Managing Finance | Business Guides | NatWest International

When preparing a budget, it is vital to show the level of sales required to cover the expenses. If the break-even sales figure is close to the sales forecast, then there is little scope for error. If you are a new business, investors will look quite closely at the margin of safety when determining whether to provide support.
 

If you are a service business, you will need to know how much to charge per hour (though you may offer your customers a fixed price). Your hourly rate equals your annual costs divided by your annual productive hours. Remember that not all of your working hours will be productive - some time will be required for promoting your business, buying supplies, doing the books, etc. You will also need to allow for holidays and illness. For any individual sale you will also need to add direct costs. If you are in manufacturing, then instead of estimating working hours start by estimating the number of products that you will sell. Include all costs - including the cost of your time and depreciation of capital equipment.

Once you know your costs and estimated selling price, you are in a position to calculate how many products or hours of your time you need to sell to break even or cover all of your costs. Any further sales will then provide you with a profit. The easiest way to do this is with a graph. The vertical axis measures money; the horizontal axis measures volume of sales. First plot your overhead costs. This will be a horizontal line - because overheads do not vary with sales. Then add direct costs, to show the total cost for a given volume of output.

Now plot your sales. The point where the sales income equals the total costs is the break-even point. The difference between your forecast sales and your total costs is profit (or loss). The difference in volume between the break-even point and the actual sales is known as the margin of safety.

The whole point of calculating the break-even point is to know the absolute minimum level of sales required. If your business is to have a future you will need sales consistently above the break-even point - to give a reasonable profit and to repay any loan finance.

There is almost always scope to reduce costs. If you cannot increase your profit through additional sales, then you will need to look at ways of reducing your costs. If necessary, seek advice from your accountant or business adviser.
 

For a new business it is likely that costs will exceed income for the first few weeks or months but you should have a plan which allows for this - and you should still be achieving your sales targets or else you will need to worry about finding the cash necessary to cover your costs.

New businesses, when asked how they will attract customers, almost always answer by saying that they will charge less than their competitors. This is a marketing strategy known as cost-leadership. It is impossible for small businesses to sustain because they do not have the economies of scale of large businesses. You may also find that if you start with low prices it is difficult to increase them as customers will want to continue buying at the lower price.
 

So you should pursue a marketing strategy of differentiation - attract customers by offering better quality, or a service or product that is unique, or because you have particular expertise, or by better after sales service, or by quicker service, etc. This will allow you to charge higher prices.

You should, however, regularly review your costs and prices - and adjust your prices as necessary.

1. Keep a close eye on your budgeted income and expenditure. If sales are not as high as required, recalculate your unit cost and sale price. If this is a price you cannot sell at, you will need to take action to increase sales or reduce costs.
2. Use your break-even sales volume to set monthly and annual sales targets. If you do not achieve these targets, you will need to take remedial action.
3. Prepare a marketing strategy based on differentiation rather than cost-leadership.

Watch the profitability of your business on a month by month basis. If your sales are level and your profit is falling, look closely at your expenditure - and cut costs. It might be sensible to plot both income and expenditure on a break-even graph and put this on your office wall.
 

If you have budgeted well, and if you achieve your sales targets without over-spending, then you will usually be okay. Watch out, though, if you sub-contract a large part of your work. In this case, you need to watch your break-even point closely as well.

Most small businesses need to keep tight control of their expenditure to remain profitable. Every time you want to spend money, ask yourself how this expense will help you add value to the work that you do for your customers. If you cannot justify the expense in terms of enhancing your product or service, or making you more efficient, then you will probably survive without it.

Competition amongst suppliers is the biggest factor on their pricing policy. So keep an eye on the different suppliers in the market and what they are charging. Remember, however, that it does not always pay to buy the cheapest. In the same way that you are aiming to differentiate yourself from your competitors, so are your suppliers. Cost is important - but you may also want to consider the quality of the product or service, after sales service, reliability of supply, etc. But always talk to your suppliers about their prices - and be ready to change if their prices are too far out of line.

You may find that you can get cheaper prices by agreeing to pay more quickly or by agreeing to a long-term supply contract. Your strongest negotiating position is knowing that you can go elsewhere for a lower price.

You may think that this is a silly question, since no-one wants to spend more than they need. However, you should be continually watching for new developments and technologies which may enable you to become more efficient and to increase your productivity.

Visit trade fairs to keep up to date with the most cost-effective equipment. Experiment with new approaches. If you employ staff, ask them for their ideas - you need to do your best to ensure that they are using all their time productively, rather than wasting it on administration or other activities that do not generate income.

1. Good cost control is part of effective financial control, so ensure that you have a good accounting system. Check the figures regularly - at least monthly - and act on the figures promptly if you identify problems.
2. Beware of false economies. Compromising your level of quality and service could lose you business. If cost cutting leads to deterioration in working conditions for staff, there is a danger that they become demoralised and perform less well - which will exacerbate the problem.
3. Confront cost problems immediately - and take action before the problem becomes insurmountable

There are various sources of finance available for starting or growing your business. The first is that you provide all the necessary money from your personal resources, but this is not an option open to everyone.

If you are starting up, or are already in business and want to expand, then there are two main sources of finance: equity and loan finance. Venture capital firms and business angels can provide equity investments in exchange for shares in your company. They'll be looking for above-average returns and an exit route, usually within five years. They'll probably want some say in the way that you run your business, but can also prove to be an excellent source of expertise and contacts.

If equity is inappropriate, or you don't want external investors, then an alternative is loan finance. This allows you to keep total ownership and control of your business, but you'll probably have to provide personal guarantees. Lenders will look at the gearing (the ratio of loan finance to total finance) and won't lend if the gearing is too high. They'll also look at interest cover - the number of times that forecast profit exceeds interest - and won't lend if this figure is too low.

Most loan finance comes from the banks. They lend around £40 billion each year to small businesses, though other finance houses also provide loans. Sometimes loans come in the form of factoring (factors pay out against your invoices, though this is effectively just a loan secured on your sales book). Sometimes, they come in the form of asset finance, though this is effectively a loan secured on your capital assets.

The finance institutions take in deposits and then seek to make a return on this money. The level of interest charged depends on their perception of the risk of lending to your business. In general, small businesses are regarded as being a higher risk, so finance institutions charge a higher rate of interest and look for enough security to cover the loan in the event that you can't meet the repayments. Administration costs can be as high for small loans as they are for larger loans, so arrangement fees are also usually payable.

As with other costs, do what you can to reduce the interest charged. Don't be afraid to negotiate. As you build up a credit record the bank will be better able to assess the risk that you represent, and should be willing to reduce the interest charged, provided you keep up your repayments.

In addition to the commercial financial institutions, there are a large number of Community Development Finance Institutions. Many of these are managed by local enterprise agencies, but there are other non-bank loan funds as well. Whilst they'll also be looking for good propositions, and personal commitment, they are often willing to lend on softer terms - possibly a reduced rate of interest, less need for security, and so on. Ask your bank manager or a professional business adviser for a list of organisations.

This depends entirely on your personal circumstances and the nature of your proposed venture. Prepare a detailed cash flow forecast as accurately as you can for the first year - this will give you a pretty good indication of your requirements. Allow yourself a level of contingency to avoid having to go back for additional finance.

Every business needs adequate finance - to buy capital equipment and to provide working capital until sales start to produce income. You may find it difficult to get credit initially and may have to pay rent in advance, provide deposits for telephones, and so on. If you don't have sufficient personal assets, then you've little choice but to look for investors or lenders.

Even if you've got the necessary resources, you should approach your business planning as if you had to raise the money externally. This should convince you that your business venture is a risk worth taking.

Depending on your personal circumstances, you may be able to start on a small scale, perhaps part time, reinvesting the profit that you make and building up the business to the point at which you can work in it full time.

It makes sense to talk to your bank at an early stage about what they require from you to support a loan application. However, there is merit in preparing the best possible case so it may help to seek appropriate advice. They should be able to help you determine the ideal mix of equity, loan finance and grant aid, prepare a suitable business plan and complete any application forms that might be necessary.

1. The key to raising finance is a solid business plan, with rigorous market research to justify your sales forecasts, together with a demonstration of your determination and commitment.
2. Explain to prospective investors your total financial requirements, split into capital for fixed assets and working capital.
3. Don't expect investors to agree immediately. If they refuse to support you, ask for feedback, address the issues, revise your plan and go elsewhere. If financiers question the viability of your idea, perhaps you should too.