Have you ever wanted to go to an exotic honeymoon vacation location like Santorini or Bora Bora? While you could pay for a trip using your credit card or savings account, you might wonder if it is in the best interest of your future finances. After all, hosting a modern wedding isn’t cheap.
This same predicament is held in business as well as in one’s personal life. CEOs and General Managers constantly calculate how their corporate activities can “fit the budget.” Some common examples of tough financial decisions include hiring future employees, purchasing new machinery for operations, or calculating the efficiency of new measures implemented to cut costs. The immediate question is typically, “Can we afford it in the short-term?”
Even when the answer is yes, the best practice in business finance is to look beyond the short-term to at least one year of this decision’s impact. While you may be able to pay a new employee $50,000 for half a year of work, an annualized allotment of $100,000 for the next full year may prove unfeasible due to the seasonality of the business.
The next step is to evaluate the best way to allocate limited resources.
Whether you have a Fortune 500 company with billions in revenue or a bootstrapped pre-revenue start-up, every company should have an out-looking financial forecast of at least 2-3 years to best judge how a business decision will affect the company in the future. The forecast should factor both historic data as well as estimated future outcomes.
Another forward looking model is a financial projection which is different from a forecast in that it is built to weigh different hypothetical strategic decisions and adjust for each scenario. An example would be a company weighing whether they should take on certain added production costs in order to accommodate excess demand. A projection would be able to factor in the added anticipated sales and additional short and long-term costs to better help management evaluate if this decision is the best course of action.
It is also a useful practice to reevaluate your plans every quarter– at a minimum– to ensure the projection of any material changes. These practices help to mitigate against potential surprises that may arise in future periods.Plan for the worst and expect the best. One popular analysis that may put you ahead of the game is to model out the effect that minimum wage increases will have on your business. You may be surprised at how even a $0.75 increase per hour can have a substantial change to your future profitability.
A common analysis among start-ups is a cash burn analysis. In this exercise, you manage your ongoing rate of cash burn to project out the remaining cash runaway time.. This analysis is vital in order to better estimate when you may need additional funding from either an external or internal source of capital.
Here at Withum, we use our years of experience of Fortune 500 and emerging companies in Financial Planning and Analysis in order to come up with the best in practice methods for creating and advising on the budgeting process. We can do everything from creating a 2-5 year financial model so your business can project future results, to working with you to define a comprehensive budget. We can help you plan for potential future income fluctuations (i.e., hiring ramps) and implement sensitivity functionality to help optimize the budget.
Whatever your next business venture may be, use these tips to protect yourself from long-term adverse effects. Setting yourself—and your business—up for financial success is a foundational step towards a prosperous enterprise.
Author: Eric Lowe, CPA | [email protected]
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