Financial Planning

Financial Planning for Small and Medium Businesses

By Andrew Grigolyunovich, CFA

© 2012, Andrew Grigolyunovich All Rights Reserved This book is protected by the copyright laws of the United States and the European Union

Financial Planning for Small and Medium Businesses. Andrew Grigolyunovich, CFA

2 www.agcapitalcfo.com – outsourced CFO services www.cfotemplates.com – professional financial Excel templates

Table of contents TABLE OF CONTENTS ......................................................................................................................................................... 2 INTRODUCTION ............................................................................................................................................................... 3 THE FINANCIAL PLANNING PROCESS FOR AN ENTERPRISE .......................................................................................................... 5 SETTING GOALS............................................................................................................................................................... 6

Questions to ask ..................................................................................................................................................... 6 Limiting factors in goal setting ............................................................................................................................... 7 Typical errors in setting goals ................................................................................................................................. 9 Execution .............................................................................................................................................................. 10

DEFINING ASSUMPTIONS ................................................................................................................................................. 12 CHOOSING THE RIGHT TOOLS ........................................................................................................................................... 15 THE STRUCTURE OF A BUDGET .......................................................................................................................................... 16

Projecting sales and cost of goods sold ................................................................................................................. 18 Projecting sales amounts ...................................................................................................................................... 23

PROJECTING OTHER COSTS .............................................................................................................................................. 27 Structuring cost budgets ....................................................................................................................................... 27 Projecting salaries ................................................................................................................................................ 29 Projecting costs for a retail network ..................................................................................................................... 34 Projecting marketing costs ................................................................................................................................... 35 Projecting other costs ........................................................................................................................................... 36 Working capital projections .................................................................................................................................. 37 Inventory projections ............................................................................................................................................ 37 Projecting account payable and accounts receivable ............................................................................................ 39 Projecting capital investment and depreciation schedules .................................................................................... 40 Projecting external financing ................................................................................................................................ 43 Adding Everything Up ........................................................................................................................................... 44

CONSOLIDATION ............................................................................................................................................................ 47 EVALUATION ................................................................................................................................................................ 48

Sensitivity analysis – checking the most critical assumptions ................................................................................ 49 Ratio analysis ....................................................................................................................................................... 49 Scenario analysis .................................................................................................................................................. 50

CONCLUSION ................................................................................................................................................................ 51 ABOUT THE AUTHOR ...................................................................................................................................................... 52

”Plans are nothing; planning is everything.”

Dwight D. Eisenhower



Introduction

My name is Andrew Grigolyunovich, CFA. I have been engaged in corporate financial planning and analysis for more than 10 years. 2012 was 11th consecutive year I have created at least one corporate budget (see more on my experience in the section About the Author).

I own a company that helps small and medium businesses avoid costly mistakes and to thereby make more money. It is common to see an owner/manager of a SME who is a great specialist in the business he or she is engaged. But even a smart, well-educated person can, at the same time, be clueless about the financial health of their company. My job is to help people understand the essential financial aspects of their businesses, to help them avoid costly mistakes and to create financial plans for them.

When discussing the book with Jon Shore, head of international business development at AG Capital CFO Services, he asked me “Do you have an interesting story to tell your readers in the introduction?” “Dozens of those” – was my reply.

Here is a great example from my recent experience.

This business case might be interesting to read but it tough to be there struggling financially. Unfortunately the problem is widespread among SMEs.

This book is designed for those business owners, managers or start-up entrepreneurs who have a great business or a good business idea, have a great understanding of their industry, but lack financial knowledge

I was working with a company that was operating in the wholesale import industry. The company wasimporting olive oil. The business model was very well-thought out; they never made an order until they hadpre-sold it with some of the largest retailers in their country with some decent margins and the companywas able to attract investor funding to finance each of the orders.

Sounds like nothing can go wrong with a business like that; however, it did. As the company started toexpand, the deal flow started to grow and the funds from each order were mixed up in the company’s bankaccount. Logically, as the business volume grew, they needed to attract more funds but at some point thecompany’s management realized that something was wrong and that the company was using newinvestments to cover old debts.

Initially they thought the problem is with their accounting because they could not attribute the cashflows tothe order flow. So, they just continued to pump funds into the company and, at the same time tried toimprove their management accounting practices. This nightmare lasted for almost a year.

They were smart enough to call for professional help. It actually turned out that the problem was evendeeper than it was expected initially. After a financial plan was created for the company, they realized thatthe problems arose not only due to the lack of accountability – the volume of the business was still not largeenough at the moment of the analysis to cover the fixed costs.

The company has learned its lessons and reorganized the purchase process. Since the business was growingquite rapidly it was not very difficult to reach the desired level of sales. Now they know how high their break-even level of sales and purchases are. Now they prosper and have a good stable and financially strongbusiness.



and do not have a CFO or Financial Director in their team. From what I have experienced since inception of AG Capital CFO Services, I can definitely say that there is a great need for good financial planning among SME’s but only few of them can reasonably do it themselves or afford to hire a professional CFO. I thought that if I could share my experience with those entrepreneurs who need financial planning and analysis but just don’t know how to do it, that this book could be my input to help making businesses more successful and a bit more efficient.

So, if you or your company finds yourself in one or more of the bullet points listed below then I am definitely writing for you.

You have an SME that does not have its own CFO; You have to make important decisions about the development path of your company; Your business model is good, the annual report shows that you work with profit but you don’t see

the proceeds on your bank account; Your company has various lines of business, product groups, sales channels; You plan to make a reorganization your company; Your results are poor and you have to create a plan on how to save your company

OK, let’s get started!



The Financial Planning Process for an Enterprise

Different businesses have completely different corporate structures. Some of them are multi-product and multi-divisional enterprises, while others are a one-man show. Regardless of the structure the financial planning process for each of them has similar steps, only the scale and the number of people involved varies.

The flowchart for the corporate budgeting process could be shown as follows.

The planning process starts with goal setting – that is the part of the process that is so often omitted and forgotten, although it definitely shouldn’t be. During this step you should define what is expected from the company – high level of profits, great dividend payout rate or a high growth rate.

During the next step you should define the main assumptions about the next year. What is the present state of economy in the world and in what state do you predict it is going to be. What will the inflation rates and currency exchange rates will be, will there be any new business expansion projects undertaken by the company, etc.

Then begins the planning process. Projecting sales and forecasting costs might happen simultaneously, especially if the company has various departments and different people are responsible for each part of the budget.

The next step is the consolidation process. In simple words, during this step you have to put projected income and costs together so the goals can be reached. This part of the process is by far the trickiest and

Goal Setting

Defining Assumptions

Administration cost planning

Planning sales and cost of goods sold

Department cost planning

Consolidation

Evaluation

Approval Performance evaluation

Revision



the most important to the success of the whole budgeting process. During this part it is necessary to understand what the most important assumptions are behind the budget, (sensitivity analysis), and to understand what the different paths are for development of the company’s business during the next year (scenario analysis).

During the evaluation process the company’s governing body, or you, evaluates the budget that was created by the finance department. In a small company where the business owner is both creating the budget and also evaluating and reviewing it, the evaluation process is actually very much integrated with the consolidation process.

Then the process is very simple. The budget is either rejected by the company’s management and is sent for re-consolidation, or is accepted and is sent to corresponding company’s departments for execution.

During the course of the year, it is very important to keep track of the budget performance so that discrepancies are quickly noticed. Sometimes, in case of very large discrepancies, the budget will be re-planned completely during the year in some companies, while other companies have a policy of making quarterly adjustments to the budget plan to match actual results.

We will cover each of the steps of the process in detail, giving the most attention, of course, to the planning and the consolidation parts of the budgeting process.

Setting Goals

Questions to ask

One of the least time-consuming, but definitely one of the most important parts of the budgeting process is goal setting. The main question you need to answer for yourself is very simple: “What do we want to achieve next year?” Note that it might be easier to find the answer for a single owner private company than for a large enterprise with several levels of management. In the latter case different people might have different views regarding the company’s development.

Regardless of the structure of the company’s governance, it is very important that each and every employee engaged in the budget planning process has the same goal in mind and actually knows exactly what the company wants to achieve so that they can plan their own part of the budget accordingly.

The goals vary and possible actions that a company would take vary widely with them:

1. We want to become the industry leader in terms of sales – we set the goal to reach $100 mln in sales to do this

2. We want to increase the company’s profit and net margins before a possible sale of the business – the goal is to reach $10 mln in net income at a 15% net margin

3. We want to maximize the level of dividends for the owners – so we set the goal to pay out $1 mln every month as dividends



4. We are in a tough financial situation and we want just to survive – the goal is to keep cash at or above 0 throughout the year

Please note that the goals need to be precise, specific and achievable – otherwise the whole process of setting goals is useless. So the goal shall be stated as “To reach $100 mln in sales” rather than “To increase sales”.

Strategies are dependent upon the goal that is set. For example; it would be logical for a company that has set its goal to become the market leader to take on every possible deal that does not bring direct losses to them and to spend a lot on marketing. Such a company will not care about its bottom line – growing the top line is the key priority. After a substantial growth in sales is achieved by the company the bottom line will improve by itself due to economies of scale.

On the other hand, a company that looks to go public or to be sold by existing owners will likely concentrate on improving its margins. Such companies might forego deals/opportunities that are on the verge of profitability but tie up too much of its resources.

Companies in stable/declining industries have good market share and stable cashflows and have limited growth opportunities because of the nature of their business, (e.g. traditional book retailers), will probably focus on profitable deals that do not require tying up too much in working capital resources or making substantial capital investments. This might be especially true when the company is private, is either the main source of income for its shareholder or the only “cash cow” in the portfolio of the shareholder. Paying out a maximum level of dividends would be the top priority for such company.

Sometimes a company finds itself in a tough financial situation with changing market conditions. This might be especially true when market conditions have changed dramatically. Consider a luxury furniture retailer in a just-collapsed real-estate market like Florida or California in 2009. Such a company, forecasting 2-digit market growth, most probably, has excess inventory that is illiquid and accrued accounts payable that now add up to several months of sales volumes. In addition to that, the sales volume of the company has dropped substantially so that now they are not even covering the direct costs in their retail locations.

In a situation like that a company tries to restructure itself, cutting costs, selling out illiquid goods at large discounts, etc. However, such changes take time and it is very critical to have enough resources to “buy” this time so that the company can fulfill its restructuring plan. By “buying time” I mean covering current costs from the accrued profits of the previous years. In situations like that a budget is usually called a restructuring plan.

It is fine to set several goals for your company, similar to a balanced scorecard approach. For example; you might want your company to increase sales by 20% while at the same time keeping the net margin at the current level of 10% and to pay out dividends of $50,000 every month. However, before getting to goal setting you need to consider your limiting factors.

Limiting factors in goal setting

In order to get the goals correctly, you should also consider your limiting factors or constraints. Some of the limiting factors might be imposed on you by creditors, investors and, actually, yourself.



Bank covenants. If a company has a bank loan, usually in the agreement among Borrower’s obligations, you will find not only an obligation to pay interest and principal on a timely basis, but also to comply with

several financial ratios or covenants. For example, if a company uses an overdraft, it might be required to keep monthly sales at least as high as the credit line limit. In such case, if your sales department plans for smaller sales, this might signal a non-compliance threat. Actually, the bank’s overdraft becomes the minimum level of monthly sales that you shall put into the budget.

Investor requirements. If a company has received private external financing the investors will usually have their own requirements regarding return on their investment that correspondingly converts into profit level requirements to the company.

Owner’s private needs. For single-owner companies, especially in cases when the company is the only source of income for the owner, the annual cost of keeping owner’s standard of living should be considered in order to define the required level of dividends from the company.

So, to sum up, before you even consider setting a measurable goal for the company for the next year you must account for all the possible covenants/external factors that might affect your choice.

The chart below is created to help you understand and write down your company’s limiting factors/covenants that need to be taken into account while setting next year’s goals.

Here is an example from a client of AG Capital CFO Services; a manufacturing company.

A few years ago a company built a new factory and received a substantial bank loan to finance the project.Despite the 10-year repayment schedule, the bank put a covenant in the loan agreement that the companyshall keep its debt/EBITDA ratio not higher than 3.5, (in other words to be able to repay the loan in 3.5years), otherwise the company would lose the favourable interest rate. So, every year, the company has tobudget for much higher level of profit in order not to lose the preferential interest rate. (Losing it would costthe company several thousand dollars annually). This has become one of their limiting factors when settingbudgeting goals.



Typical errors in setting goals

While working with various companies in different industries I have seen many different examples of the goal setting process. Some of the goals were specific and motivating. Others, as I found out from the clients’ previous experience, turned out to be distracting and demotivating. Please bear in mind that the goals you set before you begin the budgeting process can significantly influence both the budget plan itself and real-life budget performance during the course of the year. Errors in this process are costly so it is better to set the

goals from the beginning.

I have categorized the main errors made during the goal setting process and have listed the most common causes of wrong goal-setting:

Setting unattainable goals. This is a very common scenario for companies that develop business plans for new business ventures. Sometimes, in order to justify their investment needs and to show very good return on investment, these companies project their income growth at the level of hundreds and thousands of percent for a five-year period. I have seen some business plans that project a 100%+ market share, which is nonsense. So, if you are planning for a new business, keep in mind the market volume and carefully evaluate the share of the market that you will aim for.

• ........................................................................• ........................................................................• ........................................................................

Bank covenants

• ........................................................................• ........................................................................• ........................................................................

Investor covenants

• ........................................................................• ........................................................................• ........................................................................

Personal covenants



An overly-ambitious goal is set for the company. Several of years ago I enjoyed reading Jack Welch’s, (the former CEO of General Electric), book Winning. It was especially interesting to read as I was a CEO for a retail company at that time. In his book Jack Welch reveals the simple way he was setting goals for his employees – take previous year’s results and double them. As simple as that. His argument was that, at first, people get frustrated and discouraged by these ambitious goals but later they have no other choice than to start thinking out-of-the-box. For example; even if a salesman fails to fill the plan by say 20%, (and quite many of them did fail), it is still a 60% increase against the previous year’s result – a great result for the company.

However, should a company budget a sales increase of 100% it might lead to severe problems. Either the cost budgets would be increased due to the “expected” increase in income or higher dividend payouts would be promised to owners. That would lead to a depletion of the company’s cash reserve and a need to revise the plan in the middle of the year.

Goals are set regardless of economic developments. Quite often companies set goals without taking into account possible economic developments. During the latest financial crisis in 2008-2009 I saw many companies that were setting their sales forecasts without taking into account the forecasted developments in the economies of their customers’ countries.

Management cannot promptly warn owners about goal unattainability. Yes, we’ve seen examples of companies where employees, even the most senior people, silently accept whatever goals are set by the owners of the company. This can cause great harm in a company, especially if the goals are unattainable from the very beginning.

So, if you are a top-level employee, you have to keep in mind the above-mentioned reasons for errors in setting budgeting goals. If you feel that the owners of the company are setting unrealistic goals you should inform them. Otherwise, if the goals are silently accepted, reaching the goals becomes the responsibility of the manager, not the problem of the owner that has his head in the clouds.

Execution

You have evaluated different goals, decided whether you want to concentrate on growth, income or dividends, listed your limiting factors and you have learned from the mistakes others’ regarding the goal setting process. Now it’s time to execute by setting specific measurable attainable goals for your company for the next financial year.

You can use the table below as a guide. It has been limited to three lines deliberately. Setting too many goals would just scatter your attention during the year. It is even better to have just one simple goal that would be easy to express to your employees.

This goal setting problem was very pronounced for foreign subsidiaries of companies that were headquartered in countries less influenced by the crisis. One of AG Capital’s clients, a Latvian distributor Swedish construction tools had their budget approved in the end of 2008.

In January 2009 Latvia was hit by the economic recession, the GDP in 2009 fell by 18% while Sweden was one of the least affected countries during the crisis.

In August 2009 the Swedish company’s owners understood that there was a serious problem with the economy and not in the company. Only then were Latvian management persuaded the Swedish owners to revise the budget. By that time they were trailing 60% on sales against the plan.



Goal 1:______________________________________________________________________

My company’s financial goals for the year _____

Goal 2:______________________________________________________________________

Goal 3:______________________________________________________________________



Defining assumptions

OK, we’ve set the goals for the company and now it’s the time to establish your key assumptions. Some of the assumptions, like rate of growth of the economy have already been considered. Others, for example, whether you plan to open new retail locations or to expand manufacturing capacities, shall be defined at this stage.

The main goal for explicitly setting the assumptions is to get a common view over the next planning period among all the members of your team involved in the financial planning process. It is crucial for each department to have the same vision of what is expected for the company. An example of what could happen if each department works separately is presented in the box to the right.

The main categories that need to be covered in the assumptions are as follows:

1. Economic factors - industry growth, GDP growth, level of inflation, interest rates, etc.

2. Currency rates – especially if your company is involved into international business.

3. Possible changes in the applicable taxes in every market your company is serving.

4. Changes in pricing/markup policies of the company. For exchange-traded goods or raw materials you need to use a unified forecast for the price fluctuations of the goods.

5. Possible expansion projects within the company – whether and when you plan to build a new factory or open a new shop. It is a good idea to let your HR department know these plans in advance so that they are able to budget their expenses accordingly.

6. Other significant risk factors to the company.

It is a good idea to build a spreadsheet model for at least some of the projections you will be using for your budgeting purposes. Then you will be able to quickly change the assumptions if needed and will be able to automatically recalculate all the numbers in the model as well as to evaluate different scenarios that might happen during the course of the year.

One of AG Capital’s clients, a retail company working in the luxury goods sector, was severely hit by the financial crisis of 2008-2009. The company was quite successful and able to keep its cash balance positive during the restructuring process. However, one of the methods to achieve this was keeping purchases very low and selling the older items that were already in stock.

When the restructuring was over, the company’s marketing department was informed that, from now on, the company would grow sales at full speed and would allocate some funds for media advertising. The marketing manager decided to promote a special category of goods that had the highest markups. However, during the planning process for the campaign it turned out that the purchasing department was unaware that the restructuring was over and was still keeping purchase levels low.

The company had to drop the marketing campaign since they had almost nothing to sell.



An example of a key assumption sheet is shown below. This is part of the budget of a fictional company “Happy Retailer” that I will be using as an example throughout this book. This company budget projects flat industry sales (Sales +/- vs. plan); an inter-bank borrowing rate of 2%, specific sales tax rate for each of its shops, as well as a projection on the applicable tax system. All of these numbers are automatically linked to corresponding parts in the budget and will automatically adjust the final results should they be changed.



We have also created a table for you so you are able to create your own list of assumptions.



Choosing the Right Tools I am a member of quite a number of groups on LinkedIn. Some of these groups unite CFOs and financial planning specialists. Almost every other week someone in these groups begins a discussion about what is the best budgeting software on the market. Some people name some specific budgeting software; others use Excel or other spreadsheet programs.

However, in almost all of the discussions the bottom line is the same. Specific budgeting software is designed for large organizations; it is costly to buy and to customize and it helps when the planning process is very complex. Still, even the advocates of the budgeting software admit that no software possesses as much flexibility as Microsoft Excel®. Moreover, users can create financial planning models themselves, according to their own needs.

This book is designed for small and medium enterprises, not for financial planning specialists with years of experience. I am willing to bet that having read this e-book to this point you won’t need anything more advanced than Microsoft Excel for your financial planning purposes.

There are 4 options that you might considering while choosing financial planning tools, (ranked by final cost to you, except for the value of your time):

1. You might want to create an Excel spreadsheet model for your company yourself. This might require some intermediate level of Excel knowledge and, at least, some basic understanding of finance principles, if you wish to create a flexible budget with linked P&L, cashflow statement and pro-forma balance sheet. In this case you might want to download a demo file from www.cfotemplates.com that corresponds to your industry. This might give you some great ideas on how to design and structure your budget at no cost.

2. Another option that saves you time and money is to get a pre-built Microsoft Excel template applicable to your industry. Once again I would recommend www.cfotemplates.com. The templates are created by financial professionals and the company specializes in financial templates for professionals. They also offer customization of the templates for customer needs at a very affordable rate. This option is great if you value your time, as the time-consuming process of creating the financial planning model has already been done by someone else.

3. Another option is to use a consulting company that specializes in corporate finance and is very experienced in developing budgeting systems for its clients. In this case you save even more time by getting everything right from the start. A financial consulting firm will also train you and create an Excel model that you can manage yourself. Once again, my recommendation is AG Capital CFO Services. AG Capital CFO Services has introduced budgeting systems for a hundred clients. It might also be the most cost-effective way to do your budgeting as the company is located in Latvia, a lower-income member of EU.



4. The final option would be hiring the professional and experienced CFO who would create a budgeting system part of his job. However, you have to weight all the pros and cons before hiring this person since this would usually be a significant increase to your administration costs. You need to be very sure that you can afford a CFO before you hire one.

Now I will be presenting the budgeting creation process for “Happy Retailer” using one of the templates available from cfotemplates.com. Retail industry was chosen as an example since it is one of the easiest to understand for a non-finance person. The processes are quite simple and almost everyone has daily interactions with the retail industry as a customer.

The Structure of a Budget

The structure of the sample budget I will be using for illustrations in this e-book is represented in the chart below. The real-life budgets usually follow the same structure; the difference is only in the specifics of the company’s cost budgets.

To create a budget for a company you need to create separate budgets for sales, cost of goods sold, salaries, etc. Then these projections are linked together in the Profit & Loss budget. The same procedure is repeated for components of a balance sheet – you make separate projections for each component of

Cashflow budget

Profit&Loss Budget Pro-forma Balance Sheet

Sales/COGS budget

Sales salary budget

Administration salary budget

Retail network budget

Other cost budgets

Inventory purchase budget

A/R budget

A/P budget

CAPEX budget

Financing budget



working capital, for investment projects, external financing projections, etc. Then the numbers are automatically transferred to the pro-forma balance sheet.

Finally the numbers in the P&L and balance sheet projections are combined together and the cashflow budget is derived. After that you can gauge whether the projected cash flows are adequate and meet your goals. Note that the projections of all three main financial statements are interconnected – if anything changes in one of them, the changes will automatically be reflected in the other statements.

We will now examine, in detail, each of the components of the P&L budget and the pro-forma balance sheet.



Projecting sales and cost of goods sold

Creating tables for the sales budget

The most important part of the financial planning process is to understand the interconnections between the company’s sales results, variable costs, key sales drivers and the implications for the company’s working capital.

This part of the budget is the one that varies the most between industries. In the example that we use in this book I am demonstrating how to create a financial plan for a retail company.

For retail companies there are several factors that influence sales. First, the number of locations. The total turnover will be dependent on the number of shops in operation each month. This in turn will depend on the dates the new shops are expected to open. The second factor that influences sales is the seasonality.

An example of a retail company sales budget that satisfies both conditions is shown below.

Note, that there are actually two tables with a similar structure – the Sales budget and the Inputs. Projecting sales in a manner like this gives two advantages compared to a budget that has just a sales table.

The first advantage is that it makes it possible to adjust the scenario for opening the new shops by just changing the planned opening date in the Assumptions, (see above). As you may notice, the Inputs table

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total

Net Sales by Shop 3 590 878 3 130 878 3 130 878 3 370 878 3 370 878 2 709 544 3 106 344 2 709 544 3 630 878 3 630 878 3 630 878 3 987 544 40 000 000

Existing shops 3 590 878 3 130 878 3 130 878 3 130 878 3 130 878 2 517 544 2 885 544 2 517 544 3 130 878 3 130 878 3 130 878 3 437 544 36 865 200Mall Of America 502 167 436 667 436 667 436 667 436 667 349 333 401 733 349 333 436 667 436 667 436 667 480 333 5 139 567King of Prussia Mall 551 044 487 544 487 544 487 544 487 544 402 878 453 678 402 878 487 544 487 544 487 544 529 878 5 753 167Palisades Center 377 583 328 333 328 333 328 333 328 333 262 667 302 067 262 667 328 333 328 333 328 333 361 167 3 864 483The Galleria 377 583 328 333 328 333 328 333 328 333 262 667 302 067 262 667 328 333 328 333 328 333 361 167 3 864 483Sawgrass Mills 425 500 370 000 370 000 370 000 370 000 296 000 340 400 296 000 370 000 370 000 370 000 407 000 4 354 900Woodfield Mall 431 250 375 000 375 000 375 000 375 000 300 000 345 000 300 000 375 000 375 000 375 000 412 500 4 413 750Del Amo Fashion Center 471 500 410 000 410 000 410 000 410 000 328 000 377 200 328 000 410 000 410 000 410 000 451 000 4 825 700South Coast Plaza 454 250 395 000 395 000 395 000 395 000 316 000 363 400 316 000 395 000 395 000 395 000 434 500 4 649 150New shops 0 0 0 240 000 240 000 192 000 220 800 192 000 500 000 500 000 500 000 550 000 3 134 800Aventura Mall 0 0 0 240 000 240 000 192 000 220 800 192 000 240 000 240 000 240 000 264 000 2 068 800Millcreek Mall 0 0 0 0 0 0 0 0 260 000 260 000 260 000 286 000 1 066 000

Scenario correction 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Base case scenario 4 165 878 3 630 878 3 630 878 3 630 878 3 630 878 2 917 544 3 345 544 2 917 544 3 630 878 3 630 878 3 630 878 3 987 544 42 750 200

Existing shops 3 590 878 3 130 878 3 130 878 3 130 878 3 130 878 2 517 544 2 885 544 2 517 544 3 130 878 3 130 878 3 130 878 3 437 544 36 865 200Mall Of America 502 167 436 667 436 667 436 667 436 667 349 333 401 733 349 333 436 667 436 667 436 667 480 333 5 139 567King of Prussia Mall 551 044 487 544 487 544 487 544 487 544 402 878 453 678 402 878 487 544 487 544 487 544 529 878 5 753 167Palisades Center 377 583 328 333 328 333 328 333 328 333 262 667 302 067 262 667 328 333 328 333 328 333 361 167 3 864 483The Galleria 377 583 328 333 328 333 328 333 328 333 262 667 302 067 262 667 328 333 328 333 328 333 361 167 3 864 483Sawgrass Mills 425 500 370 000 370 000 370 000 370 000 296 000 340 400 296 000 370 000 370 000 370 000 407 000 4 354 900Woodfield Mall 431 250 375 000 375 000 375 000 375 000 300 000 345 000 300 000 375 000 375 000 375 000 412 500 4 413 750Del Amo Fashion Center 471 500 410 000 410 000 410 000 410 000 328 000 377 200 328 000 410 000 410 000 410 000 451 000 4 825 700South Coast Plaza 454 250 395 000 395 000 395 000 395 000 316 000 363 400 316 000 395 000 395 000 395 000 434 500 4 649 150New shops 575 000 500 000 500 000 500 000 500 000 400 000 460 000 400 000 500 000 500 000 500 000 550 000 5 885 000Aventura Mall 276 000 240 000 240 000 240 000 240 000 192 000 220 800 192 000 240 000 240 000 240 000 264 000 2 824 800Millcreek Mall 299 000 260 000 260 000 260 000 260 000 208 000 239 200 208 000 260 000 260 000 260 000 286 000 3 060 200

Happy Retailer, LLC Sales 2012

Inputs



contains projected sales for each month of the year while the Sales budget automatically utilizes the projected opening month and derives sales projections only for the months that follow. Of course, a shop that opens ahead of schedule is a rare occurrence. A late opening is far more common. However, when the budget is being created during the previous late October, it is a good thing to project possible sales for each month since most of the new opening shops will not have specific scheduled opening dates.

The second advantage is the ability to adjust the sales scenario on a company-level with just a couple of mouse clicks. Imagine a situation where you are creating the first draft of a company’s budget. You have set your goals, made your sales projection, (based on what your sales team has told you they are capable of),

and predicted costs, (based on what your heads of departments told they needed to spend). And guess what? Sales less costs don’t meet the company goals. You need to start the budget consolidation process.

The consolidation process usually requires increasing sales and cutting costs. Sometimes it is also about changing goals, but that should happen only in cases when you clearly understand that the goal is not realistically achievable. Anyway, in all of these cases you will have to vary the projected sales. In the example above we have a budget that was already balanced for seasonality and each shop performance. If you need to increase sales by 5% you will have to make 10x12=120 adjustments. Very dull work. It will also be time consuming if you have a chain of a 25 shops.

A much better alternative is to balance the base case sales scenario once and to make the changes in the Assumptions, automatically adjusting each shop’s sales by the required percentage.

Getting the right level of details

OK, now we’ve got sales projections by month and by shop. However, each of the shops sells different groups of products and, probably, also in different mixes. Different product groups usually have different sales patterns as well as different mark-ups. Therefore, for a retail budget, it is important to further break down sales by product groups.

One of AG Capital CFO Services clients is a food-processing company. A couple of years ago the company hasopened a small factory outlet near its main manufacturing site to directly serve people in the neighboringdistrict. We were asked to separate the outlet’s sales in the company’s budget from the main sales.

We asked their accountant that was responsible for the shop’s bookkeeping to make her best estimate ofpossible monthly sales. Her answer was that it is absolutely impossible to predict. "One day we may havemany clients, the other day might be quite empty”.

When we took the historical sales data by month it turned out that the variance of sales was almostinexistent. For example, October sales amounted to $9,950, November – $10,100 and December – $10,000(numbers are changed, but note the variance that is extremely small).

The accountant was right – there were "empty” days, but the next day the people came back to the outlet asthere was quite an established demand for fresh high-quality bakery.

Making sales projections from the historical data is usually easier than one can imagine. Just note the longer-term trend.



In this particular example the total sales results are split by product groups. This means that the sales breakdown by product groups influences the cost of goods sold (through mark-ups). For example; if you plan to increase sales of Shirts in the Mall of America store, increasing the 10% level to 20% will result in a corresponding drop of projected sales for other product groups as the shares of sales for different product groups will always add up to 100%.

Another option would be creating sales projections by month, by shop and also by product group. However by doing this we will start facing the issue of “overdetalization”. With higher level of details monthly fluctuations between the product groups average out. Creating too much detail in each part of the budget may result in historical fluctuations making the forecast less accurate despite forecasting at a more detailed level.

Can using too much detail hurt? Yes it can - see a real-life example below.

Therefore, in this particular case it was decided to forecast sales on shop level and then just to divide the totals by product groups for the purpose of obtaining more precise cost of goods sold.

Sales by product groups

Mall Of America

King of Prussia

Mall

Palisades Center

The Galleria

Sawgrass Mills

Woodfield Mall

Del Amo Fashion Center

South Coast Plaza

Aventura Mall

Millcreek MallShirts 10% 20% 15% 10% 10% 10% 10% 15% 10% 10%Jeans 20% 10% 15% 20% 20% 5% 20% 15% 20% 20%Jackets 15% 10% 15% 15% 15% 10% 15% 15% 15% 15%Sportswear 5% 10% 10% 10% 5% 10% 5% 10% 10% 5%Swimwear 5% 5% 10% 10% 10% 20% 5% 10% 10% 10%Socks 5% 5% 5% 5% 5% 5% 5% 5% 5% 5%Shoes 15% 15% 5% 5% 5% 15% 15% 5% 5% 5%Sweaters 5% 10% 5% 5% 10% 5% 5% 5% 5% 10%Pants 10% 5% 10% 10% 10% 10% 10% 10% 10% 10%Coats 10% 10% 10% 10% 10% 10% 10% 10% 10% 10%

Here is an example from another client, a food-processing company. They decided to forecast their saleswith a very high level of detail.

They projected their sales by months, by sales channels, and by individual products (not even productgroups). Imagine the workload for the company’s sales department to make these projections! Thecompany’s budget creation process took us four and a half months. Four of those were devoted to salesprojections. However, the workload was not even the main problem for them. The main problem arose fromthe fact that sales by items and by sales channels were not regular, especially for some niche products.

Imagine that a retailer buys some items just a couple of times per year in comparatively small amounts. It isquite difficult to predict the timing of these orders as well as the amounts since historical data, on which itmight be possible to base the forecasts, is very fragmented.

As a result, their projected product group and company totals usually match actual results. But deviationson an individual product level are just enormous. Finally, the question is – was the higher level of detailsworth the effort.



What are the possible levels of details for sales projections in this particular case? See the chart in the box.

The extreme case of not getting into details for the company’s management would be just to assume that their next year’s sales would amount to $40 MM and that’s it. However, such an approach is too unreliable – you can overlook a lot of details and not really understand what makes up these numbers. The opposite extreme would be trying to predict how many blue T-shirts reference number 405382 size M would be sold in the Galleria outlet in July.

The best way is to either predict total July sales in Galleria or to predict July sales of T-shirts in Galleria. Getting into more details in this particular case would not pay in terms of precision of forecasts.

Determining details for other industries

Ok, we have seen the example of a retail company deciding on the layout of its sales budget but what about other industries? I have created budgets for companies from very different industries. Each of these companies has a unique business model and the sales budget needs to be customized for each specific case.

The first question that you need to answer for yourself is; what is the basis for my forecast - units or money. For example, a company that is manufacturing and selling wooden pellets can usually predict sales volumes in tons but not in dollars since the prices for pellets fluctuate significantly over the year. On the other hand, food manufacturers will, most likely, make their forecasts in dollars. First, it usually takes some time and effort to re-negotiate prices with retail chains. Second, price fluctuations for food are usually not as great as for commodities.

Less details

Total sales for the year (1 figure)

Total sales by month

Detailed by month and by shop

Detailed by month by shop and by product group

Detailed by month, by shop, by product group and by supplier

Detailed by month, by shop, and by item

More details

Optimal level of details

Less details

...........................................

...........................................

...........................................

...........................................

...........................................

...........................................

More details

Optimal level of details

Possible levels of sales projection details for my company



Then, if you decide to go for units, you will have to connect units with dollars, (the budget is a financial plan, and so we plan in dollars, not in units). The most convenient way to do this is to make a special table in the Assumptions where it is possible to predict average selling prices in each particular month. For example, a chain of gas stations might forecast their sales in gallons and put an average price per gallon in the Assumptions part of the budget for gas of each octane number.

If the manufacturing process is more complicated and is needed to forecast prices for each specific product or product group, it might be a good idea to insert the table with average prices as a part of the sales budget.

After that the process is very simple. You just have to create the tables and to fill them with the forecasted numbers (see the next section on forecasting techniques).

To make the process a little bit clearer for you, I have tried to summarize the best practices from the experience of our clients from various industries.

Catering companies, cafés and restaurants are very similar in their budgeting approach to the retail sector. They forecast sales by month by location and then try to break them down by different product groups. It is especially important for them since the markups for coffee differ quite a bit from the markups for main courses.

Professional services companies, (business consultants); usually project their income in units, the number of service hours they plan to sell each month. Then they multiply the number of hours by the service price per hour. They might also go into more details and project the number of hours sold per employee (for smaller companies with several income-generating employees) or per function (for larger companies).

A similar approach is also used in providing technical services, (e.g. for automobile repair shops). Such businesses project income from their service division deriving it from the number of hours sold and multiplying it by the average hourly price of services. Then, based on the number of hours sold, these companies are usually able to derive, from their historical results, how much revenue they will generate from selling spare parts to the cars they repair.

Marketing agencies can usually project their sales by months and by clients, especially if, at the end of the previous year, they have negotiated the budgets for the next year’s work load. It might also be a good idea to make projections by products since different products will have very different pricing strategies and corresponding markups.

Retailers, as discussed, usually make their projections by months, by locations and by product groups. Depending on the type of business, projections might be based either on dollars or on units. It might be a good idea for retailers that sell more expensive items (e.g. auto retailers) to project sales by units, while retailers that sell less expensive items to project sales in dollars.

Determine the level of forecast

details

Define forecasting

basis - units or dollars

Create tables

Forecast the sales numbers and fill in the

tables



Wholesalers, depending on the specifics of business, usually make their sales projections by month, by sales channels and by product groups. Here it is absolutely essential to split forecasts to a highly detailed level since different sales channels and product groups might have different margins. Margins are often quite narrow for wholesalers to there is not much room for error.

Manufacturing companies, depending on the industry, usually project their sales by month, by sales channel and by product group. The choice of forecasting basis – units or dollars – is usually determined by one of two factors. First, the higher the price of the products the company manufactures, the more reasonable it becomes to forecast in units. For example; auto manufacturers should probably forecast in units while stationary good manufacturers will have a much easier time by forecasting in dollars.

The second factor is the level of price fluctuations. If selling prices and raw material prices fluctuate widely during the year it might be wise to make forecasts in units, while companies with stable selling prices might make life easier by forecasting in dollars.

Quite a specific approach is used by construction companies. These businesses are in a unique situation at the end of each year especially the smaller companies that specialize in working as subcontractors. Most of the contracts they have will expire within the first half of the year, although they know that there still will be some business next year. These companies can project the first months of the year with precision; however, they will have to make educated guesses about the sales during the second part of the year.

These companies project their sales per each project, specifically dividing the planned numbers between materials, labor, mechanisms, transportation and overhead. Such a division allows these companies to easily project their variable costs.

Airlines forecast their income at the level of individual flights, taking into account the scheduled list of flights, the number of rotations per month and the projected income per rotation. Income per rotation might be derived either through an average occupancy rate per flight, (for passenger flights), or a fixed amount (for cargo flights).

Real estate companies usually make forecasts at the level of each particular unit of real estate. For example, companies that own commercial properties and rent them out may try to forecast income per month per each premise (also taking into account all the clauses in the rent contracts that allow them to increase rent, for example, at the rate of inflation once a year). Possible vacancy rates shall be introduced into the sales budget as a “discount” to the maximum level of sales.

Projecting sales amounts

Ok, we have decided on the level of details for sales projections and now we have the tables for making the base case sales forecasts. But how do we know what numbers to input for each shop in each particular month?

Method 1. Historical results.



For established businesses with regular customer flow, (like retail), the best way to forecast the future is to analyze past results. The idea is very simple – get historical results for the previous year, look for seasonal patterns, consider recent and forecasted developments in the industry and in the economy and try to adjust the historical results taking into account economic developments.

For example; consider a restaurant that has historical levels of income as presented in the first row of the following table.

It is very important to look for seasonal patterns in the historical results. Note how the sales change during the year in the example. December is clearly the best month due to corporate banquets and Christmas/New Year dinners. On the other hand January and February have lower revenues. Summer results are better than average due to the addition of an outdoor terrace and longer daylight hours. Here it is noteworthy that the results peak in July. All the other months are relatively equal in sales; there are fluctuations but these are not very large.

Now when we have determined the historical seasonality, it’s time to forecast the planned results. Let’s assume that we think the economy will be steady and the increase in sales will be very modest, 5%. So, the next step is to calculate the projected results with a 5% increase. See the second line in the table above.

Finally, it is time to make the budget forecast while incorporating seasonality patterns. It might be a good idea to round the numbers. For example; an implied sales forecast for December would be $739,469, so let’s input $740,000 into the budget. The same procedure is applied for June-August results. However, the sales results for other months are derived slightly differently.

March-May and September-November periods have relatively similar sales. So it is a good idea to calculate an average of the implied sales for these months, to round it and to use the rounded figure as a sales budget for each of the months. In this example the average is $576,482, so, to be on the safe side; we round it to $575,000 and use the number for each of the six months. That is the way to keep seasonality, but to get rid of slight deviations in the results that are explained by purely accidental factors. The same procedure is applied to January-February results.

The action flow in case of using this method is depicted in the chart below.

Method 2. Break-even level of sales

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec TotalActual Sales 2011, $ 438 753 442 093 552 435 553 053 547 596 593 461 656 072 626 158 546 283 545 071 549 746 704 256 6 754 9775% increase, $ 460 691 464 198 580 057 580 706 574 976 623 134 688 876 657 466 573 597 572 325 577 233 739 469 7 092 726Sales Budget 2012, $ 462 500 462 500 575 000 575 000 575 000 625 000 690 000 655 000 575 000 575 000 575 000 740 000 7 085 000

Obtain the historical sales

results

Look for seasonality

patterns

Determine the growth rate, take the economy into

account

Forecast the sales numbers and fill

in the tables



The method described above is the easiest to understand and apply, however, the problem is that there are industries like construction, whose business is project-based and the projects are can be forecast only within a limited time frame.

It is usually not very precise to take historical results from a construction company and to assume they will be able to reach exactly the same results, (corrected by macroeconomic factors), next year. Actually, such companies, especially smaller ones, have big issues with forecasting their sales, since, at the time of forecasting, they have projects awarded to them just for the first part of the year.

So, the solution for such companies would be to start with forecasting their fixed costs instead of forecasting sales, (fixed cost projections are covered in the next part of this e-book). Then, when it is known what the cost of doing business for them is, it is possible to calculate the break-even level of sales and the level of sales that is needed to reach the goals.

The critical part here is to determine how achievable the sales goals are. For example; the construction company in the example above understands that the required level of income for them to break even is say $100 mln but they feel that the market has still not recovered and it would be unrealistic to set such a goal. Most likely the goal they will be able to achieve will be in the $70-80 mln range. This is a clear signal that their fixed costs are too high and they need to cut them in order to break-even.

Projecting sales for new business units

Forecast the fixed costs

Link variable costs to sales in the

forecasting model

Determine the level of sales required to

break-even or to reach goals

Evaluate the probability of

reaching such level of sales

One of our clients is a construction company. 2009 was a disastrous year for the whole industry as the credit market was frozen and there were very few projects for the industry. The company was making its internal restructuring, cutting costs and was using our firm to develop their financials. When we started the planning process they had just a couple of small construction contracts that were not large to fill their capacity. So first we determined the fixed costs that they needed to bear every month to stay in business, (office rent, administration salaries, interest, etc.). Then we calculated the required level of sales for the company to break even. This sales level was determined to be reasonably achievable and was accepted as the sales budget for the company. Eventually they surpassed their sales goals, ending the year with a net profit.



One of the trickiest parts of the planning process is to forecast income for a new business unit within a company. The new business unit might be a new shop for a retail company, a new restaurant for a chain of restaurants, a new product group for a wholesaler, etc. Forecasting for a startup is even trickier since the business model itself has not yet proven itself.

The easiest way to forecast sales for a new business unit is to compare it with an existing one.

In the example described earlier for the Happy Retailer, LLC, there are 2 new shops the company plans to open during the year – located in the Aventura Mall and in the Millcreek Mall. Note that the income projections for both shops are very conservative, compared to the existing shops – they are lower by 20%-27% compared to the worst of existing shops.

Projecting Cost of Goods Sold

Ok, we have already created a sales budget for the company, now we need to understand what the costs of goods are. In many industries the cost of goods, (COG), or cost of materials is usually the greatest variable expense item.

In this particular case we are projecting the markups for each product group in order to get to the cost of goods sold. The markups are usually derived from the historical data. In this particular case it is assumed that the markups stay the same throughout the year. However, if a company has different pricing strategies during different times of the year it might be a good idea to forecast markups for each separate month. For example, in some countries food processing companies that distribute eggs,

tend to increase prices before Easter due to increased demand, while the cost of goods stays the same.

Then, after the cost of goods sold has been calculated for each product group, it is possible to calculate it also by shops, as we know the break-down of sales by product groups.

Sometimes a company’s new business unit’s sales actually are the best during the first month of operations. This holds true when a very sought-after product or retailer comes to the market. The picture to the left depicts a queue at McDonald’s in Moscow in 1990. They have probably never achieved sales results like this in this restaurant since then.

Product group MarkupShirts 104%Jeans 83%Jackets 73%Sportswear 88%Swimwear 83%Socks 104%Shoes 73%Sweaters 78%Pants 83%Coats 88%



So, the planning process for the Happy Retailer LLC is as follows:

1. Forecast sales by shops 2. Forecast each product group’s share of sales for each shop 3. Derive sales by product groups 4. Forecast average markups for each product group 5. Derive the cost of goods sold for each product group 6. Derive the cost of goods sold for each shop

Projecting Other Costs

Structuring cost budgets

Each company has many different cost types. In order to get a clear view of the budget it is important to divide the costs into specific budgets and put each into a separate worksheet. There are companies that budget all the possible costs in just one worksheet and the worksheet is several hundreds of rows long. In my opinion such budgets are really onerous. The key to creating the correct number of cost budgets is to understand which departments have responsibilities for these costs.

For example, Happy Retailer’s budget contains the following cost budgets:

Retail network cost budget Sales personnel salary budget Administrative personnel salary budget HR budget Marketing budget Other selling cost budget Other operating cost budget


COGS by Shop 1 946 826 1 697 404 1 697 404 1 827 437 1 827 437 1 468 868 1 684 009 1 468 868 1 968 710 1 968 710 1 968 710 2 162 122 21 686 505

Existing shops 1 946 826 1 697 404 1 697 404 1 697 404 1 697 404 1 364 841 1 564 378 1 364 841 1 697 404 1 697 404 1 697 404 1 863 685 19 986 396Mall Of America 274 105 238 353 238 353 238 353 238 353 190 682 219 284 190 682 238 353 238 353 238 353 262 188 2 805 409King of Prussia Mall 296 837 262 631 262 631 262 631 262 631 217 023 244 388 217 023 262 631 262 631 262 631 285 435 3 099 123Palisades Center 203 527 176 980 176 980 176 980 176 980 141 584 162 821 141 584 176 980 176 980 176 980 194 678 2 083 050The Galleria 204 577 177 893 177 893 177 893 177 893 142 315 163 662 142 315 177 893 177 893 177 893 195 683 2 093 804Sawgrass Mills 231 199 201 042 201 042 201 042 201 042 160 834 184 959 160 834 201 042 201 042 201 042 221 147 2 366 268Woodfield Mall 234 363 203 794 203 794 203 794 203 794 163 035 187 490 163 035 203 794 203 794 203 794 224 173 2 398 651Del Amo Fashion Center 257 366 223 797 223 797 223 797 223 797 179 037 205 893 179 037 223 797 223 797 223 797 246 176 2 634 087South Coast Plaza 244 852 212 915 212 915 212 915 212 915 170 332 195 881 170 332 212 915 212 915 212 915 234 206 2 506 004New shops 0 0 0 130 034 130 034 104 027 119 631 104 027 271 307 271 307 271 307 298 437 1 700 109Aventura Mall 0 0 0 130 034 130 034 104 027 119 631 104 027 130 034 130 034 130 034 143 037 1 120 890Millcreek Mall 0 0 0 0 0 0 0 0 141 273 141 273 141 273 155 400 579 219

Happy Retailer, LLC Sales 2012



Administration cost budget Capital expenditure budget Financing budget

The latter two budgets are focused on forecasting balance sheet values – investments into fixed assets and external loan amortization schedules. However, these budgets also contain projections over such costs as depreciation and loan interest. The other budgets are 100% connected to the P&L statement.

The retail network cost budget is separated from the others because it is determined mostly by conditions of the rent agreements that were already signed before the start of the budgeting process. There is little discretion in taking or not taking on these costs. On the other hand these costs should be controlled for possible errors or discrepancies compared to what is agreed to in the rent agreements.

Since Happy Retailer is a retail company, it has shop personnel and administrators. In Happy Retailer’s case it is a good idea to divide personnel into 2 salary budgets, as sales people are numerous and their salaries are actually projected on a shop level, not on an individual level. Administration salaries, on the other hand, are projected on the individual level and are less variable.

For the Happy Retailer we have also created a separate HR, marketing, other selling cost, other operating cost and administration cost budgets.

When structuring your company’s cost budgets consider the following factors: (These will determine the cost budgets your company will have)

Structure – what are your company’s departments? Do they incur and control costs that no other department does? For example; an accounting department might have salaries and telecommunication costs that are born by all the other departments too. It might be a good idea to include such costs into a salary budget and a telecom budget and not to create a separate accounting budget. On the other hand, online marketing is something unique to the marketing department. That shall be put into a separate budget.

Responsible persons – who is responsible for what? If an IT manager is responsible, not only for IT equipment and software but also for controlling telecom costs, it might be a good idea to include the telecom costs into IT budget.

Cost variability – as in the example above regarding sales and administration salaries, sometimes it is a good idea to divide costs into variable and fixed and to create 2 separate cost budgets.

Discretion over costs – costs that the company has little flexibility over, like rent for the shops, might be put into a separate cost budget.



Projecting salaries

In our example Happy Retailer’s salary projections are divided into 2 separate budgets – sales personnel salaries and administration salaries.

Sales personnel salaries are projected on a shop level. Here the company is not trying to forecast what John Smith’s from Palisades Center salary will be. Sales personnel tend to have a higher rotation level so chances are, that by the end of next year, John Smith is no longer with the company or has been transferred to another position. Therefore, with the sales personnel salaries, the focus is on the necessary staffing level of shops.

It is important to understand how many people are needed for each of the shops and what the salary system is. What are the average base salaries and what percentage of turnover is paid to the personnel? These assumptions are entered into the assumption table on the sales personnel salary budget.

My company’s budget will have the following cost budgets:



Then the numbers from the Assumption table are automatically linked to the salary budget (see below). The average base salary is multiplied by the number of sales people but the commission is multiplied with the planned turnover from the sales budget for each particular shop and added to the gross salary. Note that the assumptions for the shops that are not yet opened are also put into the model. Then the formulas shall look to the Assumptions worksheet, check the opening month of a shop and correspondingly adjust the salary budget. Note this in the table below.

Please, note that the assumptions for the average payroll taxes and other payroll benefits as a percentage of total salaries are placed on the Assumptions worksheet. This part of the budget might be elaborated in greater detail depending on the complexity of the tax system in your company’s country.

Another important factor that you will need to take into account is the salary level your employees are going to receive on average, (see the last line of the salary budget – it is calculated automatically). Given the sales figures and the salary system, are you overpaying or underpaying, compared to your competitors? Will you be able to attract top employees to work for what you offer them?

ShopBase

Salary%

commission# of

salesmenMall Of America 30500 2% 8King of Prussia Mall 36500 2% 9Palisades Center 38500 2% 10The Galleria 37800 2% 5Sawgrass Mills 39000 2% 5Woodfield Mall 33000 2% 7Del Amo Fashion Center 33000 2% 7South Coast Plaza 33000 2% 7Aventura Mall 37500 2% 8Millcreek Mall 40000 2% 8

Sales Personnel Salaries & Commissions

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total1 2 3 4 5 6 7 8 9 10 11 12

Total 288 907 277 895 277 895 313 565 313 565 297 733 307 232 297 733 351 710 351 710 351 710 360 248 3 789 902

Gross Salaries 241 359 232 159 232 159 261 959 261 959 248 733 256 669 248 733 293 826 293 826 293 826 300 959 3 166 167

Existing shops 241 359 232 159 232 159 232 159 232 159 219 893 227 253 219 893 232 159 232 159 232 159 238 293 2 771 804Mall Of America 30 377 29 067 29 067 29 067 29 067 27 320 28 368 27 320 29 067 29 067 29 067 29 940 346 791King of Prussia Mall 38 396 37 126 37 126 37 126 37 126 35 433 36 449 35 433 37 126 37 126 37 126 37 973 443 563Palisades Center 39 635 38 650 38 650 38 650 38 650 37 337 38 125 37 337 38 650 38 650 38 650 39 307 462 290The Galleria 23 302 22 317 22 317 22 317 22 317 21 003 21 791 21 003 22 317 22 317 22 317 22 973 266 290Sawgrass Mills 24 760 23 650 23 650 23 650 23 650 22 170 23 058 22 170 23 650 23 650 23 650 24 390 282 098Woodfield Mall 27 875 26 750 26 750 26 750 26 750 25 250 26 150 25 250 26 750 26 750 26 750 27 500 319 275Del Amo Fashion Center 28 680 27 450 27 450 27 450 27 450 25 810 26 794 25 810 27 450 27 450 27 450 28 270 327 514South Coast Plaza 28 335 27 150 27 150 27 150 27 150 25 570 26 518 25 570 27 150 27 150 27 150 27 940 323 983New shops 0 0 0 29 800 29 800 28 840 29 416 28 840 61 667 61 667 61 667 62 667 394 363Aventura Mall 0 0 0 29 800 29 800 28 840 29 416 28 840 29 800 29 800 29 800 30 280 266 376Millcreek Mall 0 0 0 0 0 0 0 0 31 867 31 867 31 867 32 387 127 987

Payroll Taxes 23 412 22 519 22 519 25 410 25 410 24 127 24 897 24 127 28 501 28 501 28 501 29 193 307 118Other Payroll Related Benefits 24 136 23 216 23 216 26 196 26 196 24 873 25 667 24 873 29 383 29 383 29 383 30 096 316 617Number of Salespeople 58 58 58 66 66 66 66 66 74 74 74 74 67Avg Gross Salary 4161 4003 4003 3969 3969 3769 3889 3769 3971 3971 3971 4067 3959

Happy Retailer, LLC Sales Persons Salary Budget 2012



Forecasting of administration salaries takes a different approach. First of all you should review your personnel schedule and the salary system for each position. It is very important to distinguish between the positions with fixed salaries and those positions that have some variable parts of their compensation package. A nice example of a person with variable salary might be a sales agent in a wholesale company. Such salaries would be linked to the sales results with formulas, so that they correspondingly are adjusted when sales budget is changed.

So, when making projections for your company, ask yourself:

1. What positions do we have? Create a list. 2. If we expand our operations what other positions shall we have? When do we plan to add

them to the staff? 3. Does each of the positions have some sort of motivation system that is reflected in the P&L

statement? For example, stock options for the top management are rarely reflected in the books before their execution – depending on the company’s accounting policy, of course.

4. What factors influence the bonus for each employee? If you pay a percentage of sales to your sales agents then you should link the salary to the projected sales levels. On the other hand, if you use a balanced scorecard to motivate your back office employees and they receive up to a 1 month salary bonus each 6 months, depending on the score, link the base salary to the average historical score so that you can derive the average bonus amount for each person.

5. What are the applicable taxes and what percentage of salaries that we offer as additional benefits. The additional benefits might be even projected in detail for each position.

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total1 2 3 4 5 6 7 8 9 10 11 12Total 114 792 114 792 114 792 114 792 114 792 114 792 114 792 114 792 114 792 114 792 114 792 114 792 1 377 508

Gross salaries 95 900 95 900 95 900 95 900 95 900 95 900 95 900 95 900 95 900 95 900 95 900 95 900 1 150 800CEO 20 800 20 800 20 800 20 800 20 800 20 800 20 800 20 800 20 800 20 800 20 800 20 800 249 600CFO 12 500 12 500 12 500 12 500 12 500 12 500 12 500 12 500 12 500 12 500 12 500 12 500 150 000COO 12 500 12 500 12 500 12 500 12 500 12 500 12 500 12 500 12 500 12 500 12 500 12 500 150 000Head of sales and marketing 10 000 10 000 10 000 10 000 10 000 10 000 10 000 10 000 10 000 10 000 10 000 10 000 120 000Purchase specialist 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 90 000Marketing specialist 7 900 7 900 7 900 7 900 7 900 7 900 7 900 7 900 7 900 7 900 7 900 7 900 94 800Personnel specialist 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 90 000Chief accountant 7 100 7 100 7 100 7 100 7 100 7 100 7 100 7 100 7 100 7 100 7 100 7 100 85 200Head of logistics 5 500 5 500 5 500 5 500 5 500 5 500 5 500 5 500 5 500 5 500 5 500 5 500 66 000System administrator 4 600 4 600 4 600 4 600 4 600 4 600 4 600 4 600 4 600 4 600 4 600 4 600 55 200Payroll Taxes 9 302 9 302 9 302 9 302 9 302 9 302 9 302 9 302 9 302 9 302 9 302 9 302 111 628Other Payroll Related Benefits 9 590 9 590 9 590 9 590 9 590 9 590 9 590 9 590 9 590 9 590 9 590 9 590 115 080Number of Admin. Employees 10 10 10 10 10 10 10 10 10 10 10 10Avg Gross Salary 9 590 9 590 9 590 9 590 9 590 9 590 9 590 9 590 9 590 9 590 9 590 9 590

Happy Retailer, LLC Administration Salary Budget 2012



And, last but not least, businesses usually forecast salaries by the position not by the person. However, small businesses usually have only a few employees and all are wearing multiple hats depending on their talents. In such companies if one employee leaves the company the hats most likely be re-distributed until a replacement is found, taking into account each team member’s strengths and competencies. So sometimes for small companies the salary budget will actually be estimated by person, not by position.



Position:__Marketing assistant___ □Fix / Var Factors:__Sales increase during campaigns_

My company’s administration personnel:

Position:_____________________ □Fix / □Var Factors:_____________________________














Projecting costs for a retail network

The retail network cost budget is the special budget for Happy Retailer. As I mentioned above, each company’s sales projection model and the forecast cost of goods sold will be different due to business specifics. However, there is usually a cost budget that is specific to a particular industry. For example; retailers have the special budget for the cost of retail network, manufacturers have a factory overhead cost budget, transportation companies have a cost of fleet budge, etc.

In this particular case it is important to identify all the costs that are connected with keeping the retail network operational. For our retail clients we usually include in a budget like this; rent of premises, utilities costs, shopping center marketing costs, cost of uniforms for personnel, cost of cleaning of the shops, etc.

It is easy to combine all the conditions of rent agreements in one table and to automatically create corresponding cost tables with Microsoft Excel formulas. See the example below.

The above table shows a summary of the main rent conditions for each of the shops – rented area, rent rate in dollars per square foot, rent as a percentage of sales, etc. Please, note that according to the rent agreements it is assumed here that the rent at existing shops will increase by 3-6% in the 4th month of the year, April. (See the last 2 columns of the table).

Then, with the help of Excel formulas, all of the conditions stored in this table are transformed into a full-scale cost budget. In the example below I show the upper part of the retail network cost budget – the totals and the cost of rent of premises.

Note that some of the shops do not show the rent increase in April. The reason is that the increase is applied to the minimum rent rate while the turnover of the shops, according to the sales plan, is high enough for the shop to start paying the percentage-of-sales rent.

Shop Area, sq ft

Rent, $/sq ft

Rental %

Recalc. Period

Utilities $/sq ft

Marketing fee $/sq

ft

Rent increase,

%

Increase month

Existing shopsMall Of America 4200.0 8.0 8% None 0.50 0.50 4.00% 4King of Prussia Mall 4330.0 7.5 8% Month 0.50 0.50 4.00% 4Palisades Center 3180.0 8.0 8% Month 0.50 0.50 3.00% 4The Galleria 5100.0 5.0 8% Month 0.50 0.50 3.00% 4Sawgrass Mills 4750.0 6.0 8% None 0.50 0.50 3.00% 4Woodfield Mall 4600.0 6.3 8% Month 0.50 0.50 3.00% 4Del Amo Fashion Center 4900.0 6.3 8% None 0.50 0.50 6.00% 4South Coast Plaza 4700.0 6.3 8% Month 0.50 0.50 6.00% 4New shopsAventura Mall 3040.0 6.3 8% Month 5.00 5.00Millcreek Mall 3300.0 6.3 8% Month 5.00 7.00

Rental Terms



Projecting marketing costs

Estimating marketing costs sometimes is a tricky thing to do. Usually companies have full discretion with their marketing budgets, except when they have signed long-term agreements with marketing agencies. In these cases there is usually a pre-negotiated annual budget that is quite easy to forecast – just copy it from the agreement with the agency. However, most small and medium companies do their own marketing so here are some tips.

Provide necessary funds to support your seasonal activities. In the example below you can see that the forecast costs of media campaigns are much higher during sales periods. If you plan to have a seasonal sales increase but forget to provide the necessary marketing funds one of two things can happen; you will either overspend your marketing budget, or worse, fail to allocate the necessary funds and will lose potential business. Neither of these options is appealing.

Link costs that are related to some external factors with formulas to these factors. In the example above it is assumed that the customer loyalty program will generate 1,000 new loyal customers each month at a cost to the company of $2 per customer.

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total1 2 3 4 5 6 7 8 9 10 11 12Total 347 821 320 063 320 063 376 623 376 603 362 934 370 252 362 934 440 134 440 154 440 134 463 228 4 620 944

Rent of Premises 268 307 246 107 246 107 269 358 269 358 263 651 266 172 263 651 290 158 290 158 290 158 308 958 3 272 144

Existing shops 268 307 246 107 246 107 250 158 250 158 244 499 247 020 244 499 250 158 250 158 250 158 264 958 3 012 288Mall Of America 33 600 33 600 33 600 34 944 34 944 34 944 34 944 34 944 34 944 34 944 34 944 34 944 415 296King of Prussia Mall 44 084 39 004 39 004 39 004 39 004 33 774 36 294 33 774 39 004 39 004 39 004 42 390 463 341Palisades Center 30 207 26 267 26 267 26 267 26 267 26 203 26 203 26 203 26 267 26 267 26 267 28 893 321 576The Galleria 30 207 26 267 26 267 26 267 26 267 26 265 26 265 26 265 26 267 26 267 26 267 28 893 321 762Sawgrass Mills 28 500 28 500 28 500 29 355 29 355 29 355 29 355 29 355 29 355 29 355 29 355 29 355 349 695Woodfield Mall 34 500 30 000 30 000 30 000 30 000 29 849 29 849 29 849 30 000 30 000 30 000 33 000 367 048Del Amo Fashion Center 30 870 30 870 30 870 32 722 32 722 32 722 32 722 32 722 32 722 32 722 32 722 32 722 387 110South Coast Plaza 36 340 31 600 31 600 31 600 31 600 31 387 31 387 31 387 31 600 31 600 31 600 34 760 386 460New shops 0 0 0 19 200 19 200 19 152 19 152 19 152 40 000 40 000 40 000 44 000 259 856Aventura Mall 19 200 19 200 19 152 19 152 19 152 19 200 19 200 19 200 21 120 174 576Millcreek Mall 20 800 20 800 20 800 22 880 85 280

Happy Retailer, LLC Shops Expenditures Budget 2012


Total 167 180 33 442 29 820 29 820 29 820 27 180 167 442 27 180 27 180 29 820 29 820 176 296 775 000PR 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 60 000Presentation materials 1 680 7 942 4 320 4 320 4 320 1 680 1 942 1 680 1 680 4 320 4 320 10 796 49 000Internet ads 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 7 500 90 000Media campaigns 150 000 10 000 10 000 10 000 10 000 10 000 150 000 10 000 10 000 10 000 10 000 150 000 540 000Loyal customer program 2 000 2 000 2 000 2 000 2 000 2 000 2 000 2 000 2 000 2 000 2 000 2 000 24 000Other marketing costs 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 12 000

Happy Retailer, LLC Marketing Budget 2012



Projecting other costs

Other cost projections, e.g. administration costs, HR budget or other selling costs are usually less tricky to forecast than the ones that we have previously defined. These budgets are usually based on historical data and are quite straightforward.

Consider an administration cost budget for Happy Retailer. All of the costs shown above are mostly fixed costs. Most of these costs will be, more or less, equal to the previous year’s amounts, except for cases when a clear cost increase formula is provided in an agreement, (for example for office rent).

Take note of the Business trips category above. It is quite difficult to precisely predict when these costs will occur. While some of trips are planned well in advance, others cannot be foreseen. My suggestion is to forecast the annual amount that will be allocated for business trips and to divide the total budget equally between 12 months. This, of course, does not hold true in cases when most of the business trips are planned well in advance and in particular months, (e.g. annual trade shows). However, this is assumed to not be the case for Happy Retailer.

The same concept applies to other costs positions as well. Calculate an average amount for the previous year, make corrections for cost inflation and project equally to all the months, except for the cases when the differences are clearly known in advance.

Other cost budgets like HR or other selling cost budgets are projected the same way and are based upon the same principles.


Total 22 500 22 500 22 500 22 500 22 500 22 500 22 500 22 500 22 500 22 500 22 500 32 500 280 000Annual report audit 0 0 0 0 0 0 0 0 0 0 0 10 000 10 000Accountants and other consultants 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 60 000Office rent 3 500 3 500 3 500 3 500 3 500 3 500 3 500 3 500 3 500 3 500 3 500 3 500 42 000Office utilities 1 500 1 500 1 500 1 500 1 500 1 500 1 500 1 500 1 500 1 500 1 500 1 500 18 000Office cleaning 500 500 500 500 500 500 500 500 500 500 500 500 6 000Business trips 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 60 000Stationary goods 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 12 000Business partners (gifts, etc) 0 0 0 0 0 0 0 0 0 0 0 0 0Commissions for rent agreements 0 0 0 0 0 0 0 0 0 0 0 0 0Bank commissions 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 1 000 12 000Other administration expenses 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 5 000 60 000

Happy Retailer, LLC Administration Cost Budget 2012



Working capital projections

Getting high profits is not enough for the company to be financially successful or even solvent, at least in the short term. Sometimes an unexpected growth of sales and profits can lead a company to a financial disaster due to inadequate level of working capital financing.

Net working capital is calculated by subtracting current liabilities from the current assets of the company. The difference discloses the amount of financing that the company needs in order to successfully run its business.

Quite often, during periods of high growth, a company finds itself in a very bad financial situation, especially if its clients are used to long deferred payments. Suppliers ask for prepayments but margins are tight, so expansion cannot be financed from accumulated profit, (see the example to the right).

Therefore, it is crucial to forecast not only profits for the company but also changes in working capital and other balance sheet items so that at the end there is a complete interconnected package of budgets – P&L budget, cashflow budget and projected balance sheet.

For the Happy Retailer we have created 3 different budget spreadsheets for working capital projections – accounts receivable, inventory and accounts payable. All of them utilize minimum assumptions and are derived from the P&L budget.

Inventory projections

From the cost of goods sold projections you might recall that Happy Retailer has 10 different product groups. You might also recall that we have advanced quite a bit with estimates beginning with sales projections by shop, then forecasting how these sales would split by product groups and then forecasting the cost of goods sold for each product group.

Now this meticulousness begins to pay off. We are now able to forecast inventory movements for each product group, to analyze whether any of the groups have excess inventory and what the inventory refill rates should be for each product group.

The basic formula employed in the inventory budget is as follows. Purchases = COGS X refill rate + purchases for new shops. The next budget screenshot shows the structure of the inventory budget for Happy Retailer.

One of AG Capital CFO Services’ clients in the construction industry supplies very specific materials that are used in bridge construction. 2011 was great for them. After a slowdown in 2009-2010 the business volume for the company had tripled. However, by the middle of the year they were very close to bankruptcy. The main problem for the company was that they were not prepared for such a huge growth of business and did not have enough working capital. They had to pay their suppliers upfront, but their accounts receivable were averaging as much as 90 days. Rapid growth for companies is possible only when their working capital is adequately financed. Otherwise rapidly growing volume is, paradoxically, the first step to disaster. Working capital budgeting is crucial for such companies.



So, after filling in the projected starting levels of inventory at the beginning of January, everything else is calculated automatically. Cost of goods sold is automatically taken from the Sales/COGS budget. Purchases are automatically calculated by multiplying COGS by inventory refill ratio. New shop purchases are added in April and September – the months when Happy Retailer is expected to open new stores.

For simplicity it is assumed that the inventory refill ratio is 100% for each of the product groups and that purchases occur every month. However, other businesses might have less straightforward inventory policies.

For example; a company might make purchases quarterly, some of their product groups are becoming obsolete, so the refill rate is set to 0 and they are just selling out their existing stock. On the other hand, some new product groups might be added to the stock, so the initial purchase will be forecast in the budget.

In these cases the purchase table in the Inventory budget should be filled in manually and the implications for the company’s cash flows should be closely monitored. It may occur that the company might not have enough money to introduce a new product group, especially if the initial stock needs are large and the supplier is not willing to offer deferred payment terms. The cashflow budget will instantly signal the problem.

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec1 2 3 4 5 6 7 8 9 10 11 12

Inventory at the beginning of the period 7 000 000 7 000 000 7 000 000 7 000 000 8 000 000 8 000 000 8 000 000 8 000 000 8 000 000 9 000 000 9 000 000 9 000 000 7 000 000COGS 1 946 826 1 697 404 1 697 404 1 827 437 1 827 437 1 468 868 1 684 009 1 468 868 1 968 710 1 968 710 1 968 710 2 162 122 21 686 505Purchased inventory for existing shops 1 946 826 1 697 404 1 697 404 1 827 437 1 827 437 1 468 868 1 684 009 1 468 868 1 968 710 1 968 710 1 968 710 2 162 122 21 686 505Purchased inventory for new shops 1 000 000 1 000 000 2 000 000Inventory at the end of the period 7 000 000 7 000 000 7 000 000 8 000 000 8 000 000 8 000 000 8 000 000 8 000 000 9 000 000 9 000 000 9 000 000 9 000 000 9 000 000*Available funds 869 560 1 015 439 1 238 280 1 448 507 1 468 550 2 055 851 1 502 751 1 040 563 1 098 038 1 463 180 2 324 078 2 453 924Inventory at the beginning of the month 7 000 000 7 000 000 7 000 000 7 000 000 8 000 000 8 000 000 8 000 000 8 000 000 8 000 000 9 000 000 9 000 000 9 000 000 9 000 000Shirts 506 522 506 522 506 522 506 522 578 882 578 882 578 882 578 882 578 882 651 242 651 242 651 242 651 242Jeans 1 704 348 1 704 348 1 704 348 1 704 348 1 947 826 1 947 826 1 947 826 1 947 826 1 947 826 2 191 304 2 191 304 2 191 304 2 191 304Jackets 684 783 684 783 684 783 684 783 782 609 782 609 782 609 782 609 782 609 880 435 880 435 880 435 880 435Sportswear 684 783 684 783 684 783 684 783 782 609 782 609 782 609 782 609 782 609 880 435 880 435 880 435 880 435Swimwear 152 174 152 174 152 174 152 174 173 913 173 913 173 913 173 913 173 913 195 652 195 652 195 652 195 652Socks 221 739 221 739 221 739 221 739 253 416 253 416 253 416 253 416 253 416 285 093 285 093 285 093 285 093Shoes 1 269 565 1 269 565 1 269 565 1 269 565 1 450 932 1 450 932 1 450 932 1 450 932 1 450 932 1 632 298 1 632 298 1 632 298 1 632 298Sweaters 528 261 528 261 528 261 528 261 603 727 603 727 603 727 603 727 603 727 679 193 679 193 679 193 679 193Pants 486 957 486 957 486 957 486 957 556 522 556 522 556 522 556 522 556 522 626 087 626 087 626 087 626 087Coats 760 870 760 870 760 870 760 870 869 565 869 565 869 565 869 565 869 565 978 261 978 261 978 261 978 261COGS 1 946 826 1 697 404 1 697 404 1 827 437 1 827 437 1 468 868 1 684 009 1 468 868 1 968 710 1 968 710 1 968 710 2 162 122 21 686 505Shirts 223 400 195 082 195 082 206 845 206 845 166 735 190 801 166 735 219 589 219 589 219 589 240 919 2 451 213Jeans 303 897 264 716 264 716 290 914 290 914 233 432 267 921 233 432 319 296 319 296 319 296 350 875 3 458 705Jackets 283 261 246 798 246 798 267 630 267 630 214 847 246 517 214 847 290 197 290 197 290 197 318 846 3 177 766Sportswear 153 451 133 880 133 880 146 618 146 618 117 976 135 161 117 976 153 517 153 517 153 517 168 528 1 714 639Swimwear 177 919 154 940 154 940 168 040 168 040 134 782 154 737 134 782 182 230 182 230 182 230 200 278 1 995 149Socks 88 002 76 729 76 729 82 611 82 611 66 403 76 128 66 403 88 983 88 983 88 983 97 724 980 289Shoes 217 076 189 489 189 489 196 433 196 433 158 261 181 164 158 261 203 955 203 955 203 955 223 793 2 322 263Sweaters 128 287 112 024 112 024 118 765 118 765 95 734 109 553 95 734 133 371 133 371 133 371 146 347 1 437 344Pants 180 952 157 578 157 578 170 678 170 678 136 893 157 164 136 893 184 868 184 868 184 868 203 180 2 026 198Coats 190 580 166 166 166 166 178 904 178 904 143 805 164 864 143 805 192 703 192 703 192 703 211 633 2 122 938Purchases 1 946 826 1 697 404 1 697 404 2 827 437 1 827 437 1 468 868 1 684 009 1 468 868 2 968 710 1 968 710 1 968 710 2 162 122 23 686 505Shirts 223 400 195 082 195 082 279 206 206 845 166 735 190 801 166 735 291 949 219 589 219 589 240 919 2 595 934Jeans 303 897 264 716 264 716 534 392 290 914 233 432 267 921 233 432 562 774 319 296 319 296 350 875 3 945 662Jackets 283 261 246 798 246 798 365 456 267 630 214 847 246 517 214 847 388 023 290 197 290 197 318 846 3 373 418Sportswear 153 451 133 880 133 880 244 444 146 618 117 976 135 161 117 976 251 343 153 517 153 517 168 528 1 910 291Swimwear 177 919 154 940 154 940 189 779 168 040 134 782 154 737 134 782 203 970 182 230 182 230 200 278 2 038 627Socks 88 002 76 729 76 729 114 288 82 611 66 403 76 128 66 403 120 660 88 983 88 983 97 724 1 043 644Shoes 217 076 189 489 189 489 377 799 196 433 158 261 181 164 158 261 385 322 203 955 203 955 223 793 2 684 996Sweaters 128 287 112 024 112 024 194 231 118 765 95 734 109 553 95 734 208 836 133 371 133 371 146 347 1 588 276Pants 180 952 157 578 157 578 240 243 170 678 136 893 157 164 136 893 254 434 184 868 184 868 203 180 2 165 329Coats 190 580 166 166 166 166 287 600 178 904 143 805 164 864 143 805 301 399 192 703 192 703 211 633 2 340 329

Happy Retailer, LLC Inventory and Purchases 2012



Projecting account payable and accounts receivable

In this case I have provided you with a simple yet effective way of projecting accounts payable and accounts receivable. We operate with the average number of days for covering deferred payments. The calculations are simple. Total sales that occur during the month are divided by 30 days to calculate average daily sales. Then the average daily sales are multiplied by the 3 days of deferred payment. Thus we have come up with the end-of-month level of debtors for future sales.

A retail company usually has few debtors. Those debtors might be corporate customers who comprise only a small percentage of sales and the money that was paid by credit cards and has still not appeared on the company’s bank account. This is why we use just a weighted average of just 3 days for deferred payments.

The beginning-of-the-year accounts receivable balance below displays the outstanding balance on sales that have already occurred. With these debts we can forecast the repayment schedule. In the example below it is assumed that 1/3 of the debtors active at the beginning of the year will pay their balances during January, (so that the outstanding level of debtors is $266,667), and the other 2/3 will pay during February bringing the balance to 0.

Summing up the level of debtors from the future sales and the outstanding debt level from historical sales gives the total amount of the accounts receivable that is automatically included into the balance sheet.

The similar method is used also for the accounts payable, although here the weighted average deferred payment is much longer – 2.5 months or 75 days.

These two examples demonstrate a very simple way to project working capital. In your real-life working capital budget you might want to forecast accounts receivable and accounts payable with a deeper level of detail. For example; it might be a good idea to project accounts payable at the level of each individual supplier, especially in cases when there is a large difference in payment terms. All you need to do is to insert additional rows to the tables above as needed. However, in these cases you should also upgrade your Sales/COGS budget and include sales by suppliers there as well.


Planned Sales 3 590 878 3 130 878 3 130 878 3 370 878 3 370 878 2 709 544 3 106 344 2 709 544 3 630 878 3 630 878 3 630 878 3 987 544Weighted Average Deferred Payment, days 3 3 3 3 3 3 3 3 3 3 3 3Current Accounts Receivable 359 088 313 088 313 088 337 088 337 088 270 954 310 634 270 954 363 088 363 088 363 088 398 754

End-of-year Accounts Receivable Opening B. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecBalance 400 000 266 667 133 333 0 0 0 0 0 0 0 0 0 0

Happy Retailer, LLC Accounts Receivable 2012


Purchases 1 946 826 1 697 404 1 697 404 2 827 437 1 827 437 1 468 868 1 684 009 1 468 868 2 968 710 1 968 710 1 968 710 2 162 122Deferred Payment, days 75 75 75 75 75 75 75 75 75 75 75 75Current Accounts Payable 1 946 826 3 644 229 4 368 220 5 373 543 5 503 576 4 710 023 4 066 596 3 887 311 5 279 583 5 671 854 5 421 775 5 115 188

End-of-year Accounts Payable Opening B. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecBalance 5 000 000 3 000 000 1 000 000 0 0 0 0 0 0 0 0 0 0

Happy Retailer, LLC Accounts Payable 2012



Projecting capital investment and depreciation schedules

One of the most important parts of the corporate budget that significantly influences the company’s cashflow is the capital investment budget. Here you will forecast all the capital expenditures that you plan to make during the next fiscal year.

The Happy Retailer example illustrates how the capital expenditure budget is built. As noted earlier, the company plans to open 2 new stores during the course of the year – one in April and the other in September. The cost estimate for opening each of the shops amounts to $250,000.

Note that only a portion of the capital expenditures will be spent on capital items like furniture and display cases. These costs will be capitalized in the balance sheet and will be depreciated over several years according to the company’s depreciation policy.

The other part of the expenditures will not be capitalized. Actually, costs such as personnel training and initial marketing may be also included into HR and Marketing budgets correspondingly. However, from the scenario analysis point of view it is more accurate to include them into the Capital Expenditure budget.

The capital investment budget is created in such a way that when a company wants to do a scenario analysis and to alter store opening dates or even to evaluate what will happen if a store is not opened during the year, the numbers change automatically. The cost estimation is entered into the small table to the right of the main budget and the numbers will then automatically appear at the month of the shop opening.

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total1 2 3 4 5 6 7 8 9 10 11 12

Total 0 0 0 250 000 0 0 0 0 250 000 0 0 0 500 00010y depreciation 10y 0 0 0 107 143 0 0 0 0 107 143 0 0 0 214 2865y depreciation 5y 0 0 0 71 429 0 0 0 0 71 429 0 0 0 142 8573y depreciation 3y 0 0 0 35 714 0 0 0 0 35 714 0 0 0 71 429Intangible asset amortisation IA 0 0 0 0 0 0 0 0 0 0 0 0 0Non-capitalized Costs Costs 0 0 0 35 714 0 0 0 0 35 714 0 0 0 71 429Intangible assets amortization forecastTotal 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 36 000Amortization of existing int. assets 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 36 000Amortization of new int. assets 0 0 0 0 0 0 0 0 0 0 0 0 0Fixed assets depreciation forecastTotal 5 500 5 500 5 500 8 575 8 575 8 575 8 575 8 575 11 651 11 651 11 651 11 651 105 980Depreciation of existing fixed assets 5 500 5 500 5 500 5 500 5 500 5 500 5 500 5 500 5 500 5 500 5 500 5 500 66 000Depreciation of new fixed assets 0 0 0 3 075 3 075 3 075 3 075 3 075 6 151 6 151 6 151 6 151 39 980Aventura Mall Apr Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total BudgetTotal 0 0 0 250 000 0 0 0 0 0 0 0 0 250 000 250 000Capital investment 0 0 0 214 286 0 0 0 0 0 0 0 0 214 286 214 286Shop furniture 10y 0 0 0 107 143 0 0 0 0 0 0 0 0 107 143 107 143Construction works 5y 0 0 0 71 429 0 0 0 0 0 0 0 0 71 429 71 429POS Terminals and other IT equipment 3y 0 0 0 35 714 0 0 0 0 0 0 0 0 35 714 35 714Investment 4 IA 0 0 0 0 0 0 0 0 0 0 0 0 0 0Investment 5 IA 0 0 0 0 0 0 0 0 0 0 0 0 0 0Non-capitalized expenses 0 0 0 35 714 0 0 0 0 0 0 0 0 35 714 35 714Personnel training Costs 0 0 0 17 857 0 0 0 0 0 0 0 0 17 857 17 857Initial marketing Costs 0 0 0 17 857 0 0 0 0 0 0 0 0 17 857 17 857Millcreek Mall Sep Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total BudgetTotal 0 0 0 0 0 0 0 0 250 000 0 0 0 250 000 250 000Capital investment 0 0 0 0 0 0 0 0 214 286 0 0 0 214 286 214 286Shop furniture 10y 0 0 0 0 0 0 0 0 107 143 0 0 0 107 143 107 143Construction works 5y 0 0 0 0 0 0 0 0 71 429 0 0 0 71 429 71 429POS Terminals and other IT equipment 3y 0 0 0 0 0 0 0 0 35 714 0 0 0 35 714 35 714Investment 4 IA 0 0 0 0 0 0 0 0 0 0 0 0 0 0Investment 5 IA 0 0 0 0 0 0 0 0 0 0 0 0 0 0Non-capitalized expenses 0 0 0 0 0 0 0 0 35 714 0 0 0 35 714 35 714Personnel training Costs 0 0 0 0 0 0 0 0 17 857 0 0 0 17 857 17 857Initial marketing Costs 0 0 0 0 0 0 0 0 17 857 0 0 0 17 857 17 857

Happy Retailer, LLC Capital Expenditure Budget 2012



Fixed asset depreciation and intangible asset amortization schedules are also projected here. It is interesting to note that the depreciation and amortization schedules are created separately for existing assets and for new assets that the company plans to acquire during the year. The logic here is similar to the logic of the accounts payable/accounts receivable budgets.

The depreciation schedule of existing assets is easily projectable – just take a report from your accounting system. The depreciation schedule of new assets depends on the date of acquisition and the depreciation policy of the company. Then both numbers are added and the combined value is automatically included into the projected profit and loss statement.

The Happy Retailer example is a simple one. We assume that the company has just 2 investment projects – the opening of 2 new stores. However, when you consider your company’s investment projects for the next fiscal year, you must include all possible capital expenditure projects, even relatively small ones like upgrading software licenses or buying a new delivery car.

You should also ask yourself what effects the capital investment project will have on other income/cost positions. For example; if you run a pizza delivery service and you plan to buy a new car to replace an obsolete one, the effect on current costs will be very little. However, if you run a manufacturing company and you plan to make a substantial investment in new production equipment that would replace several manual operations, you will also have to make significant adjustments to your manufacturing cost budgets, not only to the capital investment budget.

The next page provides you with a short table/summary where you can summarize your capital investment needs for the next year before starting to create the budget. Remember, that anything that you plan to buy that cannot be written off immediately to your company’s expenses should be included in the capital expenditure budget. If you are not sure whether an item you plan to buy should be treated as a cost or as capital investment it is always a good idea to consult your accountant.



Project name:__________________________________ Project name:__________________________________Starting month:________________________________ Starting month:________________________________Cost positions Depr. Amount Cost positions Depr. AmountTotal $___________ Total $___________Capital investment $___________ Capital investment $___________$___________ $___________$___________ $___________$___________ $___________$___________ $___________$___________ $___________Non-capitalized expenses $___________ Non-capitalized expenses $___________$___________ $___________$___________ $___________$___________ $___________$___________ $___________$___________ $___________Project name:__________________________________ Project name:__________________________________Starting month:________________________________ Starting month:________________________________Cost positions Depr. Amount Cost positions Depr. AmountTotal $___________ Total $___________Capital investment $___________ Capital investment $___________$___________ $___________$___________ $___________$___________ $___________$___________ $___________$___________ $___________Non-capitalized expenses $___________ Non-capitalized expenses $___________$___________ $___________$___________ $___________$___________ $___________$___________ $___________$___________ $___________Project name:__________________________________ Project name:__________________________________Starting month:________________________________ Starting month:________________________________Cost positions Depr. Amount Cost positions Depr. AmountTotal $___________ Total $___________Capital investment $___________ Capital investment $___________$___________ $___________$___________ $___________$___________ $___________$___________ $___________$___________ $___________Non-capitalized expenses $___________ Non-capitalized expenses $___________$___________ $___________$___________ $___________$___________ $___________$___________ $___________$___________ $___________

My company’s new capital investment projects for the year _______



Projecting external financing

If a company is making use of or plans to make use of external financing, regardless of whether it is a loan from a bank or a subordinate loan from its owners, the profit and loss statement, (interest expense), and the balance sheet, (principal repayment), will be impacted. An external financing budget will address both issues.

In the example below I show the external financing budget for the Happy Retailer. In our calculations it is assumed that the company has two bank loans amounting to a total of $2.8 mln and a small interest-free line of credit from its owners of $250,000. The company also has two car lease agreements.

The idea here is that in the upper part of the external financing budget the principal repayments are projected. Data from this table influences the balance sheet. The lower part of the budget is automatically connected to the upper part and interest is automatically calculated based on the remaining principal amount. In my opinion this is the best approach for dealing with projected interest payments – linking the interest to the principal amount that changes every month.

The calculations also include a couple of financial ratios that reveal whether the level of financing and the interest rates are not too heavy for the company. Both the Debt/EBITDA and the Debt Service Coverage Ratio, (DSCR), are better than the required norm, (not higher than 3.5 for Debt/EBIDTA and not lower than 1.2 for DSCR), in that case. (I will not go into details about ratios as this is beyond the scope of this book).

Opening B. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Closing B.1 2 3 4 5 6 7 8 9 10 11 12

Loans 3 129 560 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 2 872 760

Liabilities 250 000 0 0 0 0 0 0 0 0 0 0 0 0 250 000Owner 250 000 0 0 0 0 0 0 0 0 0 0 0 0 250 000Owner - new financing 0 0Liabilities 2 879 560 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 2 622 760Bank Loan 1 1 500 000 -11 000 -11 000 -11 000 -11 000 -11 000 -11 000 -11 000 -11 000 -11 000 -11 000 -11 000 -11 000 1 368 000Bank Loan 2 1 300 000 -9 000 -9 000 -9 000 -9 000 -9 000 -9 000 -9 000 -9 000 -9 000 -9 000 -9 000 -9 000 1 192 000Bank Loan 3 0Bank Loan 4 0Bank Loan 5 0Bank Loan 6 0Bank Loan 7 0Long term lease 62 760 -1 400 -1 400 -1 400 -1 400 -1 400 -1 400 -1 400 -1 400 -1 400 -1 400 -1 400 -1 400 45 960Short term lease 16 800 16 800Interest payment Base rate Additional rate 10 686 10 606 10 526 10 447 10 367 10 287 10 208 10 128 10 048 9 969 9 889 9 809 122 968

Liabilities 0 0 0 0 0 0 0 0 0 0 0 0 0Owner 0.0% 0 0 0 0 0 0 0 0 0 0 0 0 0Owner - new financing 0.0% 0 0 0 0 0 0 0 0 0 0 0 0 0Liabilities Base rate Additional rate 10 686 10 606 10 526 10 447 10 367 10 287 10 208 10 128 10 048 9 969 9 889 9 809 122 969Bank Loan 1 LIBOR 3m 2.5% 5 584 5 543 5 501 5 460 5 419 5 378 5 336 5 295 5 254 5 213 5 171 5 130 64 283Bank Loan 2 LIBOR 3m 2.5% 4 841 4 808 4 774 4 740 4 706 4 673 4 639 4 605 4 571 4 538 4 504 4 470 55 868Bank Loan 3 LIBOR 3m 2.5% 0 0 0 0 0 0 0 0 0 0 0 0 0Bank Loan 4 LIBOR 3m 2.5% 0 0 0 0 0 0 0 0 0 0 0 0 0Bank Loan 5 LIBOR 3m 2.5% 0 0 0 0 0 0 0 0 0 0 0 0 0Bank Loan 6 LIBOR 3m 2.5% 0 0 0 0 0 0 0 0 0 0 0 0 0Bank Loan 7 LIBOR 3m 2.5% 0 0 0 0 0 0 0 0 0 0 0 0 0Long term lease LIBOR 3m 2.0% 205 200 195 191 186 181 177 172 167 163 158 153 2 146Short term lease LIBOR 3m 2.0% 56 56 56 56 56 56 56 56 56 56 56 56 672Commission fee Commisssion 0 0 0 1 200 0 0 0 0 0 1 200 0 0 2 400Credit line 0.3% 1 200 1 200 2 400

Debt/EBITDA 0.38DSCR 17.97

Happy Retailer, LLC External Capital Budget 2012



If you build your company’s external financing budget it might be a good idea to provide calculations of financial ratios below the budget tables linking them to the projected profitability and interest/principal payments, depending on the calculation formula for the ratios. It might be absolutely necessary if some of the ratios are included in your loan agreements as financial covenants.

Adding Everything Up

OK, we have now created all the separate parts of the budget and made detailed forecasts for each and every component of the company’s financials. The remaining part of the process is technically simple but very creative in a way. Now it’s time for add everything up – we have all the numbers, let’s just put them together.

The picture below represents a P&L budget for the Happy Retailer that was automatically created from the cost budgets that we discussed previously. Note that each cost budget is assigned at least one separate row here to make linking the projections as easy as possible.

Now the profit and loss budget is ready for the consolidation process, however, we still need to include the balance sheet and the cashflow budget in our calculations.


Net sales 3 590 878 3 130 878 3 130 878 3 370 878 3 370 878 2 709 544 3 106 344 2 709 544 3 630 878 3 630 878 3 630 878 3 987 544 40 000 000

Manufacturing costs 1 946 826 1 697 404 1 697 404 1 827 437 1 827 437 1 468 868 1 684 009 1 468 868 1 968 710 1 968 710 1 968 710 2 162 122 21 686 505Cost of goods sold 1 946 826 1 697 404 1 697 404 1 827 437 1 827 437 1 468 868 1 684 009 1 468 868 1 968 710 1 968 710 1 968 710 2 162 122 21 686 505Gross income 1 644 052 1 433 474 1 433 474 1 543 441 1 543 441 1 240 677 1 422 335 1 240 677 1 662 168 1 662 168 1 662 168 1 825 422 18 313 495

Selling expenses 854 145 675 581 673 924 773 211 768 941 736 070 896 944 736 180 870 051 872 496 872 361 1 052 910 9 782 813Sales personnel remuneration 288 907 277 895 277 895 313 565 313 565 297 733 307 232 297 733 351 710 351 710 351 710 360 248 3 789 902Other personnel expences 6 247 1 067 1 107 1 587 1 187 1 507 5 827 1 267 1 587 1 547 907 3 347 27 180Rent and other shop expenses 347 821 320 063 320 063 376 623 376 603 362 934 370 252 362 934 440 134 440 154 440 134 463 228 4 620 944Marketing costs 167 180 33 442 29 820 29 820 29 820 27 180 167 442 27 180 27 180 29 820 29 820 176 296 775 000Amortization of intangible assets 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 3 000 36 000Depreciation of fixed assets 5 500 5 500 5 500 8 575 8 575 8 575 8 575 8 575 11 651 11 651 11 651 11 651 105 980Other selling costs 35 490 34 615 36 540 40 040 36 190 35 140 34 615 35 490 34 790 34 615 35 140 35 140 427 808Administrative expenses 137 292 137 292 137 292 173 007 137 292 137 292 137 292 137 292 173 007 137 292 137 292 147 292 1 728 936Administration remuneration 114 792 114 792 114 792 114 792 114 792 114 792 114 792 114 792 114 792 114 792 114 792 114 792 1 377 508Development costs 0 0 0 35 714 0 0 0 0 35 714 0 0 0 71 429Other administrations costs 22 500 22 500 22 500 22 500 22 500 22 500 22 500 22 500 22 500 22 500 22 500 32 500 280 000Other operating revenues 0 0 0 0 0 0 0 0 0 0 0 0 0Other operating expenses 8 750 8 750 12 250 8 750 8 750 12 250 8 750 8 750 12 250 8 750 8 750 12 250 119 000Interest income 0 0 0 0 0 0 0 0 0 0 0 0 0Interest expenses 10 686 10 606 10 526 11 647 10 367 10 287 10 208 10 128 10 048 11 169 9 889 9 809 125 368Income before extraordinary item 633 179 601 245 599 482 576 826 618 090 344 778 369 142 348 327 596 812 632 461 633 875 603 161 6 557 377Non recurring income 0 0 0 0 0 0 0 0 0 0 0 0 0Non recurring expenses 0 0 0 0 0 0 0 0 0 0 0 0 0Profit before taxes 633 179 601 245 599 482 576 826 618 090 344 778 369 142 348 327 596 812 632 461 633 875 603 161 6 557 377Federal Income Tax 215 281 204 423 203 824 196 121 210 151 117 224 125 508 118 431 202 916 215 037 215 518 205 075 2 229 508State Income Tax 31 659 30 062 29 974 28 841 30 905 17 239 18 457 17 416 29 841 31 623 31 694 30 158 327 869Other taxes 0 0 0 0 0 0 0 0 0 0 0 0 0Net income 386 239 366 759 365 684 351 864 377 035 210 314 225 176 212 480 364 055 385 801 386 664 367 928 4 000 000*EBITDA 652 365 620 351 618 508 600 048 640 033 366 640 390 925 370 030 621 511 658 280 658 415 627 621 6 824 726**EBIT 643 865 611 851 610 008 588 473 628 457 355 065 379 349 358 455 606 860 643 629 643 764 612 970 6 682 746*EBITDA - Earnings before interest, taxes, depreciation and amortization**EBIT - Earnings before interest and taxes

Happy Retailer, LLC Profit and Loss Budget 2012



To forecast the balance sheet you must first input the starting values at the beginning of the year. Usually the budgeting process takes place at the end of the previous fiscal year, in November-December for a company whose fiscal year corresponds to the calendar year. At this point the starting balance sheet is still unknown, however, it is usually absolutely fine to use the most current balance sheet available, (e.g. a 9-month balance sheet as an approximation).

After you input the starting balance sheet into the projections, it is time to link the other months to the projections that are made in the working capital, CAPEX and financing budgets that we have already created. Some of the balance sheet positions that change rarely and deliberately, (e.g. reserves), are projected here manually.

Note that the current year’s retained earnings are automatically linked to the projections that we have created in the P&L budget. Note also that the cash balance is calculated automatically in the cashflow budget from the P&L and Balance sheet data and then is linked back to the balance sheet. Such interconnections ensure that changes in one of the statements are automatically reflected in the other statements.

The result should look approximately as in the picture below.

Note the small table below. This is a very helpful instrument to include in your budget since it helps to check whether the P&L budget, the balance sheet and the cashflow budget were linked together correctly. If not then the assets and liabilities will not match but you will be able to catch what the difference is and whether the problem occurs just once or is present in each of the months.

After you have managed to link all the 3 financial reports together, it is time to have a look at the cashflow statement and to evaluate the result. The cashflow budget for Happy Retailer is created as a final statement that is derived from the P&L and the balance sheet. That is why, if you need to make any changes to the cashflow budget, they must be introduced to one of the budgets from which the cashflow

Assets Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecCash 869 560 1 015 439 1 238 280 1 448 507 1 468 550 2 055 851 1 502 751 1 040 563 1 098 038 1 463 180 2 324 078 2 453 924 2 472 462Marketable securities 0 0 0 0 0 0 0 0 0 0 0 0 0Accounts receivable 400 000 625 754 446 421 313 088 337 088 337 088 270 954 310 634 270 954 363 088 363 088 363 088 398 754Sales tax overpayment 0 0 0 0 0 0 0 0 0 0 0 0 0Inventory 7 000 000 7 000 000 7 000 000 7 000 000 8 000 000 8 000 000 8 000 000 8 000 000 8 000 000 9 000 000 9 000 000 9 000 000 9 000 000Total current assets 8 269 560 8 641 194 8 684 701 8 761 595 9 805 638 10 392 939 9 773 706 9 351 197 9 368 992 10 826 268 11 687 166 11 817 012 11 871 217Long-term financial investments 1 400 000 1 400 000 1 400 000 1 400 000 1 400 000 1 400 000 1 400 000 1 400 000 1 400 000 1 400 000 1 400 000 1 400 000 1 400 000Tangible assets 2 000 000 1 994 500 1 989 000 1 983 500 2 189 210 2 180 635 2 172 060 2 163 484 2 154 909 2 357 544 2 345 893 2 334 242 2 322 591Intangible assets 250 000 247 000 244 000 241 000 238 000 235 000 232 000 229 000 226 000 223 000 220 000 217 000 214 000Total fixed assets 3 650 000 3 641 500 3 633 000 3 624 500 3 827 210 3 815 635 3 804 060 3 792 484 3 780 909 3 980 544 3 965 893 3 951 242 3 936 591Total assets 11 919 560 12 282 694 12 317 701 12 386 095 13 632 848 14 208 574 13 577 765 13 143 681 13 149 901 14 806 812 15 653 059 15 768 254 15 807 808

Equity and liabilities Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecShort-term loans 240 000 240 000 240 000 240 000 240 000 240 000 240 000 240 000 240 000 240 000 240 000 240 000 240 000Short-term leasing 16 800 16 800 16 800 16 800 16 800 16 800 16 800 16 800 16 800 16 800 16 800 16 800 16 800Accounts payable 5 000 000 4 946 826 4 644 229 4 368 220 5 373 543 5 503 576 4 710 023 4 066 596 3 887 311 5 279 583 5 671 854 5 421 775 5 115 188Sales tax debt 40 000 111 469 103 713 103 832 14 799 104 856 78 686 84 253 78 678 662 90 237 90 246 89 860Other tax liabilities 20 000 0 0 0 0 0 0 0 0 0 0 0 0Current liabilities 5 316 800 5 315 094 5 004 743 4 728 852 5 645 142 5 865 232 5 045 509 4 407 649 4 222 789 5 537 045 6 018 891 5 768 822 5 461 848Long-term loans 2 560 000 2 540 000 2 520 000 2 500 000 2 480 000 2 460 000 2 440 000 2 420 000 2 400 000 2 380 000 2 360 000 2 340 000 2 320 000Long-term leasing 62 760 61 360 59 960 58 560 57 160 55 760 54 360 52 960 51 560 50 160 48 760 47 360 45 960Owners' loans 250 000 250 000 250 000 250 000 250 000 250 000 250 000 250 000 250 000 250 000 250 000 250 000 250 000Long-term liabilities 2 872 760 2 851 360 2 829 960 2 808 560 2 787 160 2 765 760 2 744 360 2 722 960 2 701 560 2 680 160 2 658 760 2 637 360 2 615 960Total liabilities 8 189 560 8 166 454 7 834 703 7 537 412 8 432 302 8 630 992 7 789 869 7 130 609 6 924 349 8 217 205 8 677 651 8 406 182 8 077 808Provisions 0 0 0 0 0 0 0 0 0 0 0 0 0Share Capital 1 200 000 1 200 000 1 200 000 1 200 000 1 200 000 1 200 000 1 200 000 1 200 000 1 200 000 1 200 000 1 200 000 1 200 000 1 200 000Reserves 30 000 30 000 30 000 30 000 30 000 30 000 30 000 30 000 30 000 30 000 30 000 30 000 30 000Retained Earnings from prevous years 2 500 000 2 500 000 2 500 000 2 500 000 2 500 000 2 500 000 2 500 000 2 500 000 2 500 000 2 500 000 2 500 000 2 500 000 2 500 000Current year's Net Income 0 386 239 752 999 1 118 682 1 470 547 1 847 582 2 057 896 2 283 073 2 495 552 2 859 607 3 245 408 3 632 072 4 000 000Retained earnings 2 500 000 2 886 239 3 252 999 3 618 682 3 970 547 4 347 582 4 557 896 4 783 073 4 995 552 5 359 607 5 745 408 6 132 072 6 500 000Total equity 3 730 000 4 116 239 4 482 999 4 848 682 5 200 547 5 577 582 5 787 896 6 013 073 6 225 552 6 589 607 6 975 408 7 362 072 7 730 000Total equity and liabilities 11 919 560 12 282 694 12 317 701 12 386 095 13 632 848 14 208 574 13 577 765 13 143 681 13 149 901 14 806 812 15 653 059 15 768 254 15 807 808

ControlAre Assets and Liabilities equal? TRUE TRUE TRUE TRUE TRUE TRUE TRUE TRUE TRUE TRUE TRUE TRUE TRUEWhat is the difference? 0 0 0 0 0 0 0 0 0 0 0 0 0What is the monthly growth of the difference? 0 0 0 0 0 0 0 0 0 0 0 0 0

Happy Retailer, LLC Balance Sheet 2012



budget is derived. For example, if you notice there is not enough money to make capital investments in April the capital investment project shall be moved to a later period of time in the capital investment budget not in the cashflow budget itself.

So, after we have created all the other budgets, the cashflow budget for Happy Retailer looks like this:

Once again, please note the interconnections between the budgets. The cash amount in the last line of the cashflow budget is exactly the same as it is in the cash line on the balance sheet.

Cash flow statement Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total

Cash and cash equivalents at the beginning of the perio 869 560 1 015 439 1 238 280 1 448 507 1 468 550 2 055 851 1 502 751 1 040 563 1 098 038 1 463 180 2 324 078 2 453 924 869 560

Cash provided by operationsNet income (loss) 386 239 366 759 365 684 351 864 377 035 210 314 225 176 212 480 364 055 385 801 386 664 367 928 4 000 000Adjustments 19 186 19 106 19 026 23 222 21 942 21 863 21 783 21 703 24 699 25 819 24 540 24 460 267 349+ Depreciation and amortization 8 500 8 500 8 500 11 575 11 575 11 575 11 575 11 575 14 651 14 651 14 651 14 651 141 980+ Increase in provisions 0 0 0 0 0 0 0 0 0 0 0 0 0- Interest income 0 0 0 0 0 0 0 0 0 0 0 0 0+ Interest expense 10 686 10 606 10 526 11 647 10 367 10 287 10 208 10 128 10 048 11 169 9 889 9 809 125 368Decrease in operating assets- Accounts receivable -225 754 179 333 133 333 -24 000 0 66 133 -39 680 39 680 -92 133 0 0 -35 667 1 246- Inventories 0 0 0 -1 000 000 0 0 0 0 -1 000 000 0 0 0 -2 000 000Increase in operating liabilities+ Accounts payable and tax debt -1 706 -310 352 -275 890 916 289 220 090 -819 723 -637 861 -184 860 1 314 256 481 846 -250 069 -306 974 145 048Cash provided by operations 177 965 254 847 242 153 267 375 619 068 -521 412 -430 581 89 003 610 877 893 466 161 135 49 747 4 267 349

Investment activities 214 286Financial investments 0 0 0 0 0 0 0 0 0 0 0 0 0Purchases of property, plant, equipment and intangible ass 0 0 0 -214 286 0 0 0 0 -214 286 0 0 0 -428 571Investments in short-term financial instrumetns 0 0 0 0 0 0 0 0 0 0 0 0 0Interest income 0 0 0 0 0 0 0 0 0 0 0 0 0Cash used for investment activities 0 0 0 -214 286 0 0 0 0 -214 286 0 0 0 -428 571

Financing activitiesNet increase (decrease) in bank financing -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -21 400 -256 800Interest expense -10 686 -10 606 -10 526 -11 647 -10 367 -10 287 -10 208 -10 128 -10 048 -11 169 -9 889 -9 809 -125 368Net increase (decrease) in owners' financing 0 0 0 0 0 0 0 0 0 0 0 0 0Dividend payment 0 0 0 0 0 0 0 0 0 0 0 0 0Increase (decrease) in share capital 0 0 0 0 0 0 0 0 0 0 0 0 0Cash provided by (used for) financing activities -32 086 -32 006 -31 926 -33 047 -31 767 -31 687 -31 608 -31 528 -31 448 -32 569 -31 289 -31 209 -382 168

Increase (decrease) in cash and cash equivalents 145 879 222 841 210 227 20 043 587 301 -553 100 -462 189 57 475 365 143 860 898 129 846 18 538 1 602 902

Cash and cash equivalents at the end of the period 1 015 439 1 238 280 1 448 507 1 468 550 2 055 851 1 502 751 1 040 563 1 098 038 1 463 180 2 324 078 2 453 924 2 472 462 2 472 462

Happy Retailer, LLC Cash Flow Budget 2012



Consolidation While the planning stage of the budgeting process is the most time-consuming, the consolidation

process is by far the most creative. During the consolidation process you must combine the revenues and the costs that you projected, put them together and then compare the results with the goals that were set in the beginning of the process. It is quite likely that the first result that you get looks like the diagram below. The revenues and the costs just don’t go together and don’t match the goals.

And the moment you recognize this, the consolidation process begins. The goal of the consolidation is to synchronize revenues and costs with the goals that are set for the company – just like in a diagram below.

Goals

CostsRevenues

Goals

CostsRevenues



The process is simple and the logic is usually quite clear – increase planned revenues and lower planned costs. This might be easier to do for a smaller company where you are creating the budget yourself and then just present it to your employees. It might be more difficult to accomplish if the company is larger, your employees are involved in the process and you will need to negotiate new terms with them.

You must take into account that the forecasts you receive from your employees might be flawed due to the fact that they will later have to fulfill them. For example, if your sales department knows that their commissions will be linked to the plan they have put into the budget they may consciously or unconsciously try to establish the goals as small as possible. This process is called sandbagging.

There are several ways to deal with sandbagging. One option is just to be aware of it and to make proactive adjustments for it. Another option that could work for revenue budgets would be to create a motivation system for employees independent of the budget. For example; for sales personnel the budget sales plan would have nothing to do with monthly sales plans. Their monthly plans would instead be determined by a clearly pre-defined formula.

So, after making the adjustments for sandbagging you will have a budget that balances goals, revenues and costs. The next step is to use common sense and your knowledge of your business to gauge how probable it is that your team will be able to meet their sales goals and how probable it is that you will be able to stay within the projected cost budgets.

It may be that you realize that the sales and cost goals are not realistic. In this case it is important that you recognize this early on and make the appropriate adjustments.

Evaluation The next step in the budgeting process is evaluation. It may

be a formal evaluation by the board of directors or it might be just another look at the completed budget by the owner in a sole proprietorship. In any case this is a very important part of the process during which the budget will either be accepted or rejected and sent back to the financial department, or to your desk, for corrections.

During the evaluation process it is recommended that you use several tools in order to better understand the forecasted numbers and the assumptions behind them. I will briefly cover them here.

A case for sandbagging:

My CFO services company was once creating a budget for a profitable company that was operating in a growing market. However, after putting together the initial forecasts about costs and revenues from the company’s employees, the budget was showing that the company was going to operate with losses. It was quite an effort to consolidate it.



Sensitivity analysis – checking the most critical assumptions

The numbers in the budget are forecast and all of the numbers are based on assumptions. When trying to predict the future it is quite easy to make mistakes. Some of the mistakes could be very costly while others will have a very little impact on the results.

For example, fuel prices are very important to a transportation company and not very important to a professional services company. The price of fuel is influenced by price of oil while the price of oil is influenced by many different factors. It is quite difficult to precisely forecast oil prices so there are often errors in fuel price estimates. The cost of an error would be much higher for a transportation company that operates a fleet of trucks than for a financial services company that does budget analysis.

It is important to identify the assumptions that have the greatest impact on the company’s results, to double-check them and possibly to leave some reserve for the downside risk as well. Sensitivity analysis is the best way to do that.

The concept of sensitivity analysis is quite simple. When the budget is ready you must fix all the numbers and then start changing the assumptions one-by-one by the same percentage. Then you must note which of the factors causes the greatest changes in the company’s profit. Such assumptions are the most crucial ones and a great deal of attention must be given to them. It is very important to forecast such assumptions correctly since the cost of errors here would be the greatest.

For example; let’s look at Happy Retailer. Their net income is planned to be $4,000,000. Let’s decrease their sales by 10%. The net income has decreased by 24.5% to $3,018,930. Now let’s change the numbers back to the original ones and let’s try to decrease their markups by 10% (note that a 70% markup becomes 63%, not 60% after a 10% decrease). The profit has decreased less significantly, by 15.8% to 3,367,411. Now let’s change the numbers back to the initial state and let’s try to increase the base interest rate by 10% (from 2% to 2.2% per annum). The profit decreased just by 0.08% to $3,996,657.

It is very clear that the sales amounts are the most important assumption for Happy Retailer. Markups are an important assumption as well however the cost of error is less here. Bank interest rates are not important at all – the cost of error here is very low.

Keep doing these analyses to other assumptions in your budget in order to understand their impact on the final results of your company.

Ratio analysis

During the review stage it is also advised to have a look at the projected financial ratios for your company. Financial ratio analysis is actually a separate topic. There is a great deal of literature available regarding financial ratios. For instance, a very comprehensive collection of articles about financial ratio analysis are published in Investopedia and are available at: http://www.investopedia.com/university/ratios/#axzz1tzR0GZg6.

Still, keep in mind that it is a good idea to compare the ratios you have forecast for your company to the widely accepted norms or to the ratios of your competitors. If your goals are satisfied with the forecast numbers but some of the financial ratios are lagging behind the industry norm, there might be a problem with the goals not being ambitious enough.



Scenario analysis

Sometimes a company must make a vital decision during the budgeting process. For instance, whether or not to invest in new equipment that would increase the company’s production capacity.

Whether to use labor or machines in the manufacturing process, whether to concentrate on growth or on profit. In cases like these it is a good idea to develop and compare several scenarios that will estimate how the company will perform under each set of assumptions.

Another method of employing scenario analysis for a stable business would be to create a set of assumptions for the poor, average and healthy state of the economy and to evaluate whether the company would be able to cope with challenges

posed by each of the scenarios and what steps the company would need to take to mitigate these challenges. For example; in a poor economy scenario, if a company’s sales drop by 20% what costs would the company need to cut? Or in a healthy economy scenario; if a company’s sales increase by 20% where will the company get funds to finance the necessary expansion and what amount will be required?

For scenario analysis I strongly recommend using a flexible financial model that automatically recalculates all the numbers in the model after changing the assumptions. You can either create the model yourself or use a professional template from the www.cfotemplates.com website.



Conclusion Financial planning is easy when you know how to do it. In this book I have tried to make it easy for

people who don’t have an advanced education in finance but who run their own businesses, are experts in their field and who might need financial planning quite desperately.

From everything in this book there are 4 main points I would like to stress:

1. Start budgeting with setting goals. Visualize what you want to achieve, be specific. Don’t forget about the restricting factors that you might be facing;

2. Use a spreadsheet to create a flexible budget that makes it easy to change assumptions. You don’t even have to create the spreadsheet yourself – pre-built templates are available on the Internet;

3. Forecast your revenues and costs using the methods described throughout this book. Refer to a corresponding section of the book for details. Don’t forget that the final result should match your goals!

4. Create a number of different scenarios, have a look at what happens with your numbers if another set of assumptions are used. Be proactive, consider what you could do if unfavorable economic conditions or wrong movements of raw material prices for your products occur. Be prepared for the worst-case scenario just in case.

The fact that you don’t have financial education does not mean that you can’t create a great budget for your company. Your business needs financial planning, you can do it and I have tried to make the process as easy as possible for you.

I would very appreciate any feedback that you could provide on this e-book. I would like to know whether it was useful to you or not, what topics could have been covered in more details? What was relevant and what was not?

You could use the form on our website – www.cfotemplates.com/contact.html.

You can also follow my blog on financial planning and macroeconomic issues that I run at cfooutsourcing.blogspot.com.

Also, let me know if you need any assistance with your financial planning. My team and I are glad to help.

Good luck!

Andrew Grigolyunovich, CFA



About the author

Andrew Grigolyunovich, CFA, is the founder and the CEO at AG Capital CFO Services, a financial consulting company that specializes in providing outsourced CFO services for small and medium businesses.

At the age of 30 Andrew already has 10 year top management experience in finance and business management. He received his degree from Stockholm School of Economics in Riga, Latvia at the age of 20 and got his first job as a financial analyst with a mobile phone retailer. 3 months later the company announced a merger with its strongest competitor, thus forming the largest mobile phone retail company in Latvia – DT Mobile. Andrew was offered the position of CFO for the combined company, (70 locations, 250+ employees), at 21. This was just the beginning of a successful career. After spending two and a half years there, Andrew became a corporate credit manager for Swedbank’s large industrial clients, spending two years learning the specifics of bank financing, proposal evaluation and risk analysis.

During that time the previous owners of DT Mobile sold out their shares to Telia Sonera, one of Scandinavia’s largest mobile operators, and started a number of new businesses. Andrew was offered the CEO/CFO position in one of these businesses – jewelry retailer Grenardi Group. Andrew was 26 at that time.

Under Andrew’s management the company grew from an average Latvian retailer to a regional player, successfully opening subsidiaries in neighboring countries in just two years. However, the financial crisis of 2009 has forced the company to restructure, drastically cutting costs and staff, under the recovery plan developed by Andrew. He has remained with the company as an outsourced CFO and now Grenardi Group is one of the most loyal clients of AG Capital CFO Services.

Financial Planning

Documents

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