A business blueprint
Chris Roberts on the difference between profit and cash and the need for financial projections
People like talking about profits, whether it’s how much they are going to make or how much they have already made. Yes, profits are hugely important because you don’t want to be running a loss-making business. What is even more important, however, is the answer to the question: ‘Do you have enough cash to pay your bills as and when they are due?’
A simple fact is that businesses go bust when they run out of money and we really don’t want this to happen to you, so read on and find out how to avoid the pitfalls. Let’s assume a franchise supplies goods on 30 days’ credit and on a Friday afternoon they make a £20,000 sale for goods they bought for £10,000. They despatch the goods and raise an invoice.
They can, therefore, legitimately claim to have made a profit, and may decide to celebrate that weekend with several bottles of wine! If they come back into work on the Monday morning, however, and need to pay the vat bill or perhaps the wages but don’t have enough cash in the bank to do so, they are in big trouble. Yes, they have made a profit, but it is having a sufficient amount of cash, or working capital, that really matters. In reality, it’s all about timing.
The glossy brochure promoting a new franchise might state that a franchisee should be able to make a profit of £30,000 in the first year and that the start-up costs are £20,000. You could be forgiven for thinking that if you have £20,000 now to invest and you are going to make a profit by the end of the year that success is only just around the corner.
The reality is that without some sensible planning, and by this I mean checking to see how much cash or working capital is going to be needed over and above the £20,000 for the start-up costs, this is simply a car crash waiting to happen. Sales in the first few months are likely to be much lower than the last few months of the year because it will probably take some time for the business to become established.
Franchise overheads
The overheads (salaries and rent, etc.) will probably be consistently high from the first month. This means that for the first part of the year the business will be making a loss and will need some additional cash to sustain it through into the profitable months in the second part of the year.
This additional cash is what we refer to as working capital. Now the question is how much will you actually need? The only way of working this out accurately is to produce a comprehensive set of financial projections incorporating a monthly profit and loss account, a monthly cashflow forecast (a crystal ball image of your bank account showing how much money you will need to do it) and an end-of-year projected balance sheet (a list of your business assets and liabilities, showing what your business will actually look like in the future in terms of what it owes and what it owns).
This is quite a complicated but necessary process and deserves some care and attention because it is crucial to the success of your business. Do ask for help from your accountant, franchisor or business consultant and remember the old saying: turnover is vanity, profit is sanity and cash is reality.
Chris Roberts is a director of Franchise Finance, which runs various financial training courses and prepares business plans and financial projections for franchisees and franchisors with a 95 per cent success record in raising funds for their clients.
