cima business plan

A Guide to Financial Management Fundamentals for Smaller & Medium-Sized Enterprises (SMEs)

(SMEs)

A practical guide topreparing abusiness planforsmaller & medium-sized enterprises

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ForewordIt gives me a great deal of pleasure to welcome you to this first Finance Wales guide for businessand business intermediaries. A key part of our role at Finance Wales is in the provision of goodquality and practical management support. While much of this support is directly carried out on a face-to-face basis through the mentoring and investment support that Finance Wales offers, I have a strong desire to reach as many business people as possible. This guide and those thatwill follow are designed to fulfil that goal.

The importance of robust business planning is well documented and widely accepted as bestpractice for all types of business. The reality is that planning is a difficult process and one that, if not done correctly, exposes a business to the risk of being unable to manage successfullyunforeseen challenges. Despite this importance we at Finance Wales regularly see our clientshaving to juggle their time to cope with the myriad of responsibilities involved in running abusiness. In this hectic environment the routine task of business planning is often left behind.

In this guide we have attempted to simplify the process of planning but it is not intended to be a replacement for sound professional advice or a template for accessing financial support. There can be no substitute for specific advice tailored to the business’s particular needs. Nor can there be a shopping list for finding finance.

I am delighted that we have been given the kind permission of the Chartered Institute ofManagement Accountants (CIMA) to reproduce this guide, which was prepared by CIMA, inconjunction with the Fédération des Experts Comptables Européens (FEE), with considerablereliance being placed on CIMA’s “Making a Success of your Business: The Toolkit”. Weacknowledge CIMA’s assistance and would like to thank them for their support.

I hope you will find this guide a good starting point to long-term, sustainable business planning.

For more information on the ways in which Finance Wales can assist businesses andsocial enterprises, contact us on 0800 587 4140. Email: [email protected] Web: www.financewales.co.ukIf you are a textphone user, you can contact us on 18001 0800 587 4140 or18001 029 2033 8156.

To find out more about the Chartered Institute of Management Accountants, contact:Stathis Gould, Head of Technical Issues, Chartered Institute of Management Accountants,26 Chapter Street, London SW1P 4NP Tel: 020 8849 2379 Email: [email protected] Web: www.cimaglobal.com

Colin MittenChief Executive of Finance Wales

ContentsPage

1. How to use this guide 4

2. Getting started – essential preparation 5

• Basic questions for your business 5

• Basic information needed to run your business 8

• Rules of thumb 10

3. The business plan 11

• Introduction 11

• What the providers of finance want to see 12

• The budget 13

• The background 13

4. Step-by-step guide to writing the business plan 14

• Basic information for inclusion 14

• The business plan checklist 15

• Non-financial indicators 18

5. Doing it for yourself 22

• Charts for self-completion 23-42

6. Glossary of terms 43

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2. Getting started – essential preparation

Basic questions for your business

This section contains fundamental questions that managers of any kind of businessneed to ask themselves. Negative answers, or inability to answer because of lackof information, should serve as warning signals of likely problems for management toreview and resolve.

Your business

• What is your business? Why are you in business?

• What factors are critical for success? Do you analyse these factors?

• Who buys your products and why?

• Where do your profits come from?

Your strategy

• What are your business goals?

• How do you plan to achieve them?

• How do you intend to grow?

• What plans do you have for succession?

The market

• Who are your customers? Do you have sufficient information on them?

• What are their needs? How satisfied are they?

• Who are your competitors? Do you have information on them?

• What is your market share?

• What sets you apart from your competitors and makes you so special?

• How long will you be able to maintain this special market position?

• … and what happens when you lose this position?

1. How to use this guide

We have laid out this guide in order to facilitate the total planning process. By following the steps set out in these pages any business will have a soundframework for a workable long-term plan.

Firstly, managers should answer the basic questions set out in section two. It might be useful to talk these through with an independent third party such as a business advisor to ensure anobjective view. Being forthright at this stage will clearly identify the business’s strengths andweaknesses. Without such a solid foundation the rest of the planning process may become flawed.

The guide then sets out a basic framework for the body of the business plan. By addressing eachof the sections and providing a detailed description of the key factors behind each section as theyrelate to the individual business, managers will have a comprehensive document upon which theycan rely to assist with the day-to-day management of their business. In addition, this process willbuild a strong case to achieve success when applying for finance.

Finally, we have provided a range of graphical representations for key financial ratios. Our experience has shown that this is an aspect that presents many of our clients with difficulty as it is not always easy to communicate the financial strength of the business proposal in wordsand figures alone. Such graphical representations can be very powerful tools.

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The products

• What are your key products/services?

• What is your product (and process) life cycle?

• Is your product and process technology exclusive (patents), and how long is it defensible?

• Is the product range regularly updated in line with market needs?

• Who are your key suppliers? Do you know enough about them? What kind of relationships doyou have with them (e.g. co-design, partnership etc)?

Business plan

• What is your short-term business plan (of one to two years)?

• Does it have clear objectives which everyone in the business understands?

• Does the plan reflect your own ambitions, beliefs and assumptions (even if you have obtainedhelp from your financial advisers in drawing it up)?

• How does your plan identify your business opportunities and vulnerabilities, and where it is strong and weak?

• Are you also taking a longer-term approach (say three or more years)?

• How do you and your staff use the plan to guide the business? How regularly is it reviewed?

• Do you check performance against plan?

Budgets

• Do you have a budget and does it link into the business plan?

• Is it an action plan (e.g. orders, capacity planning, resource balancing)?

• How good is your budgeting process? Do you have a good early indication of your results, or do they come as a surprise to you?

• Is performance against budget checked regularly?

• And is action taken on variances?

• Do you realise that a first sign of trouble is when a business drifts off its cash targets eventhough it may still be meeting its profit targets?

Performance reporting

• Do you rely only on the accounts you prepare for legal and tax reasons to tell you what is happening?

• Do you have a monthly financial reporting system?

• Does it provide information in the same form as the budget?

• Do your financial and non-financial indicators follow the performance of the business duringthe month? How quickly are they produced? Do you use them?

• In case of declining results do you know which are the profit sensitive areas, which areas willaffect cash and sales, and where you can act fastest to reduce costs?

• How do costs run through your organisation, i.e. your fixed and variable costs, your productcosts, the stepped costs caused by expansion when you exceed current capacity?

• How robust are the information systems? Are there any ‘private’ costing and information systems?

• Are you aware of the 80:20 rule in managing your information?

Cash

• Cash is king: do you actively manage all aspects of your cash, from external financing, through working capital to cash balances themselves?

• Do you understand the crucial difference between cash in hand (and the bank) and paperprofits? And that you can go bankrupt while seemingly making profits on paper?

• Do you use external finance? If so, do you know its cost?

• Do you realise that over-rapid business growth will put a strain on your cash resources?

• Do you also realise that excess cash may stem from a shrinkage in sales?

• Do you prepare regular cash flow forecasts (possibly with the help of your financial adviser)?

• How do you control cash collection from customers and overdue accounts?

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Basic information needed to run your business

This is a general list. While some indicators (such as the breakeven point) apply to allbusinesses, others (such as many of the non-financial indicators) do not.

Managers have to determine what information is relevant for them.

If, for instance, seasonal factors are important, they need to be aware of this so thatthey can include it in their business information, plan for it, and benchmark with othersimilarly placed businesses.

All terms used are explained in the Glossary.

Breakeven point

Analysis of costs

• Fixed costs

• Variable costs (what they vary with and to what extent)

• Overhead costs

Product costs

• Direct

• Indirect

• Gross margins

Monthly earnings

Actual revenue and expenditure compared with budget

Non-financial indicators

For example, quantities, number of employees, quality, service, complaints, defects, rework, scrap,amount of stock (and location), its value and saleability, labour hours, sales volumes, number ofcredit notes

Performance by product (as applicable)

• Geographical area

• By business location

• By customer (group) if applicable

• By salesperson

Seasonal factors in sales, costs, purchases

For example, factors affected by summer months or festival periods?

Order book information

Is it balanced with a varied customer base?

Key suppliers and customers

Who are they?

Amount owed and owing (and overdue accounts)

• How good the debt is

• Monitoring

• Collecting

• Level of bad debts

Borrowings (and repayment terms), cost of borrowing and what the loans are secured on:

• Short term/long term

• Level of gearing

Investment in fixed assets

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3. The business plan

Introduction

The business plan sets out how the owners/managers of a business intend to realise its objectives. Without such a plan a business will drift.

The plan serves six main purposes.

• It enables management to think through the business in a logical and structured way and to set out the stages in the achievement of the business objectives

• It enables management to plot progress against the plan

• It ensures that both the resources needed to carry out the strategy and the time when theyare required are identified

• It is a means for making all employees aware of the direction of the business

• The document is available for discussion with prospective investors and lenders of finance(e.g. the bank)

• The plan links into the detailed, short-term, one-year budget. The purpose of a budget is:

• To monitor unit and managerial performance (the latter possibly linking into bonus arrangements)

• To forecast the out-turn of the period’s trading (through the use of flexed budgetsand based on variance analyses)

• To assist with cost control

• To project the business’s future performance

A business plan has to be specific to the organisation in question, its situation and time. This guide sets out good practice. One thing is certain, however: a business plan is not just adocument to be produced and filed. Planning is a continuous process. The business plan has tobe a living document, constantly in use to monitor, control and guide progress. That means itshould be under regular review and will need to be amended in line with changing circumstances.

Rules of thumb

Key figures which should be updated regularly and be readily available:

• Amounts owed by third parties – debtors (reported monthly)

• Accounts payable – creditors (reported monthly)

• Cash balance (and the forward position)

• Short-term investments

• Short-term borrowings compared with credit facilities

• Number of employees

• Order book

• Sales

• Market share

• Customer satisfaction data

Key ratios (as applicable to the business in question):

• Profitability ratios

• Debt/capital

• Debtor days

• Stock days

• Product and total margins

• Sales/net assets

• Turnover per employee (and comparison with competitors if known)

• Liquidity ratio

• Current ratio

The methods of calculating these ratios are explained in the Glossary.

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The budget

A typical business plan looks up to three years forward and it is normal for the firstyear of the plan to be set out in considerable detail.

This one-year plan, or budget, will be prepared in such a way that progress can be regularlymonitored (usually monthly) by checking the variance between the actual performance and thebudget, which will be phased to take account of seasonal variations.

The budget will show financial figures (cash, profit/loss working capital, etc) and also non-financial items such as personnel numbers, output, order book, etc. Budgets can be producedfor units, departments and products as well as for the total organisation.

Budgets for the forthcoming period are usually produced before the end of the current period.While it is not usual for budgets to be changed during the period to which they relate (apart fromthe most extraordinary circumstances), it is common practice for revised forecasts to beproduced during the year as circumstances change. A further refinement is to flex the budgets,i.e. to show performance at different levels of business. This makes comparisons with actualoutcomes more meaningful in cases where activity levels differ from those included in the budget.

The background

Before preparing the plan management should:

• review previous plans (if any) and their outcome

• be very clear as to their objectives – a business plan must have a purpose

• set out the key business assumptions on which their plans will be based(e.g. inflation, exchange rates, market growth, competitive pressures, etc.)

• take a critical look at their business. The classical way is by means of the strengths-weaknesses-opportunities-threats (SWOT) analysis, which identifies the business’s situationfrom four key angles. The strategies will be based on the outcome of this analysis

What the providers of finance want to see

Invariably providers of finance will want to see a business plan before advancingfinance. Not to have a business plan will be regarded as a bad sign. They will belooking not only at the plan, but at the persons behind it.

• They will want details of the owner/managers of the business, their background andexperience, other activities, etc

• They will be looking for management commitment, with enthusiasm tempered by realism

• The plan must be thought through and not be a skimpy piece of work. A few figures on aspreadsheet are not enough

• The plan must be used to run the business and there must be a means for checking progressagainst the plan. An information system must be in place to provide regular details ofprogress against plan. Finance providers are particularly wary of businesses that are slowin producing internal performance figures

• Lenders will want to guard against risk. In particular they will be looking for two assurances(sometimes known as the two ‘exits’):

• That the business has the means of making regular payment of interest on theamount loaned, and

• That if everything goes wrong the lender can still get its money back(i.e. by having a debenture over the business’s assets)

• Forward-looking financial statements, particularly the cash flow forecast, are therefore of critical importance

• The lender wants openness and no surprises. If something is going wrong it does not wantthis covered up, it wants to be informed – quickly

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4. Step-by-step guide to writing the business plan

Basic information for inclusion

• Management summary

• The rationale behind the proposal

• The owner’s/management’s goals and objectives

• Key facts: figures, history, names, addresses, references

• The marketing imperative: why this business is different from all theothers, and why it is better

• Assets, facilities, sensitivities, breakevens, vulnerabilities, SWOT

• What the funding requirement is

• Where the money will come from and how it will be repaid

• The financials should include: operating statement, balance sheet,cash flow, costings

The business plan checklist

The checklist below is intended to cover as many eventualities as possible. Obviously, most plans will not be set out in suchdetail, particularly for the smaller business. The following should therefore be used as a checklist for the plan to be based on, with the structure respected, but omittingthe detail that is not applicable.

The title pages

• Title

• One-page summary, in plain words

• Key facts at a glance

• Contents page, with details such as partnership agreements set out in the appendices

• The appendices and attachments shown separately

Introduction

• Background to the business including: when it was established, by whom, how long it has been running, previous years’ results if applicable

• Background to the owner(s)

• Key objectives

• Type of business: e.g. sole trader, partnership, private, public company

• Key assumptions behind the business plan

The product/service

• Existing business

• Strengths, weaknesses, opportunities and threats

• What makes it special: unique features of the business

• Development

• IPR

Notes Notes

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Marketing

• The present market

• Competitors and prospective competitors: products, prices, locations,likely developments

• Customers and prospective customers

• Key customers and how reliant the business is on them

• Future: prospective sales and market share

• Any other aspects, e.g. distribution

Legal aspects

• Tax and liability implications for the owners

Premises, assets, facilities and purchasing

• Premises, location, size, how owned, local taxes, planning permission, etc

• Plant and equipment, how owned, is it encumbered?

• Purchasing arrangements if applicable

• Key suppliers and how dependent the business is on them

• Security

• Insurance

People

• Management: with details of the key managers/employees (supported by C.V.s)

• Employees and terms of employment

• Organisation chart if applicable

The financials

• Past accounts and key performance figures if applicable

• Budgeted profit and loss account for the current year, plus forwardprojections

• Cash flow forecast

• Projected balance sheets

• Ratios and comparisons, ideally internally, over periods of time, and externally

• Product/service costings if applicable

• Breakeven analysis

• Capital expenditure programme

• Funding

• Risk, particularly foreign exchange risk if there is foreign business

Safety net if it all goes wrong

• What is the fall back plan?

• …in particular, what will happen if there is a cash crisis?

• Long-term lines of credit

• Replacement of a key employee

Notes Notes

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Distribution

• Delivery times

• Returns

• Breakages

• Lost deliveries

• Wrong deliveries

• Pilferage

• Out of stock

• Delays

• Chasing suppliers and expediting

Manufacturing

• Production/output

• Set-up times

• Scrap

• Rework

• Breakdowns

• Downtime

• Cycle times

• Output/head

• Machine utilisation

• Process yield

Non-financial indicators

Administration

• Number of credit notes per period (broken down by reason andamount)

• Number of invoices per period and average invoice amount

• Number of packing notes per period and average size of packing note

• Telephone logging: number of abortive calls, time before calls are answered

• Invoicing errors

• Reconciliations

• Accounting errors and rectifications

Customers/suppliers

• Top (say 20) customers

• Top (say 20) suppliers

• Inward quality failures

• Percentage of business accounted for by the top customers, and by the top suppliers

• Market share

• Complaints (detailed by cause, unit, person, customer, etc)

• New customers (and from which competitor)

• Lost customers (to which competitor and why)

• Returned goods (and why)

• Stock errors

• Lead times

• Warranty claims

Notes Notes

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Service

• Customer surveys

• Repeat business

• Unsolicited praise

• Third party views (from press comment)

• JIT record

• Delinquency in supply

• Adherence to plan

Technology

• Number (and percentage) of new products being sold which were notin existence five (and three) years ago

• Percentage sales from new products

• Speed of getting new products/services to the market

Personnel

• Succession plans

• Training schedules and achievement for key personnel

• Staff skill base and gaps against future requirements

• Staff turnover

• Absenteeism

• Staff sickness

• Staff feedback

• Results of exit interviews

• Third party opinion (from press comment)

Quality

• Incidence of non-quality, broken down into prevention, detection and failure

• Incidence of failure

• Incidence of after-sales warranty service and repairs

• Timeliness in supply

Safety

• Number of incidents

• Accidents (the accident, injury/loss of life, location, time,circumstances, etc)

Notes Notes


Last year This year 1 2 3 4 50

100

200

300

400

500

600

£000

Equity Long-term loan Retained earnings Overdraft Creditors

Last year This year 1 2 3 4 50

£000

Equity Long-term loan Retained earnings Overdraft Creditors

Chart 1: The funding structure

This chart sets out the components of the financing of the business year by year (or over anyperiod regarded as relevant), against the amounts in currency. The chart can also be used as aforecast, thereby aiding the planning of future financing. It shows the total amount as well as the make-up of the financing. It will be important to keep a good balance between equity plusretained earnings, and borrowings (‘gearing’ is explained in the Glossary). It will normally beparticularly important not to rely too heavily on the most short-term items of all, creditors andoverdrafts.

Complete your own chart

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5. Doing it for yourself

Contents Page

Chart 1: The funding structure 23

Chart 2: The cost of borrowing 24

Chart 3: Profit and loss – actual against budget 25

Chart 4: Profit and loss – summary 26

Chart 5: Cash flow – actual against budget 27

Chart 6: Cash flow – projection 28

Chart 7: Capital commitments 29

Chart 8: Capital project cost control 30

Chart 9: Utilisation of production facilities 31

Chart 10: Analysis of sales 32

Chart 11: Return on sales 33

Chart 12: Sales per customer 34

Chart 13: Simple breakeven calculation 35

Chart 14: Contribution breakeven chart 36

Chart 15: Product contribution and costs 37

Chart 16: Contribution by product 38

Chart 17: Your market position 39

Chart 18: Your market share 40

Chart 19: Orders received 41

Chart 20: Stockholding 42

23


Actual Budget

% sales

Retained profit

20

0

40

60

80

100

Tax and dividends

Marketing, admin etc.

Distribution costs

Cost of sales

Actual Budget

% sales

Retained profit

20

0

40

60

80

100

Tax and dividends

Marketing, admin etc.

Distribution costs

Cost of sales

Chart 3: Profit and loss – actual against budget

This chart is a graphical representation of the profit and loss account against budget. Both the period in question and the details of the profit and loss account are set out in the formmost relevant to the company. The chart in the example shows typical details applicable to manybusinesses. The purpose of the analysis is to provide a quick identification of performanceagainst budget, and therefore an indication of where corrective action would be required. This analysis can be linked to Chart 4.


–1 0 1 2 3 4 50

£000

Interest

10

20

30

40

50

60

70

80

90

100

Profit before interest and taxYear

–1 0 1 2 3 4 5

£000

Interest Profit before interest and tax

Year

Chart 2: The cost of borrowing

It is self-evident that businesses need to be managed prudently so that profits are not wiped outby interest payments on outside financing. This simple graph, which can be projected into thefuture, plots interest payments against profits to ensure that there is a proper balance betweenthem. In the UK it is usual for the profits figure to be shown as profits before interest and tax.


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J

–10

–5

0

5

10

15

20

£000

F M A M J J A S O N D

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Actual Budget

J

£000


Actual Budget

Chart 5: Cash flow – actual against budget

The importance of cash flow management cannot be stressed often enough. Charts 5 and 6 assistin cash flow management and supplement the cash flow projections described in the Glossary.

Chart 5 shows cash flow against budget highlighting variances to be actioned. In cash criticalsituations the time scale could be by week.


–1 0 1 2 3 4 50

% sales

10

20

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60

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Year

Retained profit Tax and dividends Marketing, admin etc.

Distribution costs Cost of sales

–1 0 1 2 3 4 50

% sales

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20

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60

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80

90

100

Year

Retained profit Tax and dividends Marketing, admin etc.

Distribution costs Cost of sales

Chart 4: Profit and loss – summary

This chart analyses the components of the profit and loss, again as a percentage of sales over a number of periods (usually years). The details depend on the company in question, and thesecan be further broken down into product or subsidiary unit analyses.


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J0

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£000


14

Budgetedexpenditure

Actual expenditure

Budgeted commitments

Actual commitments

Danger

J

£000


Month

Budgeted expenditure

Actualexpenditure

Budgeted commitments

Actualcommitments

Chart 7: Capital commitments

This chart is applicable to businesses that spend heavily on capital and/or investments. It sets outactual versus budget commitments to spend, and then compares this with the actual versusbudget spending pattern. As commitments can extend well beyond a year the chart should notnecessarily be restricted to a one-year cycle.

The chart will pin-point signs of strain, for example a divergence between actual and budget, and spend and commitment.



–10

Inflows

0 1 2 3 4 5

Inflow/outflow

50

100

–50

–100

–150

–200

Outflows

Year

–1

Inflows

0 1 2 3 4 5

Inflow/outflowOutflows

Year

Chart 6: Cash flow – projection

Chart 6 gives the forward look and projects the cash flow over the future (again this could be byyears or quarters, etc). The purpose is to identify periods of cash richness and cash strain. This is especially important in seasonal businesses.


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31


30

0

ProductA

Usage as % of capacity

Acceptable output

ProductB

ProductC

ProductD

10 20 30 40 50 60 70 80 90 100

Unacceptable output Not used

0

ProductA

Usage as % of capacity

Acceptable output

ProductB

ProductC

ProductD

10 20 30 40 50 60 70 80 90 100

Unacceptable output Not used

Chart 9: Utilisation of production facilities

There are many methods of quickly charting production. This chart sets out one such method. It shows the utilisation of total available production capacity by product (or by service or unit, as applicable). Some stated assumptions will have to be built into the chart: one such could beassuming maximum production capacity based on working 24 hours a day, seven days a week.



0

£000

3 6 9 12 15 18

Plan Actual spend

2

4

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Month

3 6 9 12 15 18

Plan Actual spend

Month

Chart 8: Capital project cost control

This chart is applicable to businesses that have major capital expenditure projects: these could be IT projects, building projects, the installation of plant and machinery, etc.

This is a standard chart and sets out spend against budget (plan). A variant could also plotpercentage of work done against plan and monitor the estimated end date. Many businessesshow their revised forecasts (spend, % of work done, end date) against the plan, so as to takeaction where these diverge from the original plan.


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%

1st quarter 2nd quarter 3rd quarter 4th quarter

Budget Actual

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%

1st quarter 2nd quarter 3rd quarter 4th quarter

Budget Actual

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Chart 11: Return on sales

This chart sets the actual percentage gross margin on sales against budget to identify variancesand sales patterns. This chart could be presented in the form of a graph, it could be set out byproduct/service or unit, it could be set out in periods more frequent than a quarter.



J0

£000


Cost of sales

10

20

30

40

50

Distribution costs, marketing, admin etc.

Retained profit

60

Month

J

£000


Cost of sales Distribution costs, marketing, admin etc.

Retained profit Month

Chart 10: Analysis of sales

This chart shows the sales development (or service performance) over the year and the analysisof the component sales costs and profit. The chart can be used to compare the salescomponents against competitors (if known) and can be shown by unit as well as in total. It will clearly be important to show the fluctuation of the sales (and the components?) in seasonalbusinesses. The total picture can also be monitored by showing the details in the form of movingannual totals (MAT).


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0

£

Volume

Fixed costs

Variable costs

Total costs

Breakeven point

Income from sales

PROFIT

LOSS

0

£

Volume

Chart 13: Simple breakeven calculation

The importance of the breakeven chart has already been stressed in the Glossary.

By identifying fixed and variable costs it is possible to calculate the amount of sales necessary in a given period to achieve breakeven. The business makes a profit once sales are above thebreakeven level.



CustomerS

CustomerR

CustomerQ

CustomerP

Chart 12: Sales per customer

It is dangerous to rely overmuch on one or a few customers. This chart sets out the degree ofreliance, and therefore of possible business vulnerability. The same type of chart can also be used to identify key suppliers, distributors, agents, etc.


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£000

A B C D

Costs Contribution point

0

50

100

150

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Contribution

250

£000

A B C D

Costs Contribution point Contribution

Chart 15: Product contribution and costs

Charts 15 and 16 focus on the contribution (see Glossary) per product or service, over a periodof time. Chart 15 compares the products (or services) and identifies the elements in their costbuild up.



0

£

Volume

Marginal costMarginal cost

Contribution

0

£

Volume

Fixed costs

Variable costs

Total costs

Breakeven point

Income from sales

PROFIT

LOSSMarginal costMarginal cost

Contribution

Chart 14: Contribution breakeven chart

Chart 14 is an expansion of Chart 13. It shows both contribution and profit.


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0

1

2

3

4

5

6

Sales£m

1 2 3 4

7

Total market

Business X

Your business

Others

Business Y

Year

Sales

1 2 3 4

Total market

Business X

Your business

Others

Business Y

Year

Chart 17: Your market position

No business exists in a vacuum. All businesses exist in a market or market segment (which mightbe product/service or geographically oriented), and it is important for them to have as muchinformation on their market and competitors as possible.

This chart shows (where known) the business’s and the competitors’ position in the total market,and the development of the market and the positions over the years (past and, where possible,projected).



Product D: no contribution

Product B 33%

Product C 17%

Product A 50%

Chart 16: Contribution by product

Chart 16 takes the total company contribution and splits it up among the products

(or services).


4140

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10

20

30

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£000


70

Actual Budget Month

J

£000


Actual MonthBudget

Chart 19: Orders received

The forward order position is a figure every chief executive needs to know. It shows thebusiness’s position with regard to breakeven; it identifies the future operating figures; it identifiespossible bottlenecks and areas for action. This chart is a quick picture of the order position. It canbe shown in many ways: against budget, by moving annual total, against sales (past and projected),against stocks, against capacity, etc.



Company Y

Others

Company X

Your company

Chart 18: Your market share

Chart 17 can also be shown in the form of a pie chart, plotting the business’s market shareagainst its competitors at a given point in time.


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6. Glossary of terms

Balance sheet

The balance sheet sets out the financial position of the business at a particular date in the past showing what the business owns, what it owes, and the owner’s equity in it.What is important to realise is that a balance sheet is a photograph of the business ata particular point in time. The main components of a balance sheet are set out below.

Fixed assets

Any asset, tangible or intangible, acquired for retention by a business for the purpose of providinga service to the business, and not held for resale in the normal course of trading.

Net current assets

• Current assets: cash or any assets likely to be converted into cash or consumed in the normalcourse of business within the normal operating cycle (usually one year), i.e. cash, stocks, good debtors (receivables), and

• Current liabilities: amounts owed which are expected to be repaid within one year, i.e. bankoverdrafts (in the UK), dividends, tax, amounts owing to trade creditors

Long-term liabilities and loan capital

• Long-term liabilities: amounts payable to external creditors (how the business is financed and how the proceeds from asset sales would be shared if the business were sold)

• Loan capital: debentures, bonds and other long-term loans to a business. Overdrafts, being theoretically repayable on demand, are not usually shown in this category

Long-term liabilities are items payable more than one year after the balance-sheet date. Short-term liabilities are included under working capital.

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J0

Monthsstock


Year 1

Month

1

2

3

4

5

6

7

8

Year 2Year 3Year 4

J

Monthsstock


Year 1

Month

Year 2Year 3Year 4

Chart 20: Stockholding

This chart shows the level of stockholding month by month over a period of years. It can be usedto compare the years with each other, to identify seasonality, to show against budget.


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Business plan

A plan which typically covers in both the long and short term:

• Customers

• Market analysis

• Resources (e.g. staff, finance)

• Service and distribution

• Selling and supplying

• Future strategy

• Product development

• Manufacture

• Stock holding and control

• Management and staff

• Finance

Business planning

The systematic review of business strategy and the development of a long-term plan to enable the business to achieve its objectives.

Cash management

Managers hardly need to be reminded that balance sheets and profit and lossaccounts are all very well, but that cash is the lifeblood of business. A business thatcannot pay its way is bankrupt. Cash has to be planned for to ensure adequate fundsare always readily available (either on hand or from the bank or other outside parties)and to provide for any seasonal factors (such as a build up of stocks), or heavyspecial one-off payments (such as tax or VAT or expenditure for fixed assets). The cash flow forecast is the document that providers of finance such as banks placemost emphasis on.

Cash flow forecast

The cash generated and spent in a given period is called the cash flow. Cash flow forecasts, linkedto the bank balance show the movement (receipts and payments) week by week or month bymonth for a period in the future. This alerts management to future cash shortages or surpluses.

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Equity

The issued ordinary share capital plus reserves. These latter represent the investment in thebusiness by the ordinary shareholders (the owners).

Retained earnings

Included in equity, retained earnings are the amounts set aside (usually apportioned out of profit)for continued investment in the business.

Budgets and planning

It goes without saying that without a plan a business merely drifts, without knowingwhere it is going. A plan gives direction to a business.

The short-term plan (the budget):

• Enables the business to organise its resources for the period in question

• Enables it to gauge the impact of unforeseen events during the period, and provides aframework for dealing with them

• Sets performance standards for subordinate managers and therefore can be a powerfulmeans of motivating them

Above all, a budget provides a safeguard against the manager’s biggest dread, unpleasantsurprises. A business plan enables providers of finance to a business to evaluate it. They willusually not lend money unless there is a viable plan.

Budget

A financial or qualitative statement of policy expressed in financial and non-financial terms andprepared and approved by management prior to a defined period of time (usually the business’sfinancial year). It is normally financially focussed and will show income, expenditure, sales andprofitability. Budgets are usually phased over the months (or quarters) of the year in question, andit will be particularly important to do this where the business is seasonal.

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• Overhead costs: general expenses that cannot be related to products and services, typically head office costs

• Marginal costs: the amount, at any given volume of business, by which aggregate costs are changed if the volume of business is increased or decreased by one unit, in other wordsthe extra cost of one further unit or the cost that would be avoided if the unit was notproduced or provided. In this context a unit is either a single article or a standard measuresuch as a litre or kilogram, but may in certain circumstances be an operation, process or even part of an organisation

Financial ratios

Business managers need to be aware of the more important ratios used by outsiders(such as banks) to evaluate the financial strength and the profitability of businesses.

Gearing

The ratio of fixed-interest capital and long-term borrowing to equity capital. It is calculated asfollows:

Fixed dividend capital + long-term loans x100%

Equity funds

The significance of this ratio is that finance providers are usually unwilling to lend to a businesswith an unfavourable balance between the owners’ investment and borrowing from outside.Businesses in this situation which are able to attract outside lending will find themselves paying a heavy price for such loans. A ratio of up to 1:2 between fixed-rate capital and equity capital isusually regarded as satisfactory. This ratio also shows the scope for further borrowing should it be necessary.

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Costs and costing

There is a whole series of internal indicators used by businesses as appropriate, to guide them in their financial management.

Breakeven point

The level of activity at which contribution (i.e. sales revenue less variable costs) covers all fixedcosts so that there is neither profit nor loss. It may be calculated by the use of a breakeven chartor by the use of formulas. For example:

Total fixed cost = number of units to be sold to break even

Contribution per unit

Breakeven chart

A chart which indicates the approximate profit and loss at different levels of sales volumes withina limited range.

The breakeven point is critical to the understanding of the business, i.e.:

• Where profits begin to be made in a period

• Where there is scope for marginal pricing

• The cost/volume relationship

Costs

An understanding of the nature of the costs running through the business is essential to properbusiness management (such as the definition of the breakeven point) and to cost management.

• Fixed costs: costs that do not vary with the level of business but remain constant over aperiod of time and which, within certain operational limits, tend to be unaffected byfluctuations in the level of activity. Examples are: rent, business rates, insurance

• Variable costs: costs that vary with the level of business

• Direct costs: costs which can be economically identified with a specific product or saleableservice, e.g. employees, material, etc

• Indirect costs: costs that cannot be related directly to a specific product or service, e.g.managers covering several areas, power, floor space in general use, general stores, etc

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Methodologies

Benchmarking

The assessment of how well a business is doing against competitors and similar firms and theanalysis of what must be done to improve performance to be as good as, and do better than, the industry leaders. Benchmarking covers non-financial as well as financial figures. It goes without saying that for benchmarking to be carried out properly, the business has toprepare figures (financial as well as non-financial) that can be compared with other businesses.

Factoring

The sale of debts (normally only ‘clean’ debts, however) to a third party (the factor) at a discountin return for prompt cash. The factor in effect takes over the running of the sales ledger.

Invoice discounting

As with factoring, debts are sold to the factor but here the business continues to operate its ownsales ledger and deals with customers when collecting outstanding debts.

Just-in-time (JIT)

A technique for the organisation of work flows to allow rapid, high quality, flexible production whileminimising manufacturing waste and stock levels. This is usually done in conjunction with supplierswho supply the products exactly when (and only when) they are needed. The management ofsupermarkets is an excellent example of the use of this technique.

Just-in-time production

A system which is driven by demand for finished products whereby each component on aproduction line is produced only when needed for the next stage.

Just-in-time purchasing

Matching the receipt of material closely with usage so that raw material inventories are reducedto near zero levels.

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Current ratio

This is the ratio of current assets to current liabilities. Current assets are stocks, plus amountsowing and due to be received within a year, and cash. Current liabilities are amounts owed and due to be repaid within a year.

The significance of this ratio is that it indicates the cushion available to short-term creditorsagainst a possible shortfall in the realised value of current assets. The ‘rule of thumb’ oftenquoted is that the ratio should be about 2:1, though the averages in some industry sectors tend to be lower.

A ratio in excess of 2:1 may indicate excess stocks, inadequate credit control or under-utilised cash.

Liquidity ratio (also known as the acid test ratio)

This shows the ratio of liquid assets to current liabilities. Liquid assets are debtors (amounts owed) plus cash. Current liabilities are debts the business has to repay within a year.

The significance of this ratio is that it relates short-term obligations to funds likely to be availableto meet them. The ‘rule of thumb’ is that the ratio should be about 1:1 though some sectoraverages tend to be lower. Ratios below 1:1 however, may indicate financial stress. A ratio much inexcess of 1:1 may indicate inadequate credit control or under-utilised cash.

Profitability ratios

The most commonly used profitability ratios are profit on net assets (or return on capitalemployed – ROCE ), and return on investment (ROI) showing the return on the total investmentin the business.

These show how well the business has used its investment in capital and has turned it into profit.Two ratios combine to give the main ROCE ratio.

• Profit/sales: indicating margins achieved and expressed as a percentage of sales

• Sales/net assets: indicating efficiency in the use of assets and expressed as the rate ofturnover of net assets in relation to sales

Each of these has a group of subsidiary ratios, the purpose of which is to indicate:

• The order in which improvements in performance should be sought

• The maintenance or improvement of performance (by observing trends)

• The effect of improvement in each area on the main ratio, profit/net assets

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Operating expenses

Expenses, other than cost of goods sold, incurred in the normal operation of the business (typically administration, distribution and selling expenses).

Gross margin

The difference between sales revenue and cost of sales.

Contribution

Sales value less the variable cost of sales. It may be expressed as total contribution or as apercentage of sales.

Profit

• Gross profit: excess of sales revenue over cost of sales

• Net profit: profit after all expenses (which can be before or after tax and/or interest, provided this is made clear)

Working capital

Working capital is the capital available for conducting the day-to-day operations of the business. Working capital is defined as the excess of current assets over currentliabilities (i.e. cash, plus amounts owed by debtors, plus stocks, less amounts owingto creditors). It consists of short-term items all of which have a direct and immediateimpact on cash.

The details below describe the main items of working capital and the main indicators used in its management.

Stocks (or inventories)

Goods held comprising:

• Goods or other assets purchased for resale

• Raw materials and components purchased for incorporation into products for sale

• Products and services in intermediate stages of completion (work-in-progress)

Only goods that can be and are expected to be sold are included, i.e. obsolete and defectivestocks must be excluded.

Stock holding period

The period during which stock is held in relation to sales. Normally the aim of a business is to reduce this period to the minimum consistent with sales and continuing production.

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SWOT analysis

A critical assessment of the business’s strengths, weaknesses, opportunities and threats(SWOT), in relation to the internal and environmental factors affecting the business, in order to establish its condition prior to the preparation of a strategic review or a long-term plan.

Total quality management (TQM)

The continuous improvement in quality, productivity and effectiveness obtained by establishingmanagement responsibility for processes as well as output.

Key suppliers and customers

The 80/20 rule is useful here, i.e. the 20% or so of the customers/suppliers that account for80% or so of the business/management time/activity/problems. It is remarkable how constantthis rule is and how widespread its application, e.g. the 20% of employees who take up 80% ofthe management’s time, the 20% of the fleet vehicles that cause 80% of the problems, etc. Try to ensure diversity in clients and suppliers to avoid over dependence on any one organisation.

Turnover per employee

It is very common to view the trends and relate this ratio to competitors and to industry averages.

Profit and loss account

The profit and loss account sets out how the business has performed over a period of time (a month and/or a quarter, and/or a year), the beginning and end of the periodbeing marked by balance sheets. It can be seen as the movement from one balancesheet to another in operating terms. In particular the profit and loss account will showhow well the business is doing and whether it is paying its way. A business thatconsistently fails to make a profit cannot survive.

An operating statement is a shortened form of profit and loss account which excludesthe non-trading items such as interest payable, rents receivable (where there are non-trading items) etc.

The key items in a profit and loss account are as follows.

Sales revenue or turnover

Shown net of VAT.

Cost of sales

Usually includes only those costs that would be allocated to stocks, i.e. costs incurred inmanufacture – materials, direct wages, power, etc. In a service business the cost of sales wouldcover the payment to third parties for items comprised in the service provided by the business.

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Disclaimer

© CIMA (data and other material) (2003)

© Finance Wales (cover design) 2003

All rights reserved. No part of this publication may be reproduced, transmitted in any form or by any means or stored in any retrieval system of any nature without permission, except forpermitted fair dealing under the Copyright, Designs and Patents Act 1988 or in accordance withthe terms of an appropriate licence. Application for permission for other use of copyrightmaterial including permission to reproduce extracts in other published works shall be made to the copyright holders. Full acknowledgment of author, publisher, copyright holder and sourcemust be given.

This document is aimed primarily at intermediaries operating between Finance Wales and its prospective clients but may also be provided to other types of organisation from time to time.No representation is made as to whether Finance Wales will provide funding to those who followthe relevant guidelines detailed in this document.

In all cases this document is intended for guidance only and Finance Wales gives no warranty,either express or implied, as to the accuracy of any data used by Finance Wales in preparing thisdocument or as to any other data set out or opinions expressed in this document. Except for anymisrepresentation made fraudulently, CIMA and Finance Wales do not accept any liability for anyloss or damage arising in any way whether directly or indirectly out of or in connection with theuse of or reliance on this document or for any defect or error in this document.This document is not intended to be a substitute for obtaining professional advice as appropriate.

This document is available in Welsh or English, electronically, in large print, braille, and alternative formats on request.

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Stock turn

The number of times stock is ‘turned over’ or utilised during a given period, generally a year, but adapted to individual requirements for internal control purposes. Where individual productmargins are small (as in sales of canned foods for instance), the aim would be to turn over thestock very frequently. Where the stock cannot be turned over so frequently (e.g. luxury clothes or cars), the objective will be to achieve substantial margins for each individual item sold.

Stock days

These are calculated as follows:

Stock at the due date (i.e. period end) x days in the period (i.e. 365)

Total cost of sales for the period (say a year)

The significance of this statistic is that (in comparison with trends over time within the businessor with other businesses), it can indicate whether excessive levels of stock are being held, tyingup cash unnecessarily.

Amounts owed by third parties (also called debtors, outstandings and receivables)

Money owed to the business by its customers or others.

These should be split up according to when payment is/has been due so as to identify thosewithin the due period and the overdues (30, 60, 90 etc. days overdue). The significance of thissplit is that it shows the company where to focus the credit control, i.e. on the overdue element,particularly the long overdues (e.g. 90 days or more).

Debtor days

These are calculated as follows:

Debtors (at the due date) x days in the period (i.e. 365)

Sales (inc. VAT) in the period

The usual period taken is a year, thus a year’s sales would be taken and 365 days could be used.It is also usual to show this ratio in terms of months or weeks.

The significance of this ratio is that it indicates the effectiveness of credit control procedures ingeneral. The figure of days outstanding should be compared with trends over time within thebusiness, with the standard terms of business, and with ratios achieved by competitors. The organisation cannot benefit from money tied up unnecessarily in receivables.

Borrowings and repayment terms

These should be identified by: amount borrowed, terms, when due to be repaid.

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Notes Notes

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RHAN-ARIENNIR Y PROSIECTGAN YR UNDEB EWROPEAIDD

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For further information about CIMA, email [email protected]

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