Written by: Roger Scherping
A business projection is not an accounting tool! It’s a management tool. Whether you’re starting a business or your business has been around for a while, understanding the numbers of your business is critical to your success. I’ve asked many entrepreneurs how they know it’s the right time to expand their business or whether they can afford to hire a new employee. Their answer worries me because it’s usually a shoulder shrug followed by, “I just go with my gut.”
You’ve got too much riding on your business to just go with your gut! Of course, most small business owners don’t have a strong finance background, and often they don’t even have a controller to help them. Many have no idea how to run the numbers before they make a big decision. But a good model of your business will either confirm what you thought and make you more confident in your decision, or it will stop you from making a choice that will haunt you down the road.
A Turnaround Company
Not long ago I met an online retail company that was completely out of cash. Their bank was beginning the process of pushing them out. They had no way to satisfy the bank, and they owed dozens of vendors thousands in past due invoices. The only numbers they had on their business were a basic income statement and balance sheet.
I helped them model their business. We started with a sales forecast for the next 12 months. We then projected what their cost of sales and order fulfillment costs would be. We calculated their inventory needs based on current turns and how many days of inventory they had on hand. We budgeted for their employees and overhead expenses. We forecasted their planned expenditures for website and operating software updates. When we were done they had, for the first time ever, an idea of what their business looked like 12 months out. And they saw just how much worse their cash was going to get if they kept going the way they were going.
Time to Make Changes
So they used what the projection told them to take action. Realizing that their inventory was overstocked, they sold off old inventory that wasn’t moving. They priced these goods at whatever they could get for them. Gross margin didn’t matter; cash did. That new cash allowed them to pay off some very old and very angry vendors. With the vendors happy again, they began ordering new merchandise. But this time the emphasis was on what would turn quickly. They had to more than double the number of inventory turns that they were achieving before.
Over the next 12 months, we updated their financial model every month. We recalculated their inventory turns every month. We reforecasted sales and expenses. This way they always had a good idea of where their ship was headed. It took a long time, but their strategy stabilized things financially. They are now making a small profit, and they are caught up with all of their vendors. They aren’t out of their bank yet, but they can present a nice turnaround picture and a projection of even better stability and growth ahead.
A Fast Growing Company
Another company I know is a fast-growing startup. Sales are no problem for them. They started their business with hundreds of thousands of dollars in orders and the need to quickly import many container loads of product from Asia. One might say that their problem is cash, and that wouldn’t be incorrect. Their real problem, though, is that the owners aren’t thinking beyond their short-term cash need. No one is thinking about how this business will grow. What do sales look like 6 or 12 months out? When are they adding additional products? What are the margins on those products? When do you begin hiring employees? What will your overhead costs be as the company grows?
The owners aren’t looking at their business holistically. They’re just thinking about how to get enough cash to pay for their imminent containers. I’ve told them the importance of modeling their business and getting a firm grasp on cash flow, sales, and profits so that they capitalize on the great opportunity that they have. A tool like ProjectionSmart would give them that 12-month look-ahead on their business. Having this understanding of their business will also be extremely helpful when they talk to banks. Are they listening? Stay tuned for updates.
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.