5.3 Financial management tools

We have looked at the construction and amendment of the cash flow and profit-and-loss accounts. These are more powerful than they seem at first viewing. They can provide:

• Bank credit limit forecast: the cash flow enables the likely bank credit limit to be calculated. This enables us to forecast where we may have problems, and work out a solution.
• Profit: we will not survive if we do not make a profit. The profit-and-loss enables us to test our business model for profitability – and adjust.
• Budget forecast: the figures we put into the two spreadsheets for future months are, in reality, a budget. The spreadsheets enable us to flex these budgets and ask ‘what if’ questions. We will also be able to identify variances from the budget.
• Risk calculation: the ‘what if’ ability of spreadsheets enables us to consider the greatest risks and see what effect they might have. In the case of Catterline, one risk would be currency fluctuations. The bank might advise Hannah that it is prudent to consider the risk of a 10 per cent devaluation of our currency. The spreadsheet would quickly enable Hannah to see what the increased price of components would mean to cash flow and profit.
• Investment: the spreadsheets enable us to identify future investment needs and potential gaps in funding. Catterline might benefit from a £100,000 investment, but the profit-and-loss will show what profits could be generated if the bank credit limit was reduced by the investment. The spreadsheets would also show potential investors how the company was expected to perform in the future. Some organisations produce cash-flow and profit-and-loss forecasts for three years to do this.

It should also be clear from the above analysis that a new start up business’s room for manoeuvre can be strongly affected by the lines of credit it is able to negotiate (usually with its bank). On the whole, banks are usually very helpful if they are told well in advance about a cash flow problem that requires reconsideration of credit limit levels. They see this advance warning as an indication that management has the proper controls in place. On the other hand, they are very unimpressed with an organisation that finds out that they have just gone over their agreed credit limit.

The cash flow for the next 18 months – updated each month – will give Hannah advance warning of any cash flow problems and enable her to either deal with the problem or contact the bank to discuss credit arrangements.

‘What if’ questions are essential to minimise risks at start-up. When producing a business plan it is very difficult to forecast all the changes that could take place in the external environment, particularly changes in sales of your product or service. Using a spreadsheet to see the results of possible changes will enable you to minimise risk and have a contingency plan for a sudden drop or rise in sales.