Managing Your Finances

Managing Your Finances

by Colin Barrow, Stephen Brookson
     
 

Expert advice for success in a small business. Learn from an expert the most effective way to manage your business finances. From preparing a business plan and raising capital to establishing sound management and financial controls, this jargon free-guide shows you how to run your business successfully. Essential know-how on taxation and legal issues is supplemented… See more details below

Overview

Expert advice for success in a small business. Learn from an expert the most effective way to manage your business finances. From preparing a business plan and raising capital to establishing sound management and financial controls, this jargon free-guide shows you how to run your business successfully. Essential know-how on taxation and legal issues is supplemented by helpful charts and diagrams, at-a-glance tip boxes, case studies, questionnaires, and checklists that gives you a complete understanding of small-business finance. In Estimating Finances, you'll learn about preparing your business plan, and forecasting cash flow. Then move on to Raising the Money, to find out about organizing your business, and choosing a source of finance, followed by Tracking the Money, which covers keeping the books, the profit and loss account, the balance sheet, and accounting rules. Finally, discover the keys to Controlling the Numbers, from watching the big picture, going into detail, and setting out your budget, to improving your performance. Managing Your Finances also provides Useful Information, from legal matters, financial matters, and glossary, to useful contacts, and suggested reading. Managing Your Finances is one of four new titles in an innovative series of practical guides, covering every aspect of business, for everyone starting their own small business.

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Product Details

ISBN-13:
9780789471987
Publisher:
DK Publishing, Inc.
Publication date:
05/28/2001
Series:
Small Business Guides Series
Edition description:
1 AMER ED
Pages:
192
Product dimensions:
6.10(w) x 8.58(h) x 0.77(d)

Read an Excerpt


Chapter One


Preparing Your
Business Plan

A well-prepared business plan is the foundation upon which the financial success of your business depends. It will also help you to decide how much money is needed, by when, and for what purposes. A business plan is a selling document that conveys the excitement and promise of your business to a potential backer or shareholder. That audience can include outsiders, such as the bank, venture capitalists, or even current and prospective employees who need to be confident that there is a future in the business for them.


Perhaps the most important step in managing the finances of any new venture or expanding an existing one is the construction of a business plan. The plan should be prepared and written by you with the help of other people who are vital to its implementation. Such a plan must include your goals for the enterprise, both short and long term, as well as a description of the products or services you will offer, and the market opportunities you have anticipated for them. Finally, it should include an explanation of the resources, financial and other, that you are able to employ to achieve your goals in the face of competition.

    No start-up or growing business should be without a current business plan that has been reviewed within the past six months. The planning horizon should be at least three years, because it takes this long to implement anything of strategic merit. The first year of the plan will form the framework for the operating budget. This is the profit and loss style description of how you will execute your businessstrategy (For more information on profit and loss, see pp. 84-39.)


Why Have
a Business Plan?


A business plan will be a useful tool both for you, as the owner of the business, and for any outsiders who are interested in your business, such as prospective employees and potential financial backers. Its benefits justify the work needed to prepare the plan. Constructing a business plan has four immediate benefits:

It tests the validity of your ideas.

It gives you the confidence to proceed.

It provides an overview of your financial requirements.

It gives you valuable planning experience.


Testing Your Ideas

The systematic approach required in creating a business plan means you make your mistakes on paper, rather than in the marketplace.


Increasing Your Confidence

Once completed, a business plan will make you feel more confident in your ability to set up and operate your planned venture. It may even compensate for any lack of capital and experience, provided of course that you have other factors in your favor, such as a sound idea and a sizable market opportunity for your proposed product or service.


Giving an Overview of Your
Financial Requirements

Your business plan will show how much money is needed, what it is needed for, and when and for how long it is required.

    Undercapitalization and early cash flow problems are two important reasons why new business activities fail, so if you have a soundly prepared business plan you can reduce these risks of failure. You can also safely experiment, on paper, with a range of viable strategies, and so concentrate on options that make the most efficient use of scarce financial resources.

    It would be an overstatement to say that your business plan is the passport to sources of finance. It will, however, help you to display your grasp of the financial dynamics of your business to the full, and to communicate your ideas to others in a way that will be easier for them to understand and to appreciate the reasoning behind your ideas. These outside parties could be bankers, potential investors, partners, or advisory agencies. Once they know what you are trying to do, they will be better able to help and advise you.


Providing Planning Experience

Preparing a business plan will give you an insight into the financial planning process. It is this process itself that is important to the long-term financial health of a business, and not simply the plan that comes out of it. Businesses are dynamic, as are the commercial and competitive environments in which they operate, and no one expects every event as recorded on a business plan to occur exactly as predicted. But the understanding and knowledge you will gain as you go through the process of constructing your plan will prepare your business for any changes that it may face, and so enable it to adjust quickly


Avoiding a High-Risk Start-up

Despite these many valuable benefits, thousands of would-be entrepreneurs still attempt to start without a business plan. The most common such offenders are businesses that appear to need little or no capital at the outset, or whose founders have funds of their own; in both cases it is believed unnecessary to expose the project to harsh financial appraisal.

    The former hypothesis is usually based on the easily exploded myth that customers will all pay cash on the spot and that suppliers will wait for months to be paid. In the meantime, the proprietor has the use of these funds to finance the business. Such model customers and suppliers are, unfortunately, thinner on the ground than optimistic entrepreneurs think. In any event, two important market rules still apply: either the product or service being offered fails to sell like hot cakes, and mountains of unpaid inventory builds up in the warehouse, all of which eventually have to be financed, or it does sell like hot cakes, as a result of which more financially robust entrepreneurs are attracted into the market. Without the staying power that adequate financing provides, these new competitors will rapidly kill off the business.

    In the second scenario, those would-be entrepreneurs with funds of their own or, worse still, borrowed from friends and relatives, tend to think that the time spent in preparing a business plan could be more usefully spent looking for premises, buying a new car, or installing a computer. In short, anything that inhibits them from immediate action is viewed as a waste of time.

    Most people's initial perception of their business venture is flawed in some major respect, so jumping in at the deep end is risky, and unnecessarily so. Flaws can often be discovered cheaply during the preparation of a business plan; they are always discovered in the marketplace, invariably at a much higher and often fatal cost


Aiming Your Plan at
Potential Financiers


All successful businesses need external financing at some stage in their development, and if you are to succeed in raising those funds it is important to examine what financiers expect from you.

    It is often said that there is no shortage of money for new and growing businesses, the only scarce commodities being good ideas and people with the ability to exploit them. From the potential entrepreneur's position, this is often hard to believe. Out of every 1,000 business plans received by venture capital providers, only 100 or so are examined in any detail, less than 10 are pursued to the negotiating stage, and only one of those is finally invested in.

    To a great extent, the decision whether to proceed beyond an initial reading of the plan will depend on the quality of the financial arguments and the revenue, or sales, model used to support the investment proposal. The business plan is the ticket of admission, giving the entrepreneur their first and often only chance to impress any prospective sources of financing with the quality of their proposal.

    It follows that to have any chance at all of getting financial support, your business plan should pay high regard to the likely requirements of potential financiers. The two main potential sources of financing, banks and venture capitalists, each have different requirements.


What the Banks Look For

Bankers and other sources of debt capital are looking for asset security to back their loan, and the near certainty of getting their money back. Essentially, banks are in the business of converting illiquid assets, such as property or stock, into liquid assets, such as cash or overdraft facilities. They will also charge an interest rate that reflects current market conditions and their view of the level of risk of the proposal. Depending on the nature of the business in question and the purpose for which the money is being used, bankers will take a two- to five-year view.

    Bankers will usually expect a business to start repaying both the loan and the interest on a monthly or quarterly basis as soon as the loan has been granted, although in some cases a capital holiday of up to two years can be negotiated, during which time no repayments are made. In the early stages of any loan, the interest charges make up the lion's share of payments, in the same way as mortgage repayments, and you must allow for this in your cash flow projections.

    Bankers hope that a business will succeed in order that they can lend more money in the future and provide more banking services, such as insurance or tax advice, to a loyal customer. It follows from this appreciation of lenders' needs that banks are much less interested in rapid growth and the consequent capital gain than they are in being assured of a steady stream of earnings almost from the outset of the business trading.


Dos and Don'ts of
Borrowing Money


[check] Do borrow as much as your plan says you need.

[check] Do talk to several lenders before deciding from whom to borrow.

[check] Do explain the risks of your business as well as the rewards.

[check] Do make sure the loan term is long enough for you to reach breakeven.


X Don't borrow from anyone who can't afford it.

X Don't raise money until you need it and so incur unnecessary charges.

X Don't conceal information about your credit or
business record from a prospective lender.

X Don't ignore government guaranteed programs; they can be better lending value.


What the Venture
Capitalists Look For

Most new or fast-growing businesses generally do not make immediate profits, so money for such enterprises must come from elsewhere. Risk or equity capital — the capital of a business that comes from the issue of shares — as other types of funds are called, comes from venture capital firms, as well as being put in by founders, their families, and friends.

    Because the inherent risks of investing in new and young ventures are greater than those of investing in established companies, venture capital fund managers have to offer their investors the chance of larger overall returns. To do that, fund managers not only have to keep failures to a minimum, they also have to pick some big winners — ventures with annual compound growth rates above 35 percent — to offset the inevitable mediocre performers. (Bearing in mind the massive growth in internet access, it is hardly surprising that the dot.com sector has sucked up so much equity financing.) Typically, a fund manager would expect any 10 investments to comprise one star, seven also-rans, and two flops. However, despite this outcome, venture capital fund managers are looking only for winners, so, unless you are projecting high growth in the short to medium term, the chances of getting venture capital are slim.

Venture Capitalists as Shareholders

Not only are venture capitalists looking for winners, they are also looking for a shareholding in your business. The size of the shareholding will vary with each business.

If the venture capital firm sees that you have a great business idea, a first-class team, and a product/service that is ready to roll, they would be looking for a third or more of the shares in your business as their reward for putting up the money. That portion could be further reduced if the management is putting (or have put) in some of their own money, or if a bank is lending. If the idea is not fully developed, or your team is weak — in which case they may want to put in a director and a managing executive and work with you to strengthen the team — they may aim for more than a third of your business to compensate for the increased risk.

It all comes down to how much you need the money, how risky the venture is, how much money could he made from your business, and your skills as a negotiator.

Fast-growing companies typically have no cash available to pay dividends and, in the case of many dot.coms, may not have made any profits in any case, so investors can profit only by selling their holdings. With this in mind, the venture capitalists need to have an exit strategy in view at the outset, such as an initial public offering or a potential corporate buyer.

Short-term Investment

Unlike many entrepreneurs (and some lending bankers), who see their ventures as lifelong commitments to success and growth, venture capitalists have a relatively short-term horizon. Typically, they are looking to liquidate small company investments within two to six years, allowing them to pay out individual investors and to have funds available for tomorrow's winners. So your financial plan needs to accommodate this timescale.


Balancing the Sources

To be successful, your business must be targeted at the needs of these two sources of financing, and in particular at the balance between the two. Lending bankers ideally look for a ratio of 1:1, which means that half the business's finances are borrowed and half comes from risk capital. Banks have been known to go to a ratio of 4:1, but rarely willingly or at the outset of their involvement. Venture capital providers will almost always encourage entrepreneurs to take on new debt capital to match the level of equity, or share, funding.

    If you are planning to raise money from friends and relatives either as debt or equity, then their needs must also be taken into account in your business plan.


Believable Growth Forecasts

Right at the heart of every investment or lending proposition is the need to demonstrate that the business will deliver a satisfactory financial result. The business plan needs to show, in summary form, the key results to be achieved. This should cover sales, cash flow, profits, margins, and investment returns for a sufficient period to give confidence.

    Entrepreneurs are naturally ebullient when explaining the future prospects of their businesses. They frequently believe that the sky is the limit when it comes to growth and that the lack of money is the only thing that stands between them and their almost certain success.

    It is true that if you are looking for venture capital, then the providers are also looking for rapid growth. However, it is also good to remember that financiers are dealing with thousands of investment proposals each year, and already have money tied up in hundreds of business sectors. It follows that they already have a perception of what the accepted financial results and marketing approaches currently are for any sector. Any new company's business plan showing projections that are outside the ranges perceived as acceptable within an industry will raise questions in the investor's mind.

    Make your growth forecasts believable, supporting them with hard facts where possible. If your forecasts are on the low side, then approach the more cautious lending bankers, rather than venture capitalists. The former often see a modest forecast as a virtue, lending credibility to the business proposal as a whole, rather than being impressed by ambitious goals.


Presenting
a Business Plan


Having decided on the contents of your business plan, you now need to consider how to present the material in order to make it into a professional and impressive document that will convince backers to support your idea.


Deciding on the Packaging

Every product is enhanced by appropriate packaging, and a business plan is no exception. Most experts prefer a simple spiral binding with a clear plastic cover front and back. This makes it easy for the reader to move from section to section, and it ensures that the document will survive the frequent handling that every successful business plan is likely to get. A letter-quality printer, using a 12-point typeface, double spacing, and wide margins, will result in a pleasing and easy-to-read plan.

    There is no such thing as a universal business-plan format. That being said, experience has taught us that certain styles have been more successful than others. Following these guidelines will result in an effective business plan that covers most requirements. Not every subheading will be relevant, but the general format is robust and is equally suitable for new businesses of any size.


Cover and Title Page

First, the cover should show the name of your business, its address, phone and fax numbers, email address, and website (if you have one), and the date on which this version of the plan was prepared. It should confirm that this is the business's current view on its position and financing needs.

    Second, the title page, immediately behind the front cover, should repeat the above information and also give the founder's name, address, and phone number. A home phone number can be helpful, particularly for investors, who often work irregular hours.


The Executive Summary

Ideally one page, but certainly no longer than two, the executive summary follows the title page. Writing this is the most difficult task, but it is the single most important part of the business plan. Done well, it can favorably dispose the reader from the outset. Done badly, or not at all, the plan may not get beyond the mail room. The executive summary can be written only after the business plan has been completed, because it summarizes all the contents of the plan.


The Table of Contents

This page follows the executive summary and is the "map" that will guide readers through the business proposal. If that map is obscure, muddled, or even missing, then you are likely to end up with lost or irritated readers who are in no mind to back your proposal.

    Each main section should be listed, numbered, and given a page number. Elements within each section should also be numbered; for example, Section 1 would contain elements 1.1, 1.2, and so forth.


The Body of the Plan

The contents of the business plan should include the following main sections, each with its own heading:

The Business and its Management Outline a brief history of the business and its performance to date and give details on key staff, current mission, capital structure, legal entity, and professional advisers.

Products and Services Give a description of products and services, their applications, competitive advantage, and proprietary position. Include details on the state of readiness of new products and services, and development cost estimates.

Marketing Provide a brief overview of the market by major segment, showing size and growth. Explain the current and proposed marketing strategy for each major segment, covering price, promotion, distribution channels, selling methods, location requirements, and the need for acquisitions, mergers, or joint ventures, if any.

Management and Staffing Give details on current key staff and on any recruitment needs to achieve the planned goals. Include information on staff retention strategies, reward systems, and training plans.

Operations Describe how your products are made, how your services are provided, how quality standards are assured, and how your output can be stepped up or down to meet the varying levels of demand implied in the business plan. It is important to demonstrate a degree of flexibility.

Financial Forecast and Controls Provide a projected profit and loss statement (see pp. 84-89), together with a description of the key controls used to monitor and review your performance.

Financing Requirements Show the finances needed to achieve the planned goals, together with timings. You should also demonstrate how the business would proceed using only internal funding. The gap between the two levels of production is what the extra money will help to deliver.

Appendices could include a resumé for each of the key team members, technical data, patents, copyrights and designs, details on professional advisers, audited financial statements, consultants' reports, abstracts of market surveys, details of orders in hand, and so on.


Addressing the Reader

Clearly a business plan will be more effective if it is written with the reader in mind. This will involve some research into the particular interests, foibles, and idiosyncrasies of those readers. Of the four likely types of readers, bankers are more interested in hearing about certainties and steady growth, venture capitalists are also interested in dreams of great things to come, potential partners are concerned with whether or not this is a venture they want to share in, and potential employees will want to be convinced that you can offer them interesting and secure employment.

    It is a good idea to carry out your research before the final editing of your business plan, so that you can incorporate something of this knowledge into the way it is presented. You may find that slightly different versions of the plan have to be made for different audiences. This makes the reader feel that the proposal has been addressed to them rather than just being a "Dear Sir or Madam" type of missive. The fundamentals of the plan will, however, remain constant whatever the readership.


Editing Your Plan

The first draft of the business plan may have several authors and it can be written ignoring the niceties of grammar and style. Now would be a good time to talk over the proposal with your legal adviser, to keep you on the straight and narrow, and with a friendly banker or venture capitalist. Their opinions can give you an insider's view as to the strengths and weaknesses of your proposal at a stage when you still have time to alter it.

    When the first draft has been revised, then comes the task of editing. Here grammar, spelling, and a consistent style do matter. The end result must be a crisp, correct, clear, and complete plan, no more than 20 pages long. If you are not a confident writer, you may need help with the editing. Your local librarian or college may be able to help by providing you with suitable contacts.

(Continues...)

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