Keeping proper records and understanding financial reports are vital for understanding the financial state and cash flow of your business. 

Budgets and forecasts

Financial forecasts assist you to meet your business goals. They are a future prediction of your business finances, as compared with statements, which provide details of actual results or progress.

Predicting the financial future of your business is not easy, especially if you’re starting a business and don’t have a trading history. However, forecasting and making adjustments frequently will enable you to become more accurate.

Monthly or weekly forecasts may be necessary when starting your business, experiencing rapid growth, or having financial difficulties. Regular forecasts allow you to closely monitor your finances and develop strategies to fix problems before they become major issues.

Monthly or quarterly forecasts may be more appropriate for a stable, established business. Financial forecasts may include the following.

Start-up costs

Whether starting a new business or purchasing an existing one you will need to factor in start-up costs, such as:

  • legal or accounting fees
  • insurance costs
  • furniture, equipment, supplies or fit-out
  • stock
  • advertising
  • permits
  • cash required to fund the business until you start collecting payments from customers
  • staff wages
  • leasing costs of property, plant and equipment

To help you calculate these costs download our initial start-up costs calculator.

Tip: Starting a business often costs more than you expect; it is a good idea to add an extra 20 per cent to your forecast to allow for unexpected expenses.

Sales

Estimating the sales your business will generate over the forecast period can be difficult. If you are starting a new business you can base your estimates on market research and industry benchmarks. For an established business, take into account previous sales data over the same time period. You will also need to consider the current market and other economic conditions.

Download our sales forecast calculator to help with your planning.

Tip: Regularly review actual sales figures against your forecast, revising your forecast accordingly if the results differ from those expected. Being able to identify the reason for the difference may help you to address a problem before it becomes a major issue.

Expenses

An expenses forecast estimates your ongoing operational costs over a period of time. Business expenses may include (amongst others) rent, insurances, vehicles, advertising, employee wages, and accounting and legal fees.

If you are starting a new business, base your forecast on market research and industry benchmarks. If you are already operating a business, use records from previous years to assist you. Make sure you allow for any likely changes, such as an increase in costs or employing additional staff.

Download our operating expenses forecast tool to help you track your expenses.

Cost of goods sold (COGS)

If you sell physical products you will need to forecast how much it costs to produce or stock them.

The COGS forecast relates to your sales forecast. If you are forecasting an increase in sales, the cost of producing the goods will also increase (you will need to purchase more components or stock).

To forecast COGS you will need to include all the direct costs associated with production and preparation for sale. These may include:

  • the wholesale cost of buying completed goods, raw materials or parts
  • packaging
  • freight and freight insurance 
  • commissions paid on sales
  • direct labour costs used to manufacture the product

Download our cost of goods sold (COGS) calculator to help you track your costs

Cash flow

A cash flow forecast estimates the amount of money you expect to flow in (receipts) and out (payments) of your business, including projected income and expenses. A forecast is usually done over a 12 month period but could also cover a shorter period, such as a month.

Cash flow forecasts can help you identify when you may have extra cash available or experience shortages, so you can make the right decisions for your business. It is important to review your cash flow forecast regularly against actual results. A forecast can provide warning signs that may help you to avoid future financial problems. Watch out if your cash payments are more than cash receipts – you will run out of money.

Download our cash flow forecast tool to help you plan.

Profit and loss (P&L)

Usually produced monthly, this is a summary of income and expenses for your business. The P&L will inform you whether your business made or lost money for the month under review.

A P&L usually has five main components:

  • revenue (sales/turnover)
  • cost of goods sold (COGS)
  • gross profit (revenue minus COGS)
  • expenses
  • net profit (gross profit minus expenses)

Formula: Sales – COGS = gross profit – expenses = net profit

The net profit will show whether your business has earned or lost money. When reviewing your P&L it is useful to analyse four key benchmarks or performance indicators (KPIs).

Analysis KPI Formula
What percentage of the sales price covers the cost of providing or producing the product or service? COGS as a percentage of sales/revenue COGS ÷ revenue x 100
Is my business running profitably? Gross profit margin Net profit margin Gross profit ÷ revenue x 100
Net profit ÷ revenue x 100
What percentage of the sale price covers the fixed costs of my business? Expenses as a percentage of sales/revenue Expenses ÷ revenue x 100

Gross profit is an indicator of efficiency. The higher the gross profit margin the better, as your business keeps more from each dollar of sales. If your gross profit margin decreases over time you will need to determine the reason and take action to address the decline.

The net profit margin is an indicator of how much profit you make (before tax) from every dollar you spend. A fall in net profit margin generally means you are paying more in expenses, which needs to be monitored. More profitable businesses generally spend less of their income on expenses.

View our example profit and loss statement.

Your business structure will determine how some expenses are calculated. Your accountant can provide detailed advice regarding your structure.

Sole traders – drawings (money taken by the owner for personal use) are not an expense. You pay tax on the net profit regardless of how much you have taken in drawings.

Partners – if there is a partnership agreement, net profit is allocated according to the proportion set out in the agreement. If there is no agreement, net profit is shared equally between the partners. Each partner pays tax on the amount of net profit they receive, regardless of how much the partner may have taken out as drawings.

Companies – salaries for working directors are treated as an expense along with employees’ wages. Net profit is available for distribution to shareholders as dividends. Net profit and taxable income can be different because for tax purposes some expenses may or may not be allowable and some income may be assessable or not assessable.

Balance sheet

A balance sheet is a snapshot of what a business owns (assets) and owes (liabilities) at a specific point in time. A balance sheet is usually completed at the end of a month or financial year and is an indicator of the financial health of your business.

A balance sheet is in three sections:

  • assets – including cash, stock, equipment, money owed to business, goodwill
  • liabilities – including loans, credit card debts, tax liabilities, money owed to suppliers
  • owner’s equity – the amount left after liabilities are deducted from assets
  • Assets and liabilities are divided into current (short-term) and non-current (long-term) as shown below:
    • Current assets: Items of value that are expected to be consumed or converted into cash within the next 12 months, such as stock that turns over regularly and payments from debtors.
    • Non-current assets: Items not expected to be consumed or converted into cash within the next 12 months, such as equipment, vehicles, buildings, and goodwill.
    • Current liabilities: Items expected to be paid within the next 12 months, such as credit card debts, tax owed, short-term loans, and stock purchases.
    • Non-current liabilities: Items not expected to be settled within the next 12 months, such as mortgages on buildings and long-term loans.

View our example balance sheet.

Financial health indicators

Your P&L and balance sheet can be analysed in more detail to determine key performance indicators (KPIs) as outlined below.

Analysis KPI Formula
What level of sales do I need to cover all my expenses? Breakeven point COGS + expenses
Is my business operating profitably Gross profit margin Net profit margin Gross profit ÷ revenue x
100 Net profit ÷ revenue x 100
Does my business have too much debt? Debt to income ratio Total liabilities ÷ sales x 100
Can my business survive an economic downturn? Debt to equity ratio Total liabilities ÷ equity x 100
Can my business afford to pay its bills? Liquidity ratio Current liabilities ÷ current assets x 100
How much working capital should I retain in the business? Working capital ratio Current assets ÷ current liabilities
Is my business earning a worthwhile return? Return on investment Net profit ÷ equity x 100
How quickly is my stock turning over? Inventory turnover Closing stock ÷ COGS x 365
How many days do customers take to pay me? Accounts receivable Accounts receivable ÷ net sales x 365
How quickly am I paying invoices? Accounts payable turnover Accounts payable ÷ purchases x 365
Are my expenses under control? Expenses ratio COGS + total expenses - (depreciation and interest) ÷ revenue x 100