Now is the time to get started on financial projections for the coming year, and these are the fail-safe steps that will help you do just that.
Remember the story I told in my last blog, the one about the CEO who doubled his sales as a result of projections? That CEO was focused on revenue streams. That’s where all projections have to start. You must determine what your revenue streams will be, either by service or product line.
Total revenue or total sales over the course of a year don’t just happen. Three ingredients go into generating those revenues. The first is the number of customers your company has. The second is the transaction frequency, or how often your company is expected to do business over the next year with each of those customers. And the third, of course, is the average transaction value. If you had a hundred customers and did business with each 10 times a year, with the average transaction $1,000, you’d have sales for the year of one million.
The other thing to focus upon is the velocity of these sales transactions. Velocity is likely to move up and down over the year, and you’ll have months or seasons where velocity is comparatively higher than at other times. Your company won’t record the same level of sales each month, so give thought to how that will vary.
The next step in the approach is to establish the gross margins of each revenue stream. The gross margin is a very, very important number in your financial statement, and a topic into which we’ll delve more deeply in a future newsletter.
In order to make informed future financial decisions, you must know the gross margin. That’s a combination of looking at the direct costs to produce each revenue stream, and adjusting your sales prices as needed to hit your targets.
Let’s define direct costs, as opposed to overhead costs. A direct cost is any expense related to generating that sale and delivering it to the customer, while overhead costs are not directly related to that sale.
The final step is studying overhead needed to generate revenue streams. Most businesses, I think, let overhead be where it is, realizing it will cost so much to generate those revenues. Some CEOs will take it a step further, saying, “No, let’s allocate a portion of overhead to each of those revenue streams.”
The result of projections is peace of mind for business owners, because they’ve laid out a plan. If you’d like a plan for the year ahead, get in touch with me.
I offer a 100 percent guarantee on my work. I take on only clients I can help. Call me and let’s talk about your business. My phone number is 630-269-7646.
For those not inclined to be organized, the idea of doing your own accounting beyond balancing your checkbook may make you a little queasy. However, you’ve managed to keep your lunch this far, and guess what? You’re almost done! Over the past three weeks, we’ve discussed balance sheets, income statements, and cash flow statements; today, we will be discussing the linchpin that allows the financial statements to communicate in a clear and logical manner… the chart of accounts.
Week 4: Do You Have the Right Chart of Accounts?
Well if you don’t, then you should, and hopefully after this, you will. Your business life has the chance to become incredibly more coherent once you implement the right one. In layman’s terms, a chart of accounts (COA) is just that — a chart, made by you, listing each of your General Ledger account names that describe the nature of the account; all your financial transactions get recorded by coding the transaction following the COA . SmallBusiness.com refers to it as “an accounting term that describes a list of common ways money is used by a business so that its owners and managers can organize revenues, costs, and assets into categories.” It is, for any business, an invaluable tool. Remember, the coherency of financial statements is all in the coding.
Below is a basic format for setting up the COA.
|Income Tax Expense||900-999||9000-9999|
The 3-digit coding can accommodate two product lines; if you have more than two, use 4-digit coding which considerably expands the coding universe. Please note that service lines may be substituted for product lines.
Direct Costs may be defined as costs directly associated with the cost to manufacture, warehouse, distribute, deliver, or to consult, for a “line of business”. Direct Costs exclude selling, general and administrative expenses. These are Operating Expenses, or Overhead.
A chart of accounts is made to be adaptable to each business’ unique needs, so go ahead and tailor it! This is a system made to make your life and the running of your business easier, not to add more stress. Keep it simple. That is the best way to keep it focused, and keeping yourself focused means that you allow yourself more time to explore opportunities that will grow your business profitably by having coherent financial statements.