The long-term or strategic plan focuses on Pro Forma Statements of Income
prepared for annual periods three to five years into the future. You may be
asking yourself, “How can I possibly predict what will affect my business
that far into the future?” Granted, it’s hard to imagine all the variables
that will affect your business in the next year, let alone the next three
to five years. The key, however, is control–control of your business’s
future course of expansion through the use of the financial tools explained
in the preceding chapters.
First determine a rate of growth that is desirable and reasonably
attainable. Then employ Pro Formas and Cash Flow Budgets to calculate the
capital required to finance the inventory, plant, equipment, and personnel
needs necessary to attain that growth in sales volume. The business
owner/manager must anticipate capital needs in time to make satisfactory
arrangements for outside funds if internally generated funds from retained
earnings are insufficient.
Growth can be funded in only two ways: with profits or by borrowing. If
expansion outstrips the capital available to support higher levels of
accounts receivable, inventory, fixed assets, and operating expenses, a
business’s development will be slowed or stopped entirely by its failure to
meet debts as they become payable. Such insolvency will result in the
business’s assets being liquidated to meet the demands of the creditors.
The only way to avoid this “outstripping of capital” is by planning to
control growth. Growth must be understood to be controlled. This
understanding requires knowledge of past financial performance and of the
future requirements of the business.
These needs must be forecast in writing–using the Pro Forma Income
Statement in particular–for three to five years in the future. After
projecting reasonable sales volumes and profitability, use the Cash Flow
Budget to determine (on a quarterly basis for the next three to five years)
how these projected sales volumes translate into the flow of cash in and
out of the business during normal operations. Where additional inventory,
equipment, or other physical assets are necessary to support the sales
forecast you must determine whether or not the business will generate
enough profit to sustain the growth forecast.
Often, businesses simply grow too rapidly for internally generated cash to
sufficiently support the growth. If profits are inadequate to carry the
growth forecast, the owner/manager must either make arrangements for
working growth capital to borrowed, or slow growth to allow internal cash
to “catch up” and keep pace with the expansion. Because arranging financing
and obtaining additional equity capital takes time, this need must be
anticipated well in advance to avoid business interruption.
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