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June 1994

How to branch into entrepreneurial planning. (CPA in Industry)

by Montero, Andre S.

    Abstract- Many new businesses fail because of lack of planning. Although most entrepreneurs have definite ideas on how to establish their business, very few bother to write their plans down. This is unfortunate because laying down plans on paper forces business people to take a closer look at potential problems and to develop strategies for success. A good business plan includes a sales forecast which would serve as the entrepreneur's basis for budgeting operating expenses and for conducting a break-even analysis. The plan should also have provisions for projecting income statements, performing cash-flow analysis, measuring the progress of the business at regular intervals, and revising all financial plans and goals in light of new information and developments. Additionally, the plan must also provide for the enterpreneurs' compliance with professional standards.

The Business Plan

All entrepreneurs have plans on how to start their businesses, but few, unless forced, will take the time to write them down. A business plan is a document in which the entrepreneur writes down detailed plans for such functions as accounting, finance, production, marketing, and organization. Writing the plan forces the entrepreneur to consider problems in advance and to devise strategies for success. All banks require that a loan application be accompanied by a business plan.

Financial Sections of The Business Plan

Sales Forecast. The data for forecasts comes from the entrepreneur. An accountant can assist by questioning the assumptions and compiling the findings in a useful format. The sales forecast is always prepared first and should receive the most scrutiny. For example, to prepare the sales forecast for a start-up restaurant, the questions that should be asked include the following.

* How many seats are in the restaurant?

* How many meals a day are being served? (breakfast? lunch? dinner?)

* How many seatings will there be for each meal?

* At what percentage of capacity will the restaurant be utilized for each of the meals? How was this percentage determined? By marketing studies? By observing the competition? By past experiences?

* What will be the average bill for each meal? (This will be based in part on the menu prices.)

The answers to questions like these can be used to forecast gross revenue. Several projections should be prepared by changing some of the assumptions--in particular the number of customers. At a minimum there should be a best, worst, most likely and a break-even forecast.

Budgeting Expenses

The sales projection is used to forecast the operating expenses. Once again, the information must come from the entrepreneur. Typical questions would include the following:

* How many employees would be necessary to support the activity level that was developed in the sales forecast? The total payroll costs can be derived from this information.

* How large an establishment would be needed to support the projected sales? Has a rent estimate been obtained from a real estate professional?

* Has an insurance estimate been obtained from a knowledgeable insurance agent?

Through such questions, and by receiving independent expense estimates whenever possible, all the operating expenses can be projected. Since at least four estimates of sales were forecasted, there must be an estimate of expenses for each one.

Break-even analysis is a managerial tool that calculates the amount of sales revenue that is necessary to either break even (no profit or loss) or to obtain a certain level of profitability. The calculation is done by categorizing all of the expenses as either fixed or variable and using a simple mathematical formula. While this calculation produces only an approximation, it is still one of the most important forecasts that can be prepared.

Projected Income Statements

Having projected sales, expenses, and the break-even point, the next step is to prepare at least four projected income statements for the first year. The first would be based on an optimistic forecast of sales, the second on the most likely amount of sales, the third on the break- even point and the last on a pessimistic forecast. Another managerial tool is called the margin of safety. By comparing what the entrepreneur believes to be the most likely outcome to the amount of sales needed to break even, the entrepreneur gets an idea about how much his or her estimates can be off before showing a loss.

Cash-Flow Analysis

Profitability is not enough to insure the success of a new business. To succeed, a business must generate enough cash flow to meet its financial obligations. To plan for this need, a cash-flow projection by month for at least the first year and preferably for the first three years is essential. When preparing this analysis, ways to improve the cash flow can be identified. The suggestions might include types of financing available, the use of credit terms to accelerate receivables, or the importance of inventory turnover. Planning will avoid the lack of liquidity that leads to missed opportunities and sometimes to business failure.

Planning and Control

The planning process doesn't end when the company opens its doors for business. Having set goals, it is important for the entrepreneur to measure progress at regular intervals. It would be impossible to sail across the Atlantic Ocean without a system of navigation, just as it would be impossible for a business to reach its goals without a navigation system to guide it from its present position to the final destination.

The entrepreneur navigates by the accounting system. The actual amounts of sales, expenses, and cash flow should be compared to monthly budgets so that problems can be rectified before they threaten the survivability of the enterprise. Management by exception is a method which focuses attention and resources to the areas that are not meeting the company's goals. Problems cannot be solved unless they are first identified.

As the business progresses, the accumulation of actual data gives the entrepreneur more accurate information to forecast future operating results. It is important to revise all the financial plans and goals as soon as new information becomes available. This is accomplished by repeating all the planning steps using the new information. If the original financial forecasts were prepared using a computerized spread- sheet, updating them is simple.

Professional Standards

If a practicing CPA becomes involved with the process, he or she must follow professional standards. These standards can be found in two AICPA publications, AICPA Professional Standards--Volume 1, AT Section 200, which covers financial forecasts and projections, and the Guide for Prospective Financial Information.

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