So you have a great business idea which you believe will be successful. The only drawback is that you need to borrow money to purchase supplies or simply to buy time for the business to generate sales and become self-financing.
Whatever the reason for borrowing money, it’s likely that you will be asked for a business plan accompanied by a cashflow and profit and loss forecast. Although they look very similar, these are very different forecasts .
Bank managers are trained to study these forecasts so it is important that you take your time and undertake as much research as possible to be as accurate as you can.
What is a Profit and Loss Forecast?
A profit and loss forecast helps you to determine whether your business may be profitable and therefore provide some comfort for you to proceed with your plan. If, on the other hand, you realise that there is no way you can make a profit for a year or two, then you need to understand the consequences of this and whether your business will be able to survive.
It’s important to note that if a business is making losses for a period, then these losses will require financing either by an external financier such as a bank, or via your own resources. Losses will be reflected in the cash flow forecast which is why financiers require both forecasts. They want to see what the worst position may be. Likewise, if the business is profitable, with profitable sales your forecast should confirm this by showing improved cash flow.
A profit and loss forecast is usually written to cover a 12-month period. Some financial institutions may ask for a second years forecast and rarely would a business be asked for a third. A forecast is basically a table of numbers representing the income and expenditure incurred by a business on a monthly basis. It is presented as a table with each cost detailed down the side and the month name across the top (see below).
How accurate must it be? The answer is simple, it should be as accurate as you can make it.
Whilst it is appreciated that you have no control on sales revenues, there has to be some sound basis for you to predict what sales you will generate.
How to write a profit and loss forecast
Before you discover how to write and present your forecasts, it’s important to quickly mention that presentation is important. It is better to present printed forecasts on a spreadsheet rather than hand-written. Most people have access to standard software packages like Windows Excel, so there should not be any excuses for shoddy presentation.
Here’s some simple steps to create your own forecast:
1. Start by thinking about your VAT
Before you commence researching or writing your forecast, it’s important to mention VAT. A business that exceeds £85,000 per annum in sales MUST be VAT registered. This is a simple process. If, when writing your forecast, you realise that sales will exceed £85,000 then you have a choice whether to register for VAT when you are ready to commence trading, or wait until later in the year when sales are close to the registration threshold.
Most business have numerous set up costs from plant and machinery, IT equipment, purchasing stock etc. These items are usually sold inclusive of VAT. If you anticipate being VAT registered in the future, it’s worth considering registering early so you can reclaim the VAT on these items. I recommend you write your cash flow forecasts to cover both VAT scenarios as the cash position will be vastly different.
When writing your profit and loss forecast, if you expect to be VAT registered, then the number you will input will be net (without) VAT. Profit and loss forecasts do not include VAT. When you create your cash flow forecast, all figures are inclusive of VAT. You will therefore need to calculate the VAT per period i.e. month or quarter on all of your sales, purchases and vat rated overheads so that you are showing you are paying VAT to the Government.
2. Plan your sales figures
Your sales will be the first line on your forecast.You may decide it will take three months to set up your business and therefore you do not expect to generate any sales until month 4, and then only a small amount. That’s fine, as this is usual. Sales may grow month on month as your marketing and sales activity increases.
Banks expect all businesses to have an element of seasonality. This means that there is a quiet time and a peak e.g. the peak for a retailer may be Christmas. This could be a quiet period for the consulting industry as companies are generally busier leading up to the Christmas period.
You may decide to show a number of sales lines because your business will be selling a variety of products or services. I suggest you categorise rather than a line per product e.g. if your business was retailing vehicles, then you could have a separate sales line for car, vans, trucks etc.
3. Make sure to include a running total
Before moving on to the next subject, I suggest you add one more column after the final month. This should be your total. If you understand how to write formulas then this column can be set up to automatically calculate the numbers across each line. It is advisable to do this because any changes you make at a later stage will ensure the totals are correct rather than you having to add up each number again.
4. Add in any planned Purchases
After sales, the next area on the left column is purchases. These are the raw materials you require to make your product and can include packaging. If your business sells services, then it’s unlikely you will have to input figures here.
5. Don’t forget your Direct Expenses
There may be some costs that are occurred and can vary depending on the volume of sales you generate. These could be distribution of goods, production wages etc. List the individual costs here and input the figures. If you are good at formulas, you may decide to show these costs as an inputted figure or as a percentage of sales e.g. if you know distribution costs will be 10% of sales, then you could input this way.
6. Use this information to formulate your Gross Profit
Once you have input direct expenses, you need to introduce a line titled “Gross Profit”. Gross profit is calculated by subtracting purchases and direct expenses from wages. This is the profit on goods before the business incurs fixed costs which you’ll discover below. It’s important to show this as a figure but you should know this as a percentage of sales.
7. List your Fixed Costs
These are all of the other costs incurred in a business e.g. rent, rates, telephone, waste, insurance, administration wages. As you see, they are the costs to the business of trading in the premises, generating sales (marketing), accountant’s fees, finance interest. They are the costs of doing business.
Whilst completing your list of fixed costs, note that this includes wages for administration or office staff but not necessarily staff directly involved in production. You must take into consideration tax costs of your team so ensure you list gross wages plus employers PAYE. It’s also worth mentioning that recruitment can be a very long and difficult process. With this in mind, you may need to consider a lead in time to find the staff you require and include a training cost to help them become more productive faster.
Again, list these on a line-by-line basis and total in your final column as you did with sales, purchases and direct costs.
It’s also worth generating a sub-total at the bottom of each column for all of the fixed costs.
8. Calculate your Net Profit
Now you are in a position to calculate net profit by subtracting the fixed costs on a column by column basis from gross profit. You can have a total in the right hand column again showing the total net profit for the year.
This completes your forecast and shows you instantly the volume of sales you require on a monthly basis make a profit.
A Summary of all your figures could be valuable
For your business plan, it is worth writing a summary of how each of the figures was created e.g. rent is £250 per month as I have a confirmed quote from the landlord of the building. That’s all you need to say. Ensure you have the paper trail in another file in case the financier wishes you to prove it. They may decide to verify the numbers.
The more thorough you are when creating an accurate-as-possible profit and loss forecast, the more credibility you will have with the financier, which in turn is going to elevate your chances of securing the finance you require.
Whilst you may decide to ask your accountant to write your forecast, they will still require a lot of input from you. They cannot magically create figures as they do not know your business. This will take time and it is definitely time well spent. It could be that the forecast will show you that the business model in your head does not work. It’s better knowing this early before you commit to the business venture. Alternatively, you may discover the business could be highly profitable and drive you forward at a faster pace.
When you check your figures, recognise the bank or any financier will undertake simple scenario testing. I recommend you also do the same. This is where you ask the “what if” questions such as:
- What if sales were 10% less. How does this effect the forecast and cash? Is there sufficient profit margin to cover costs or will it simply take longer to achieve your initial business goals.
- What if sales were 10% higher. How does this change the requirement for funding? Will the business have sufficient staff and resources to deliver?
The most important advice I can give you is to take your time and ensure you have listed all of your costs and been realistic on your sales estimates. Your credibility is on the line here and so is the financiers. They will have a good idea whether you have taken the time to complete the forecast well. It is your job to understand and be able to explain the make-up of your profit and loss forecast so do not leave it to someone else unless it is purely for the presentation element and you have checked and double-checked the numbers.
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There are a number of important points worth mentioning to finish this article. If, when you have completed your forecasts and tested the strength of the numbers using the 10% either way rule, remember that there is great responsibility in becoming a business owner. Being a business owner can be an exciting prospect, and it should be too, otherwise it isn’t for you. But, remember that you have a duty to financiers, your customers, suppliers, staff and your family to run it well, so please make sure you organise yourself and your team well.
Finally, use every resource you can to skill yourself and your team. Ignorance is not a good defence when something goes wrong and it’s always your neck on the line. I encourage you to do your research and talk to successful business owners.
Important resources from Yell to help your business
Hopefully, you’ve read other articles from Yell which will help you make good decisions on your business venture. I encourage you to read as many articles as you can and most definitely read the cash flow article I have written which goes hand-in-hand with this article on profit and loss forecasts.
Yell also offers many other ways to help budding or existing business owners.
Find out what sets Yell apart from the competition: https://business.yell.com/why-yell/
Check out Yell’s full range of managed digital marketing solutions here: https://business.yell.com./solutions/
Find the right package for your business: https://business.yell.com/solution-advisor/
This article was originally published on 26 June 2017, and updated on 29 July 2019.
