one of the most important choices you will make because your accounting software is one of the most important business management tools you will invest in.

If you’re choosing professional software from a reputable software developer, the particular brand name shouldn’t really matter if they are trustworthy and have a strong local presence.

Goedkoop is indeed duurkoop

Too often I hear horror stories of small businesses buying the cheapest product on the shelf which is fine… until things go wrong.

The package doesn’t work properly, they can’t get support, the phones go unanswered and the company they bought the software from doesn’t have the resources to service its customers.

Take advice from your friends, your accountant, your bank, and then make sure you choose a brand with an established reputation and a local office that provides training, support and after-sales service.  Above all, understand that you are making an investment, not a purchase.

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