How to Foresee And Predict Your Financial Future
IT WAS 2004. The economy was booming, and so was Joel Riordan's manufacturing business. With his company's volume at an all time high, Joel was traveling around the country, hustling to get the volume even higher.
In June of that year, Joel, an associate of mine, and I were sitting in our conference room reviewing the financial statements of Joel's company. My associate and I were noting a trend. Sales were strong, but profits weren't where they should be. Expenses were increasing far too rapidly. "Joel, what's going on?" I asked. "Every expense category on your financial statement is growing out of proportion, and we're concerned."
"Accountants," Joel responded. "Our volume is greater than ever, we're on an upswing, and you worry. Too high a profit means too much tax to pay. I'm enjoying myself."
During the year things turned sour for Joel. His volume declined steadily. Six months later we met again.
�Joel, you've got to cut the fat out of the company," I warned. "You've shown a loss for the last two quarters and your expenses are too high. Let�s put together a P&L and cash flow forecast. Let�s see what your future cash requirement will be, as we need to figure out how long your cash will last. I�m afraid trouble may be just ahead.�
Joel responded in his typical manner: "What I need are better sales reps and a better general manager to help me run the company."
"What you really need," I insisted, "is to get expenses under control, cut down on some travel, stay home, manage the company, and have some realistic P&L and cash flow forecasts so we can anticipate what lies ahead before it�s too late."
I thought to myself, Most companies start forecasting what�s going to happen when it is too late. When things start to hit the fan they get religion. We are about to have another living example.
Joel's sales continued to decline, and although he managed to survive another year his company took its final breath in 2006. Joel could have saved his company and made a good living, but he had spent himself into so much debt when things were good that he couldn't continue when conditions changed.
Joel was not an isolated case. His knock-the-world-dead-with-volume and spend, spend, spend philÂosophy is practiced far too often.
I once asked Joel if we could crunch some numbers and let him know how much cash he would have in the bank at the end of every month for the year. He said yes. Unfortunately, it was never done. He was too busy to take the time to give us the information we needed.
When Joel�s company went into bankruptcy, they hired a turnaround specialist whose first task was to develop a set of forecasts to get a handle on the company�s future cash flow needs. It was a classic case of too little, too late.
Most people involved in entrepreneurial companies spend a great deal of time attempting to increase sales, but do little to control the financial side of the business. Certainly, I wouldn't abandon the notion of increasing volume. But remember, with adequate financial control and reduced expenses, every dollar saved in expenses and operating costs results in a dollar more in profit. A one-to-one ratio. It may take $10, $15, $20 or even more of increased sales to produce the same one dollar profit.
Thus, when you view the profound impact of financial planning and its impact on the bottom line, it becomes essential that all efforts be made to plan for profit and cash flow�rather than wait for profitability to just happen.
WHEN YOU TAKE A TRIP, YOU PLAN YOUR ITINERARY
The two-week vacation is pretty much the standard in the business community today. A major part of planning the vacation is to hire a travel agent to set up flights, hotels, tours, basically everything that is needed to have a great and successful vacation. Family and friends become involved in this ritual of planning the itinerary. Everyone has a suggestion on the fun spots to visit and how to make certain there is not a moment wasted.
What I have found over the many years I have been in practice is how much time is spent on planning for a two-week vacation, but how little time is spent on the planning for the remaining fifty weeks�e.g., planning for profit.
WHY DO ENTREPRENEURS HATE TO PLAN?
Planning is boring.
Planning keeps them from doing what they want to do.
The plan takes too long to prepare.
Plans drown them in meaningless detail.
Planning is crystal ball gazing.
Results are never achieved.
Planning is too expensive.
KNOWLEDGE IS POWER
There�s an old truism: �Knowledge is power�.
There is no doubt that knowledge is power, but let�s rework those three words. How about: �Knowledge is peace of mind�?
Planning is the most powerful thing that you can do. Planning allows you to see the future. We�ve said it before, but it�s worth repeating: Can you have any more power than the ability to see the future?
Clearly, most entrepreneurs believe that developing a forecast of future financial events is somewhat akin to crystal ball gazing. Anytime one attempts to foresee future events, there is some guessing to be done. But if the process is dynamic (that is, it changes as conditions change), then the element of guessing will disappear�with the resultant forecast becoming the most powerful and useful tool in the arsenal of the entrepreneur.
YOU CAN�T MANAGE THE PAST
You can�t manage the past. You can only manage the future. The more you know about the future, the more effective you can be. Need cash? How much? When? A solid financial forecast will provide the answers.
I was recently asked to speak at a Los Angeles banking conference. They wanted me to spend some time discussing how to develop a financial forecast. They had become frustrated with the number of their customers requesting loans who, when asked how much they needed, replied, �How much will you loan me?�
THREE STEPS TO BETTER FINANCIAL UNDERSTANDING
When I advise clients or groups of entrepreneurial business people to control their costs and expenses, the most common response I hear is defeat. "How can I? Suppliers are constantly hounding us with increases. A day doesn't go by without someone asking for more money."
Expenses can be controlled. It's up to you.
There are three steps that will lead to greater expense control:
1. Become familiar with the expenses of your business.
2. Anticipate in advance what those expenses should be.
3. Manage them by exception.
FINANCIAL STATEMENTS SHOULD TELL YOU A STORY
What are the expenses of your business? Be honest with yourself. Do you really know? It is not unusual for owners and managers to be so bogged down in details that they never take the time to review the various expense categories of the business.
What are you spending money on? I have sat in countless meetings where the management of the business doesn�t have clue as to what makes up a given expense in the financial statement. Just look over your com-pany's financial statements. Review the various categories of expenditure. Are they telling you a story? Are you satisfied with the detail? Too little? Too much? Do know what the expense is for? What did the bookkeeper bury in the category?
It's your company. Pay heed to your financial stateÂments. They should tell you what you want and need to know to better manage profitability and cash flow.
DESIGN THEM YOURSELF
Here's an easy way to design financial statements that can be more meaningful to you and tell you the story:
Next time you sign checks, sit with your bookkeeper and have a detailed list of the company's expense categories available. As you sign each check, ask yourself if you want to know on a regular basis how much you spend for the item the check represents. For example, you sign a $250 check payable to the post office. You know you don't spend much on postage, so you are not concerned. But say the check is for $4,500. And now you're curious about what postage costs. You�d like to have this information on a regular basis. Ask the bookkeeper where this item is on the financial statement. The bookkeeper may tell you, �It's in office supplies.� If it's lumped together with all the other items in the category of office supplies, direct the bookkeeper to set up a new category for postage so it will be reflected on your financial statement as a separate item. Now, each time you review your profit and loss, postage will be a separate line item giving you the information you want and need to know.
If you follow this procedure for all the bills being paid, you will develop financial categories that have meaning to you. Remember, the statement must tell you what is going on. You are the one responsible for the success or failure of the business. Therefore, it is essential to design expense categories for your needs, your curiosity, your style.
It's your money.
ANTICIPATE YOUR EXPENSES
Earlier, I said the most powerful tool available to the entrepreneur is a financial forecast that will predict the future for the next twelve months or longer. One of the great benefits in using the forecast is to always be in a position to monitor where you are against where you wanted to be.
Every business operating in today's world must have a dynamic financial forecast that changes as circumstances change. A forecast that will tell management on a regular basis how much cash they will need and when they will need it. A forecast that will tell you your company�s cash balances at the end of every month for the next twelve months.
Wouldn�t you like to know?
You�ll never be able to control expenses if you don't know what they should be. You can spend and spend, but you can't know if you've spent too much�if you haven't given any forethought as to what you should be spending.
Once you have determined what an operating expense should be and you compare it to what it actually is, you will be in a position to know if you have achieved the goal of controlling your expenses.
A THEFT COULD HAVE BEEN PREVENTED
Here is an example of how the process of comparing actual expenses to the financial forecast would have caught a company theft early, and quite possibly have prevented the indiscretion altogether.
Joe Scott and Eric Brown had been partners in the manufacturing business for ten years. They had started on a shoestring yet built their company to its present $8,000,000 per annum sales volume. Profits were consistently high.
Joe was about ten years older than Eric and had a nasty temper. He controlled the purse strings of the company and frankly was tough to deal with.
Eric's position in the company was in production. He paid little attention to financial matters and seemed only concerned with what his annual salary would be.
The office I was sitting in was cold. Joe always had the air conditioning on too high. He sat behind a beautifully polished Bank of England desk, unaware of my discomfort and vaguely annoyed about the thrust of my request for the meeting.
Eric sat to my right. He also seemed oblivious to the chill and likewise to Joe's irritation with me. On the desk in front of us were copies of the financial statements of the past two years.
"My reason for this meeting," I said, tapping the most recent statement with my pencil, "is to express concern over the rise in the company's expenses. Compared to recent periods, they seem excepÂtionally high."
Joe took issue immediately. "Your concerns are unfounded and the figures must be wrong. Call in the bookkeeper."
In a moment we were joined by Sue, the company bookkeeper, a very thin, short woman who always looked as though she had been working for the past twenty-four hours. She was an excellent bookÂkeeper. "Sue, your numbers are wrong," Joe said.
Sue didn't give an inch. "You always say that, Mr. Scott."
We were at an immediate impasse, and to break it, Sue and I retired to her office to review the ledgers. When we reported that the numbers were indeed right, Joe began to mumble.
"When you spend money," I began, "how do you know if you're going overboard or not?"
"Sue prepares a report," Joe said brusquely.
"But we've just seen what happens when Sue presents the figures. You challenge them, and even when they check out, you don't pay any attention to them. You should be getting information more often, and both of you should compare the actual figures against previous targets. You should do this every month."
For years I had attempted to convince them to use some kind of forecast, and for years, they had passed. We parted with Joe and Eric upbeat. Why not? Profits were good, Eric continued to receive his salary and Joe released some anger.
About a week later, Eric Brown, uncharacteristically agitated and concerned, called my office. �That S.O.B. Joe has been paying personal expenses through the business without my knowledge."
No wonder, I thought, that expenses hadn't seemed too high for Joe. "How much?" I asked.
"About $50,000. We're still checking."
We left matters with Eric's promise that he'd call me if Sue's investigations produced any more results. Two days later, Eric was back on the line. ''We're up to $75,000" he said.
"Ouch," I said.
"You're telling me," Eric mumbled. We ended our conversation.
Two more days passed before I heard from Eric again. "This year alone, $250,000."
What happened? Neither of the partners was responsible to the company. Joe Scott, with control over the purse strings, was able to spend, spend, and spend. Eric, involved only in his production, didn't have any idea where the company was going and where it should be.
Had Joe and Eric reviewed financial data regularly and compared the data to predetermined goals, Joe would have had a difficult time spending company funds on personal expenditures. The variance from expected results would have been glaring enough to support my concern and would have been easily spotted. More than likely, the theft would not have taken place.
IT WAS 2004. The economy was booming, and so was Joel Riordan's manufacturing business. With his company's volume at an all time high, Joel was traveling around the country, hustling to get the volume even higher.
In June of that year, Joel, an associate of mine, and I were sitting in our conference room reviewing the financial statements of Joel's company. My associate and I were noting a trend. Sales were strong, but profits weren't where they should be. Expenses were increasing far too rapidly. "Joel, what's going on?" I asked. "Every expense category on your financial statement is growing out of proportion, and we're concerned."
"Accountants," Joel responded. "Our volume is greater than ever, we're on an upswing, and you worry. Too high a profit means too much tax to pay. I'm enjoying myself."
During the year things turned sour for Joel. His volume declined steadily. Six months later we met again.
�Joel, you've got to cut the fat out of the company," I warned. "You've shown a loss for the last two quarters and your expenses are too high. Let�s put together a P&L and cash flow forecast. Let�s see what your future cash requirement will be, as we need to figure out how long your cash will last. I�m afraid trouble may be just ahead.�
Joel responded in his typical manner: "What I need are better sales reps and a better general manager to help me run the company."
"What you really need," I insisted, "is to get expenses under control, cut down on some travel, stay home, manage the company, and have some realistic P&L and cash flow forecasts so we can anticipate what lies ahead before it�s too late."
I thought to myself, Most companies start forecasting what�s going to happen when it is too late. When things start to hit the fan they get religion. We are about to have another living example.
Joel's sales continued to decline, and although he managed to survive another year his company took its final breath in 2006. Joel could have saved his company and made a good living, but he had spent himself into so much debt when things were good that he couldn't continue when conditions changed.
Joel was not an isolated case. His knock-the-world-dead-with-volume and spend, spend, spend philÂosophy is practiced far too often.
I once asked Joel if we could crunch some numbers and let him know how much cash he would have in the bank at the end of every month for the year. He said yes. Unfortunately, it was never done. He was too busy to take the time to give us the information we needed.
When Joel�s company went into bankruptcy, they hired a turnaround specialist whose first task was to develop a set of forecasts to get a handle on the company�s future cash flow needs. It was a classic case of too little, too late.
Most people involved in entrepreneurial companies spend a great deal of time attempting to increase sales, but do little to control the financial side of the business. Certainly, I wouldn't abandon the notion of increasing volume. But remember, with adequate financial control and reduced expenses, every dollar saved in expenses and operating costs results in a dollar more in profit. A one-to-one ratio. It may take $10, $15, $20 or even more of increased sales to produce the same one dollar profit.
Thus, when you view the profound impact of financial planning and its impact on the bottom line, it becomes essential that all efforts be made to plan for profit and cash flow�rather than wait for profitability to just happen.
WHEN YOU TAKE A TRIP, YOU PLAN YOUR ITINERARY
The two-week vacation is pretty much the standard in the business community today. A major part of planning the vacation is to hire a travel agent to set up flights, hotels, tours, basically everything that is needed to have a great and successful vacation. Family and friends become involved in this ritual of planning the itinerary. Everyone has a suggestion on the fun spots to visit and how to make certain there is not a moment wasted.
What I have found over the many years I have been in practice is how much time is spent on planning for a two-week vacation, but how little time is spent on the planning for the remaining fifty weeks�e.g., planning for profit.
WHY DO ENTREPRENEURS HATE TO PLAN?
Planning is boring.
Planning keeps them from doing what they want to do.
The plan takes too long to prepare.
Plans drown them in meaningless detail.
Planning is crystal ball gazing.
Results are never achieved.
Planning is too expensive.
KNOWLEDGE IS POWER
There�s an old truism: �Knowledge is power�.
There is no doubt that knowledge is power, but let�s rework those three words. How about: �Knowledge is peace of mind�?
Planning is the most powerful thing that you can do. Planning allows you to see the future. We�ve said it before, but it�s worth repeating: Can you have any more power than the ability to see the future?
Clearly, most entrepreneurs believe that developing a forecast of future financial events is somewhat akin to crystal ball gazing. Anytime one attempts to foresee future events, there is some guessing to be done. But if the process is dynamic (that is, it changes as conditions change), then the element of guessing will disappear�with the resultant forecast becoming the most powerful and useful tool in the arsenal of the entrepreneur.
YOU CAN�T MANAGE THE PAST
You can�t manage the past. You can only manage the future. The more you know about the future, the more effective you can be. Need cash? How much? When? A solid financial forecast will provide the answers.
I was recently asked to speak at a Los Angeles banking conference. They wanted me to spend some time discussing how to develop a financial forecast. They had become frustrated with the number of their customers requesting loans who, when asked how much they needed, replied, �How much will you loan me?�
THREE STEPS TO BETTER FINANCIAL UNDERSTANDING
When I advise clients or groups of entrepreneurial business people to control their costs and expenses, the most common response I hear is defeat. "How can I? Suppliers are constantly hounding us with increases. A day doesn't go by without someone asking for more money."
Expenses can be controlled. It's up to you.
There are three steps that will lead to greater expense control:
1. Become familiar with the expenses of your business.
2. Anticipate in advance what those expenses should be.
3. Manage them by exception.
FINANCIAL STATEMENTS SHOULD TELL YOU A STORY
What are the expenses of your business? Be honest with yourself. Do you really know? It is not unusual for owners and managers to be so bogged down in details that they never take the time to review the various expense categories of the business.
What are you spending money on? I have sat in countless meetings where the management of the business doesn�t have clue as to what makes up a given expense in the financial statement. Just look over your com-pany's financial statements. Review the various categories of expenditure. Are they telling you a story? Are you satisfied with the detail? Too little? Too much? Do know what the expense is for? What did the bookkeeper bury in the category?
It's your company. Pay heed to your financial stateÂments. They should tell you what you want and need to know to better manage profitability and cash flow.
DESIGN THEM YOURSELF
Here's an easy way to design financial statements that can be more meaningful to you and tell you the story:
Next time you sign checks, sit with your bookkeeper and have a detailed list of the company's expense categories available. As you sign each check, ask yourself if you want to know on a regular basis how much you spend for the item the check represents. For example, you sign a $250 check payable to the post office. You know you don't spend much on postage, so you are not concerned. But say the check is for $4,500. And now you're curious about what postage costs. You�d like to have this information on a regular basis. Ask the bookkeeper where this item is on the financial statement. The bookkeeper may tell you, �It's in office supplies.� If it's lumped together with all the other items in the category of office supplies, direct the bookkeeper to set up a new category for postage so it will be reflected on your financial statement as a separate item. Now, each time you review your profit and loss, postage will be a separate line item giving you the information you want and need to know.
If you follow this procedure for all the bills being paid, you will develop financial categories that have meaning to you. Remember, the statement must tell you what is going on. You are the one responsible for the success or failure of the business. Therefore, it is essential to design expense categories for your needs, your curiosity, your style.
It's your money.
ANTICIPATE YOUR EXPENSES
Earlier, I said the most powerful tool available to the entrepreneur is a financial forecast that will predict the future for the next twelve months or longer. One of the great benefits in using the forecast is to always be in a position to monitor where you are against where you wanted to be.
Every business operating in today's world must have a dynamic financial forecast that changes as circumstances change. A forecast that will tell management on a regular basis how much cash they will need and when they will need it. A forecast that will tell you your company�s cash balances at the end of every month for the next twelve months.
Wouldn�t you like to know?
You�ll never be able to control expenses if you don't know what they should be. You can spend and spend, but you can't know if you've spent too much�if you haven't given any forethought as to what you should be spending.
Once you have determined what an operating expense should be and you compare it to what it actually is, you will be in a position to know if you have achieved the goal of controlling your expenses.
A THEFT COULD HAVE BEEN PREVENTED
Here is an example of how the process of comparing actual expenses to the financial forecast would have caught a company theft early, and quite possibly have prevented the indiscretion altogether.
Joe Scott and Eric Brown had been partners in the manufacturing business for ten years. They had started on a shoestring yet built their company to its present $8,000,000 per annum sales volume. Profits were consistently high.
Joe was about ten years older than Eric and had a nasty temper. He controlled the purse strings of the company and frankly was tough to deal with.
Eric's position in the company was in production. He paid little attention to financial matters and seemed only concerned with what his annual salary would be.
The office I was sitting in was cold. Joe always had the air conditioning on too high. He sat behind a beautifully polished Bank of England desk, unaware of my discomfort and vaguely annoyed about the thrust of my request for the meeting.
Eric sat to my right. He also seemed oblivious to the chill and likewise to Joe's irritation with me. On the desk in front of us were copies of the financial statements of the past two years.
"My reason for this meeting," I said, tapping the most recent statement with my pencil, "is to express concern over the rise in the company's expenses. Compared to recent periods, they seem excepÂtionally high."
Joe took issue immediately. "Your concerns are unfounded and the figures must be wrong. Call in the bookkeeper."
In a moment we were joined by Sue, the company bookkeeper, a very thin, short woman who always looked as though she had been working for the past twenty-four hours. She was an excellent bookÂkeeper. "Sue, your numbers are wrong," Joe said.
Sue didn't give an inch. "You always say that, Mr. Scott."
We were at an immediate impasse, and to break it, Sue and I retired to her office to review the ledgers. When we reported that the numbers were indeed right, Joe began to mumble.
"When you spend money," I began, "how do you know if you're going overboard or not?"
"Sue prepares a report," Joe said brusquely.
"But we've just seen what happens when Sue presents the figures. You challenge them, and even when they check out, you don't pay any attention to them. You should be getting information more often, and both of you should compare the actual figures against previous targets. You should do this every month."
For years I had attempted to convince them to use some kind of forecast, and for years, they had passed. We parted with Joe and Eric upbeat. Why not? Profits were good, Eric continued to receive his salary and Joe released some anger.
About a week later, Eric Brown, uncharacteristically agitated and concerned, called my office. �That S.O.B. Joe has been paying personal expenses through the business without my knowledge."
No wonder, I thought, that expenses hadn't seemed too high for Joe. "How much?" I asked.
"About $50,000. We're still checking."
We left matters with Eric's promise that he'd call me if Sue's investigations produced any more results. Two days later, Eric was back on the line. ''We're up to $75,000" he said.
"Ouch," I said.
"You're telling me," Eric mumbled. We ended our conversation.
Two more days passed before I heard from Eric again. "This year alone, $250,000."
What happened? Neither of the partners was responsible to the company. Joe Scott, with control over the purse strings, was able to spend, spend, and spend. Eric, involved only in his production, didn't have any idea where the company was going and where it should be.
Had Joe and Eric reviewed financial data regularly and compared the data to predetermined goals, Joe would have had a difficult time spending company funds on personal expenditures. The variance from expected results would have been glaring enough to support my concern and would have been easily spotted. More than likely, the theft would not have taken place.