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A Beginners Guide To Cashflow Forecasting Part 2: Working Out Costs

Welcome back to part 2 of our in-depth series on cashflow forecasting, where we go into depth about every aspect of creating a cashflow forecast for your business, from scratch. In our previous post, we talked all about how you go about forecasting your sales, and the things you need to take into account as you do it. If you missed that first part, you can catch up here. In this section, we’re going to talk all about how you can work out the cost of sales for your business, from product costs to services, loans and even VAT.

Cost forecasting is the more challenging element of a forecast, since it lays bare exactly what your business is spending and where. This can reveal some alarming spending for some businesses, but that’s not always a bad thing. If you know where the money is going, then you can take steps to remedy it. The purpose of this cashflow forecast is to help you understand exactly what it is you need to spend, so that you can plan your investments to match your income and avoid dipping into the red. The process for this is basically the same as with your sales forecast, but instead of filling in what you expect to sell, fill in what you expect to spend. No payment is too small to be missed off this list, and you should try and make sure you are fairly accurate with when the payments would be made, as this will be important later. Some examples of payments you may need to include are:

  • Premises rent
  • Employee salaries (including yours)
  • Insurance payments
  • Purchasing stock
  • Equipment

 

Once you have all of your costs written down, you can sort them into their respective groups. You may find that 8 or 9 expenses are all part of your cost of sale, while 4 others are one-off equipment purchases, and some are your annual insurance payments. If you’re not sure what belongs in what categories, we have a few tips for you.

 

Cost of Sales

A lot of people use the term ‘cost of sale’ to cover every expense they have – but that’s just not true. Cost of sales is a very clearly defined thing, and covers any expense that is directly attributable to the production of goods or services sold by your business. Generally, businesses selling products will have a higher cost of sales, since there are elements like the cost of materials and labour cost to take into account. You wouldn’t include more indirect costs here – like marketing or distribution – you’re just looking at exactly how much it costs to make one product. While technically you could skip this stage, doing it alongside your cash flow forecast is really valuable as they are so closely related.

The important thing to take into account here is timing. You might decide to buy a product a month before you get income from selling it, which will affect your cash flow. You might bulk buy products to last you several months, or you might choose to only order stock when a buyer comes in. All of these little variations in the cost of sale can have ab huge impact on your cash flow, so it’s important to plan them correctly. With this plan, you can work out how much each sale is costing you, when it’s costing you, and how much profit you make on each. This is maybe one of the most enlightening exercises we do with some of our clients.

 

Operational Costs

Next, it’s time to look at operational costs. These are your fixed outgoings that allow you to run your business. You’ll be paying these costs whether you make £1 a month or £10,000 a month, because they are the costs that keep your business going. So, you will have fixed costs for things like:

  • Rent
  • Phone line rental
  • Internet connections
  • Utility bills
  • Salaries

 

And all sorts of other day-to-day running costs for your business. These should be known quantities that don’t fluctuate much, so it should be easy to map these out. Just make sure to reference your list of direct debits to make sure you haven’t missed anything. Put together, these two sections should give you a fairly good idea of how much money you’ll need to make just to cover your costs. It’ll also make you more aware of when the big costs are likely to hit your business. For example – do you pay all your bills monthly, or do you get hit with a big annual bill? Is there one month where the costs all seem to pile up, and you need to make sure you have enough in the bank to cover everything?

 

Assets

Most businesses need to buy certain items to run their business effectively. That can be anything from a computer to a piece of machinery – anything that retains value after the initial purchase is classed as an asset to your business. These are items you will physically own, usually for a long period of time. Separating them out from your operational costs allows you to see where the big chunks of money fall and what they are for, so your cashflow forecast won’t end up looking skewed. The types of asset you are likely to purchase depends on the type of business you are running, and can vary hugely. For example, an office-based business will need to buy office furniture and computers, whereas a retail store will need shelving units, storage areas and tills. A tradesman will need a van and high-quality tools, while a coffee shop will need coffee machines, grinders and other specialist equipment. All of these things will need to be bought at a certain time, and need to be planned for in advance so that your cash flow stays positive.

 

Loans & Repayments

Funding is an interesting one, because depending on your accountant or bookkeeper you will be told to put it in different places. Personally, I like to consider it as a separate line item, so that I can be clear of where money is coming from or going to, and when. This is particularly important when you take out business loans, which need to be accounted for in the cash flow, along with any repayments on those loans. There are lots of different ways loans can be structured, so I can’t tell you exactly how that will impact your cash flow. But what we can say is that your individual repayments do need to be factored in if you want to stay on top of your money.

 

VAT

Of course, there is another outgoing that many businesses need to (but forget) to budget for, and that’s VAT. If you are VAT registered, you need to bear in mind when your bill will arrive and plan for it, as it can dramatically affect your profitability. But if you look at a profit and loss statement for a business, you won’t see VAT anywhere. That’s because VAT doesn’t actually affect your profits, but what it does affect is your cash flow. If you’re VAT registered, you will be collecting an extra 20% in payments from your customers, which will go into your bank account with everything else. But at some point in the year, you will get a VAT bill, and that money will need to go back out. This is an area that trips a lot of business owners forget about, so it’s important to factor it in. A good trick is to set up a separate account for VAT, and put a small amount into it each month so that you’re not caught short.

That’s it for this part of our beginner’s guide to cashflow forecasting. In the next and final part, we’ll be covering how you put together all of the information you’ve generated into a single cashflow forecast, and what to do with it next. If you have any questions in the meantime, we’d love to be able to help. Just get in touch with the team at Deerbridge today.