One of the big impacts of the covid-19 pandemic is the impact on the economy. A lot of businesses, especially retail businesses, are gone because people are reluctant / forced to stay at home under government regulations.
A Good Financial Forecast Is Necessary
When the retail businesses get no sales but still need to pay for regular expenses like rental and inventories, they couldn’t have the sufficient cash to sustain their businesses. As a result, their failure is inevitable.
Most of the businesses didn’t realize this crisis in early 2020 when then COVID-19 just got started. They thought they might be able to survive from this. This is clearly proved to be over-optimistic now. In fact, running business is always risky, but those risks were ignored when the economy looked fine (which was actually not after the financial crisis in 2008).
As responsible businessmen, we should always prepare financial forecast for our business and regularly evaluate the assumptions and trends to make sure we could take any action before anything bad happen. A good financial forecast is important to businesses because it will tell us a lot of important information to judge whether the business could grow and expand, or will be dead very soon.
I might tell you the 5 key elements of preparing financial forecast in the coming future. Today, let me introduce to you the 5 key figures that matter in running businesses.
1st Key Figure – Revenue
This is one of the figures that my boss always asked for. Actually, Revenue is defined as the income that a business has from its normal business activities, usually from the sales of goods and services to customers. In other words, it tells us whether we make money or not.
That is why every time when I have a meeting with my current boss, the first figures he would ask is the Revenue of the month. Also, it is one of the figures that my boss in my previous company always remember.
From accounting point of view, when we are looking at the Income Statement (One of the key statements of Financial Statements. Business owners should know this if they care about their businesses.), we need to pay attention to the fact that Revenue also shows the timing factor.
For example, if a total of $100,000 sales in Income Statement doesn’t mean we have one-month income of $100,000, because some of the sales might be considered as income from the future month. If we just see the total of $100,000 as one-month Revenue, it would result in relatively fluctuated and incorrect pattern of Revenue.
Based on the Accounting standard IFRS 15, we need to recognize the income over the period. By doing so, we can make sure we are looking at the right amount of Revenue at particular time (monthly or quarterly). Therefore, we can foresee the extend of growth of the business, and whether we need to take precaution if the Revenue drops gradually.
2nd Key Figure – Cost of Goods Sold, COGS
We may see this as the cost of the products we are selling. However, according to Accounting standard IFRS 15, the definition of COGS is actually the costs that relate directly to a contract in sales.
This is the 2nd figure on the Income Statement that my boss always asks for. He would do everything in order to minimize this cost (while boosting the Revenue).
To identify this COGS, we need to know what is driving the Revenue. For example, the company I am working for is a logistics and storage company. The main cost of the company is the cost of the warehouse and the logistic cost. The warehouse cost might include the rental fee and the labour, and the logistics cost might include the cost of the fleets and depreciation of the vans.
By reviewing the cost efficiency of warehouse and logistics department, my boss can see if the company is able to reduce the cost while achieving the same level of Sales. It also tells the Gross Profit Margin to my boss for further analysis (which is the next figure I am going to talk about).
Generally speaking, it is not correct to say that the more cost we incur, the more Sales we will obtain, because when the cost is incurred to certain level, there might be bottleneck in the whole process which might slow down the sales process and hence result in wastage. Detailed analysis is required to find the perfect amount of COGS.
3rd Key Figure – Gross Profit Margin (GP Margin)
Although Revenue and COGS are important figures to our business, they cannot tell much information individually. In general, the Revenue figure only tells us how much sales we have made so far, but it doesn’t tell how much we have spent as cost. On the other hand, the COGS figure only tells us how much money we have spent so far to generate sales, but it doesn’t tell us how much we have earned.
In order to see the profitability of the business, we use the 3rd Key figure, Gross Profit Margin. GP Margin is the Gross Profit as a percentage of Revenue, which is in turn derived by deducting the COGS from the Revenue. It shows how much profit can be converted from every dollar of Revenue we earn.
We expect to see high % of GP Margin because it indicates that our business can make profit on sales and hence it is efficient to convert the the direct cost into money. On the other hand, if we get a low % of GP Margin, we can interpret it as a low efficiency in converting direct cost into money. In other words, the business might be deteriorating.
There is no standard for this figure. Different industries have their own “Good” GP Margin. For example, my boss told me that our goal is to achieve around 40% GP Margin at group level, which has already defeat other competitors in the same industry (logistics and storage).
Besides, we need to bear in mind that the business might still be losing money when the GP Margin is positive and high. It is because the business might incur a lot of Sales and Administration Expenses (eg, wages, office rental, etc) which is presented below the GP Margin. As a result, the Net Profit Before Tax might be negative (ie, Net lost). However, those expenses can be reduced as they are mainly overhead cost / fixed cost.
4th Key Figure – Accounts Receivables
Cash is King. This is one of the first rules of running businesses.
There is always future for the businesses if we have sufficient cash on hand. However, even if we can offer the best product / service, we cannot expend the business if we have no cash.
We need cash to do various things. For example, we need to hire high quality employees to help, pay on the marketing campaign, invest on the machines or equipment we need, spend on the research and development, etc. Therefore, we need to make sure we have sufficient cash on hand, ie, minimize the liquidity risk.
In the above I mentioned that we need to earn more Revenue. However, High Revenue doesn’t mean more cash. According to IFRS 15, we can recognize the Revenue as long as we have fulfilled the performance obligation (ie, the products / services we promised to deliver to our customers). However, the customers might need make the payment until future days, say, 30 days from now. In that sense, we might receive no cash even we have earned the Revenue.
When we receive no cash but earned Revenue, we use Account Receivables as intermediate account to control how much cash we are expecting to collect.
If we confirmed that we don’t request immediate payment from customers, we need to actively manage our Account Receivables. A lot of businessmen ignore the Account Receivables but just make the Income statement look good. They focus too much on the Revenue instead of the Account Receivables, eventually they have run out of cash.
Remember: The less the amount in Account Receivables, the more we can get the cash from our customer, and the more cash we have on hand to run the business.
5th Key Figure – Net Cash Burn
Some people only care about the cash received. When there is cash inflow, they are happy and think their effort is finally repaid. However, they forgot to check how much they have spent so far, which might result in significant Net Cash Burn in their businesses.
In general, Net Cash Burn means cash outflow is more than cash inflow. It is normal to have positive Net Cash because we don’t expect to net off the cash outflow with the cash inflow, ie, achieve breakeven point in the early stage of the businesses.
For example, the logistics and storage company I am working for still have net cash burn after 5 years operation. However, as long as we have sufficient cash at bank it is fine to have Net Cash Burn. This also implies that we have been greatly investing in the business (ie, incur a lot of CAPEX) so as to expand the business scale.
Generally speaking, the Net Cash Burn will gradually be reduced as we expect more customers to pay for our products / service. Therefore, we should finally achieve Net Cash Inflow eventually. By that time, we might look for another potential opportunities to expand the business.
There are tens of thousands of indicators to study whether a business is growing or dying, eg, Rate Of Return (ROI), Customer Acquisition Cost (CAC), etc, but I think the above five figures are the most basic ones and the easiest to understand. When we start familiar with the business, we can then look for more indicators to monitor the business.
To sum up, we have the following 5 Key Figures in Running Businesses:
- 1st Key Figure – Revenue
- 2nd Key Figure – Cost of Goods Sold, COGS
- 3rd Key Figure – Gross Profit Margin (GP Margin)
- 4th Key Figure – Accounts Receivables
- 5th Key Figure – Net Cash Burn
If you have any questions or have anything things to share, you can reach out to me via email firstname.lastname@example.org.
Besides, if you want to know more about what I have learnt from other successful people, you can click the below link. This could the one of the life-changing articles for you: