Written by: Roger Scherping
I’ve spent most of my career trying to see the financial future of the companies I managed. I’ve seen what happens when small companies don’t know what their next 12 months look like, or when they don’t understand the financial impact of their business decisions. So based on my own experiences, I’ve put together 10 reasons why you should do monthly business projections in 2021.
1. Troubled companies need a path
I start with this one because it was when I was turning around companies that I realized the importance of doing projections. I took over several companies that were in danger of closing their doors, and I was always successful at getting them back on the tracks and moving forward again. I realized later that was because I was always able to figure out what was going to happen. I’d figure out what our revenue was going to be and our costs, and then I was able to project our profit and our cash flow. That told me whether we were going to have enough cash or need a bank loan and when things would begin turning around and we could expect to start generating positive cash flow.
Those projections help guide our decision making as we got the company back on its feet. They told us how much we had to raise sales. They told us what we’d need from our vendors. They told us what we could afford to spend and when. And they helped me sleep at night; I would never have gotten any sleep without knowing that we had a clear plan to get us out of trouble.
So if 2020 was not kind to you and you find your company struggling, then learn to always look 12 months out. Instead of just looking backwards with your financial statements, learn to do a monthly projection so that you have a clear plan to get out of trouble.
2. Peace of mind
I hear this one a lot from our customers. They are considering starting a business, but they can’t answer questions like, Can I make money at this? So they cross their fingers and take the leap, full of fear and uncertainty. Or they have an existing business and are uneasy not knowing what lies ahead. Maybe they are uneasy because they don’t know where the path that they are on will take them in the next 12 months.
A projection gives these people peace of mind. By understanding the numbers of their business, they relax because they can see the future 12 or 24 months out. Then, with a clear mind, they can put their worries behind them because they have a clear vision of the future.
3. Lack of planning is a leading cause of business failure
This could be number 1 on this list because it is so true. There are lots of great quotes on planning. My favorites are:
“Planning is bringing the future into the present so that you can do something about it now.”Alan Lakein
“In preparing for battle I have always found that plans are useless, but planning is indispensable.”Dwight D Eisenhower
“Planning is an unnatural process; it is much more fun to do something. The nicest thing about not planning is that failure comes as a complete surprise, rather than being preceded by a period of worry and depression.”John Harvey-Jones
The best way to plan for business success is by doing a monthly projection. Someone told me recently, “You can’t call your banker on Thursday night and say, ‘Uh, I can’t make payroll tomorrow’.” It just doesn’t work that way. You’ve got to plan ahead if you want to succeed.
4. You want to grow?
Nothing taxes your business’s resources more than sales growth. A growing company will need capital for inventory and receivables, capital expenditures, additional personnel, and working capital. If your plans are to grow in 2021, do you know how much cash you’ll need? The worst thing would be that your growth was suddenly strangled by a lack of capital.
Actually, banks love to work with growing companies. They are always happy to lend on receivables, inventory and capital purchases. They will even lend on projected cash flow. So make sure you understand the financial impact that your growth plans will have and the amount of capital you will need. Do a projection.
5. Your bank will require a projection in 2021
The pandemic is going to have a significant impact on banks and borrowers in 2021. Most businesses suffered in 2020. That’s no surprise. Bankers have told me that at the end of 2020, a large number of small business borrowers had fallen behind on their payments or failed to meet their loan covenants. This puts these small business loans in danger of being reclassified as “troubled” or in need of restructuring.
Bank regulators understand about 2020, and they are willing to give small businesses a “pass” on 2020 because of the unanticipated impact of the pandemic. The regulators are willing to look past 2020 under two conditions. First, the small business needs to be able to clearly explain the financial impact that the pandemic had on their business in 2020. And second, they need to demonstrate how they will survive in 2021 by providing a projection for the next 12 months.
Projections have not been this important since 2008.
6. Understand what drives your cash flow
One unexpected benefit of doing a projection is that you will get a better understanding of what drives your cash flow. Once you have your projection done, you can make adjustments and watch the results. What happens to cash if you collect your receivables 5 days fast? if you reduce inventory by 10%? if you renegotiate your debt payments?
You might be surprised by the results, and they might drive you to make changes in your operations that improve your cash management. And when you need to talk to your banker, they will be impressed with the extent to which you really understand your business and what drives your cash flow.
7. See your financial future!
My dad once told me that decision making isn’t difficult. What’s difficult is information gathering. For example, he said, how difficult would it be to pick the right stock to purchase if you had a copy of next year’s Wall Street Journal?
Imagine how much easier your decision making would be if you could look into the future. You’d be able to anticipate problems and deal with them now, when they’re small, instead of later when they are much bigger and more difficult to fix. You could see well ahead of time whether you need to increase your bank line of credit this year. You’d know if you can take money out of the business later this year for that home remodel you want to do.
When I was president of a $20M company and had my own CFO, I still did my own projections. I just had to look ahead and see our financial future!
8. Understand the financial impact of your business decisions
Seeing your financial future also allows you to better understand the financial impact of your business decisions. Start with a baseline projection, maybe assuming a 2% increase in sales. Then modify that to include a 10% increase. What impact does that have on your bottom line and on your cash flow?
Or maybe you’re considering adding a new product line or purchasing some new equipment. Revise your projection and compare the results to the baseline projection.
I knew a guy once who bought three franchises. After he opened the first one, I asked him when he’d know it was the right time to open the next one. He just shrugged his shoulders. He had no way of understanding the financial impact of a big decision like this. What he needed was a projection that allowed him to model his decision and see the financial impact so that he was no longer in the dark.
9. Project your cash balance
Is there any financial metric that’s more important than your cash balance? I think it’s more important than sales or even profit.
Without cash, your vendors don’t get paid or you miss payroll, and then your business stops. A projection will tell you your expected cash balance each month. You’ll see the lowest it will get during the year, and if it might go negative you can make changes now! Reduce inventory or spending, or accelerate collections.
Many small business owners’ understanding of their cash situation is limited to their current bank balance! Learn to look ahead to keep your cash balance positive!
About the author:
Roger Scherping has many years of financial and general management experience in small companies. As CFO, COO, general manager, or president, he has successfully grown companies of up to $20 million in sales. Many of these companies were in trouble, and he turned them around and created for them a path for profitable growth. Roger’s expertise is in financial management, business planning, managing and fixing small businesses, and financial modeling.