Tools for Managing Your Finances

The Financial Planning pages provide information about some of the key tools that you will need to help you plan and manage your business finances.

The content on this page has been broken down into subsections to help provide you with some high level information about budgeting, cashflow forecasting, profit and loss accounts and the balance sheet along with links to the national information website where you can go to read more detailed information about these tools and more.

This section also includes some interesting case studies which illustrate how these tools have been used to help businesses.

 Budgeting Basics

It's essential to plan and tightly manage your business's financial performance. Creating a budgeting process is the most effective way to keep your business - and its finances - on track.
When you're running a business, it's easy to focus on day-to-day problems and forget the bigger picture. However, successful businesses invest time to create and manage budgets, prepare and review business plans and regularly monitor finance and performance. Structured planning can make all the difference to the growth of your business. It will enable you to concentrate your resources on improving profits, reducing costs and increasing returns on investment.
New small business owners may run their businesses in a relaxed way and may not see the need to budget. However, if you are planning for your business's future, you will need to fund your plans. Budgeting is the most effective way to control your cashflow, allowing you to invest in new opportunities at the appropriate time.
If your business is growing, you may not always be able to be hands-on with every part of it. You may have to split your budget up between different areas such as sales, production, marketing, etc. You'll find that money starts to move in many different directions through your organisation - having a budget is vital to ensuring that you stay in control of expenditure.
A Budget plan is to.
• control your finances
• ensure you can continue to fund your current commitments
• enable you to make confident financial decisions and meet your objectives
• ensure you have enough money for your future projects
It outlines what you will spend your money on and how that spending will be financed. However, it is not a forecast. A forecast is a prediction of the future whereas a budget is a planned outcome that your business wants to achieve.
There are a number of benefits of drawing up a business budget, including being better able to:
• manage your money effectively
• allocate appropriate resources to projects
• monitor performance
• meet your objectives
• improve decision-making
• identify problems before they occur - such as the need to raise finance or cashflow difficulties
• plan for the future
• increase staff motivation

 Creating a Budget

Creating, monitoring and managing a budget is key to business success. It should help you allocate resources where they are needed, and should not be complicated. You simply need to work out what you are likely to earn and spend in the budget period.
As your business grows, your total operating budget is likely to be made up of several individual budgets such as your marketing or sales budgets.
Begin by asking these questions:
• What are the projected sales for the budget period? Be realistic - if you over-estimate, it will cause you problems in the future.
• What are the direct costs of sales - i.e. costs of materials, components or sub-contractors to make the product or supply the service?
• What are the fixed costs or overheads?
• You should break down the fixed costs and overheads by type, e.g.:
• Cost of premises, including rent or mortgage, business rates and service charges
• Staff costs - e.g. pay, benefits, National Insurance
• Utilities - e.g. heating, lighting, telephone or internet connection
• Printing, postage and stationery
• Vehicle expenses
• Equipment costs
• Advertising and promotion
• Travel and subsistence expenses
• Legal and professional costs, including insurance
• Your business may have different types of expenses and you may need to divide the budget by department. Don't forget to add in how much you need to pay yourself and include an allowance for tax.
Your business plan should help in establishing projected sales, cost of sales, fixed costs and overheads, so it would be worthwhile preparing this first.
Once you have figures for income and expenditure, you can work out how much money you're making. You can look at your costs and work out ways to reduce them, as well as seeing if you are likely to have cashflow problems. By doing this you give yourself time to do something about any problems.
You should stick to your budget as far as possible, but review and revise it as needed. Successful businesses often have a rolling budget.

 How to Use Your Budget

If you base your budget on your business plan, you will be creating a financial action plan. This can be useful, particularly if you review your budgets regularly as part of your annual planning cycle.
Your budget can serve as:
• an indicator of the costs and revenues linked to each of your activities
• a way of providing information and supporting management decisions throughout the year
• a means of monitoring and controlling your business, particularly if you analyse the differences between your actual and budgeted income.
To use your budgets effectively, you will need to review and revise them frequently. This is particularly true if your business is growing and you are planning to move into new areas.
Using up-to-date budgets enables you to be flexible and also lets you manage your cashflow and identify what needs to be achieved in the next budgeting period.
There are two main areas to consider when reviewing your budget - income and expenditure.
Your actual income - each month, you should compare your actual income with your sales budget. To do this, you should:
• analyse the reasons for any shortfall - for example, lower sales volumes, flat markets and underperforming products
• consider the reasons for a particularly high turnover - for example, whether your targets were too low
• compare the timing of your income with your projections and check that they fit
Analysing these variations will help you to set future budgets more accurately and also allow you to take action where needed.
Your actual expenditure - regularly review your actual expenditure against your budget. This will help you to predict future costs with greater reliability. You should:
• look at how your fixed costs differed from your budget
• check that your variable costs were in line with your budget - normally variable costs adjust in line with your sales volume
• analyse any reasons for changes in the relationship between costs and turnover
• analyse any differences in the timing of your expenditure - for example, by checking suppliers' payment terms

 Cash Flow Basics

Cash enables a business to survive and prosper and is the primary indicator of business health. While a business can survive for a short time without sales or profits, without cash it will die. For this reason the inflow and outflow of cash – the cashflow - needs careful monitoring and management.
To trade effectively and be able to grow your business, you need to build up cash balances by ensuring that the timing of cash movements puts you in a positive cashflow situation overall.
Bear in mind that having a lot of cash in your bank does not necessarily make good business sense. If you do not need to use it immediately, put spare cash into an account where it will earn a higher rate of interest, or use it as capital for short-term investments.
You should note that income and expenditure cashflows rarely occur together, with inflows often lagging behind. Your aim must be to speed up the inflows and slow down the outflows.
Cash Inflows
• Payment for goods or services from your customers.
• Receipt of a bank loan.
• Interest on savings and investments.
• Shareholder investments.
• Increased bank overdrafts or loans.
Cash outflows
• Purchase of stock, raw materials or tools.
• Wages, rents and daily operating expenses.
• Purchase of fixed assets - PCs, machinery, office furniture, etc.
• Loan repayments.
• Dividend payments.
• Income tax, corporation tax, VAT and other taxes.
• Reduced overdraft facilities. 

 Cash Flow Forecasting

Cashflow forecasting enables you to predict peaks and troughs in your cash balance. It helps you to plan borrowing and tells you how much surplus cash you're likely to have at a given time. Many banks require profit and balance sheet forecasts as well as a cashflow before considering a loan.
The cashflow forecast identifies the sources and amounts of cash coming into your business and the destinations and amounts of cash going out over a given period. There are normally two columns, listing forecast and actual amounts respectively.
The forecast is usually done for a year or quarter in advance and divided into weeks or months. In extremely difficult cashflow situations a daily cashflow forecast might be helpful. It is best to pick periods during which most of your fixed costs - such as salaries - go out. The forecast lists:
• receipts
• payments
• excess of receipts over payments - with negative figures shown in brackets
• opening bank balance
• closing bank balance
It is important to base initial sales forecasts on realistic estimates. If you have an established business, an acceptable method is to combine sales revenues for the same period 12 months earlier with predicted growth.
Download our sample cashflow projection spreadsheet (below).

 Managing Cash Flow

Effective cashflow management is as critical to business survival as providing services or products. Many of your regular cash outflows, such as salaries, loan repayments and tax, have to be made on fixed dates. You must always be in a position to meet these payments in order to avoid large fines or a disgruntled workforce.
It is important that you incorporate warning signals into your cashflow forecast. For example, if predicted cash levels come close to your overdraft limits, this should sound an alarm and trigger action to bring cash back to an acceptable level. See our guide on how to identify potential cashflow problems.
Ideally, you should always have a contingency plan, such as retaining a minimum amount of cash in the business, perhaps in an interest-earning account. This 'rainy day' money can be used to meet short-term cash shortages.
Below are some of the key methods to help reduce the time gap between expenditure and receipt of income.
Customer Management
• Define a credit policy that clearly sets out your standard payment terms.
• Issue invoices promptly, and regularly chase outstanding payments. Use an aged debtor list to keep track of invoices that are overdue and monitor your performance in getting paid. See our guides on managing late payment and getting paid on time.
• Consider exercising your right to charge penalty interest for late payment.
• Consider offering discounts for prompt payment.
• Negotiate deposits or staged payments for large contracts. It's in your customers' interests that you don't go out of business trying to meet their demands.
• Consider using a third party to buy your invoices in return for a percentage of the total.
Supplier management
• Ask for extended credit terms. Giving your suppliers incentives such as large or regular orders may help, but make sure you have a market for the orders you're placing. Alternatively, consider reducing stock levels and using just-in-time systems.
• You may be liable for several different taxes including income tax, corporation tax, VAT, business rates and stamp duty. It is important to keep good records to help you calculate your liability and complete your returns accurately.
• If you are registered for VAT, it makes sense to buy major items at the end rather than the start of a VAT period. This can often improve your cashflow, because you can set the VAT on the purchase off against the VAT you charge on sales. This may help plug a temporary cashflow gap.
• HM Revenue & Customs (HMRC) has launched a support service to help businesses struggling to meet tax, National Insurance or other payments owed to HMRC.
• If you are concerned that you may not be able to pay amounts that are owed or will soon be owed to HMRC, you can contact the HMRC Business Payment Support Service (BPSS). HMRC staff will review your situation and discuss temporary payment arrangements tailored to your business' circumstances.
• You can contact the HMRC Business Payment Support Service Helpline on Tel 0845 302 1435.
Asset management
Consider leasing fixed assets, e.g. equipment, or buying them on hire purchase. Buying outright can result in a huge drain on cash in the first year of business.

 Profit & Loss Basics

A profit and loss account is a summary of business transactions for a given period - normally 12 months. By deducting total expenditure from total income, it shows on the 'bottom line' whether your business made a profit or loss at the end of that period.
A profit and loss account is produced primarily for business purposes - to show owners, shareholders or potential investors how the business is performing. But most of the information is also used by HM Revenue & Customs to check your tax calculations.
By law, if your business is a limited company or a partnership whose members are limited companies, you must produce a profit and loss account for each financial year.
Self-employed sole traders and most partnerships don't need to create a formal profit and loss account - but they do need to keep adequate records to complete their Self Assessment tax return fully and accurately.
However, there are key benefits to producing formal accounts. If you are looking to grow your business, or need a loan or mortgage, for example, most institutions will ask to see three years' accounts.
Accurate record keeping has important benefits. It:
• gives you the information you need to manage and grow your business
• enables you to report on your profit or loss easily and quickly when required
• will improve your chances of getting a loan or mortgage
• makes filling in your tax return easier and quicker
• makes completing VAT Returns straightforward - if you are registered for VAT
• helps you or your business pay the right tax
• provides back-up for claims for certain allowances
• helps you plan and budget for tax payments
• reduces the risk of interest on late payments or late-filing penalties
• helps reduce fees if you use an accountant - your annual accounts will be far easier to produce.

 Records Required For Producing a Profit & Loss Account

Whatever your business type, you must keep accurate records of your income and expenditure. You need to keep self-employment records for five years after the 31 January deadline - and you may need to keep them for longer if you file your return late or if HM Revenue & Customs starts a check. You need to keep limited company or partnership records for six years after the latest date your tax return is due.
The basic records you will need to keep should provide:
• a record of all your sales (turnover) and other income (such as, bank interest, sale of equipment, rental income, personal funds put into a limited company, etc.) - your income
• a record of all your purchases and expenses - your expenditure – which can be split between 3 key areas: cost of sales - the base cost of obtaining or creating your product, business expenses, cost of equipment you have bought or leased for long-term use. (If your business is VAT-registered, you will need to record details of any VAT included in your expenditure).
You may also need to keep:
• a separate list for petty cash expenditure if relevant
• a record of goods taken for personal use and payments to the business for these
• a record of money taken out for personal use or paid in from personal funds - this applies to limited companies
• back-up documents for all of the above
You will need the information above to create your profit and loss account and to complete your tax returns.

 Profit & Loss Accounting Periods and Tax

Businesses normally work out their profit and loss for a twelve month period. This makes it easy to see how well your business is doing each year, and to compare one year with the next.
The way your accounts are taxed depends on what type of business you have.
Accounts for self-employed and partnerships
Self-employed sole traders and business partnerships are normally taxed on the profits for the 12 month accounting period ending during the tax year. The tax year runs from 6 April to 5 April the following year.
For example, if you make your annual accounts up to 31 December each year, your profits to 31 December 2010 are used in your 2010-11 tax return (for the year to 5 April 2011).
The simplest approach can be to make your annual accounts up to 31 March or 5 April, so that they match the tax year.
Special rules apply when you start or close a business, or if you decide to change your accounting period, to ensure that all your profits are fairly taxed.
To find out more about accounting periods for the self-employed and partnerships, download a helpsheet on how to calculate your taxable profits from the HM Revenue & Customs (HMRC).
Limited companies are required to submit annual accounts to Companies House, including a profit and loss account.
When you start a new company, the financial year automatically runs to the end of the month a year after the company is incorporated. For example, if a company is incorporated on 10 June, the first financial year runs from 10 June to 30 June the following year. But you can choose a different financial year end if you wish.
Your profit subject to Corporation Tax is normally based on an accounting period that matches this financial year. There are special rules if your accounting period is longer than twelve months (for example, if your new company makes up its accounts to a date more than a year away).
For more information, contact HM Revenue & Customs (HMRC) or see the government information website,

 Balance Sheet Basics

Your balance sheet is a financial statement at a given point in time. It provides a snapshot summary of what your business owns or is owed - assets - and what it owes - liabilities - at a particular date.
The balance sheet therefore shows how your business is being funded and how you are using these funds.
There are three ways you may use your balance sheet:
• for reporting purposes as part of a limited company's annual accounts
• to help you and other interested parties such as investors, creditors or shareholders to assess the worth of your business at a given moment
• as a tool to help you analyse and improve the management of your business
Other key benefits of producing a balance sheet include:
• if you want to raise finance, most lenders or investors will want to see three years' accounts
• if you want to bid for large contracts, including government contracts, the client will probably want to see audited accounts
• producing formal accounts - including a balance sheet - will help you monitor the performance of your business
Limited companies and limited liability partnerships
Limited companies and limited liability partnerships must produce a balance sheet as part of their annual accounts for submission to Companies House, HM Revenue & Customs (HMRC) and shareholders.
As well as the balance sheet, annual accounts include the:
• profit and loss account
• auditor's reports - unless exemptions apply
• directors' report
• notes to the accounts - these should provide any information you think may be relevant, eg supplementary financial information or additional detail.
Other parties who may wish to see the accounts - and therefore the balance sheet - are:
• potential lenders or investors
• potential purchasers of the business
• government departments carrying out inspections
• employees
• trade unions
There are strict deadlines for submitting annual accounts and returns to Companies House and HMRC - you may have to pay a fine if you send them in late.
Self-employed people, partners and partnerships
Self-employed people, partners and partnerships are not required to submit formal accounts and balance sheets on their tax return. However, the returns do require the relevant financial details to be entered in a set format, so you may find it beneficial to prepare the figures in a balance sheet format.

 Contents of the Balance Sheet

A balance sheet shows:
• fixed assets - long-term possessions
• current assets - short-term possessions
• current liabilities - what the business owes and must repay in the short term
• long-term liabilities - including owner's or shareholders' capital
The balance sheet is so-called because there is a debit entry and a credit entry for everything (but one entry may be to the profit and loss account), so the total value of the assets is always the same value as the total of the liabilities.
Fixed Assets Include:
• tangible assets - e.g. buildings, land, machinery, computers, fixtures and fittings - shown at their depreciated or resale value where appropriate
• intangible assets - e.g. goodwill, intellectual property rights (such as patents, trade marks and website domain names) and long-term investments
Current assets
Are short-term assets whose value can fluctuate from day to day and can include:
• stock
• work in progress
• money owed by customers
• cash in hand or at the bank
• short-term investments
• pre-payments - e.g. advance rents
Current liabilities are amounts owing and due within one year. These include:
• money owed to suppliers
• short-term loans, overdrafts or other finance
• taxes due within the year - VAT, PAYE (Pay As You Earn) and National Insurance
Long term liabilities Include:
• creditors due after one year - the amounts due to be repaid in loans or financing after one year, e.g. bank or directors' loans, finance agreements
• capital and reserves - share capital and retained profits, after dividends (if your business is a limited company), or proprietors capital invested in business (if you are an unincorporated business)
By law the balance sheet must include the elements shown above in bold. However, what each includes will vary from business to business. The firm's external accountant will usually decide how to present the information, although if you have a qualified accountant on staff, they may make this decision.

 Accounting Periods

A balance sheet normally reflects a company's position on its accounting reference date (ARD), which is the last day of its accounting reference period. The accounting reference period, also known as the financial year, is usually 12 months. However, it can be longer or shorter in the first year of trading, or if the ARD is subsequently changed for some reason.
Companies House automatically sets the first ARD. Thus the end of the first financial year is the first anniversary of the last day of the month in which the company was formed. If you decide to change this, you will need to notify Companies House.
You should also notify HM Revenue & Customs (HMRC) if you change your ARD. Self-employed people and partnerships can choose their first accounting period. Subsequent accounts are usually prepared a year after the first balance sheet date.
Your business may decide to draw up accounts to help you monitor business performance as frequently as monthly. In this case the figures - often known as management accounts - are for internal use only. You do not need to file them with Companies House or HMRC.
If you need one to one help with Financial Planning, search our local contacts list| or see the Support Scheme| pages. ACCA (the Association of Chartered Certified Accountants) also offers some useful business finance guides on it's website.