“Businesses do not plan to fail, they fail to plan” (Part 5)

By Peter Cox November 01, 2014 Industry news

This fifth and final article brings it all together and shows how you use the budget to generate extra cash flow – the life blood of any business.

Now that we have a yearly purchase target of $1,584,000 (refer last issue) we can now set a monthly purchase budget.

 

WORKING OUT PURCHASING ACTIVITY

The first thing one needs to do is to work out the purchase activity based on historical data.

For example say 10% of purchases (goods ordered) occur in April and 8% is ordered in May. We can use these months as a case study to set an open to buy budget. (Of course at the start of the financial year the purchase budget would be set for 12 months.)

Therefore the sales budget and purchase budget for April would look as follows:

  • Sales target (based on 10% see above) $260,000
  • Cost of sales target (@ 100% – 30% GP% target) $182,000
  • Stock difference (actual opening stock – target closing stock ÷ 12):
  • $600,000 – $364,000 = $236,000 ÷ 12 = $19,666

The stock difference is the fact that we have to reduce the stockholding by $236,000 to achieve a closing stock target of $364,000.

Therefore the target purchases for April is cost of stock going out the door at cost ($182,000) less the stock difference per month ($19,666) which equals $162,334.

The May purchase target is calculated as follows:

  • Sales target (based on 8% see above) $208,000
  • Cost of sales target (@ 100% – 30% GP% target) $145,600
  • Stock Difference (actual opening stock – target closing stock ÷ 12):
  • $600,000 - $364,000 = $236,000 ÷ 12 = $19,666

The stock difference is the fact that we have to reduce the stockholding by $236,000 over the course of the 12 month to achieve a closing stock target of $364,000.

Therefore the target purchases for May is cost of stock going out the door at cost ($145,600) less the stock difference per month ($19,666) which equals $125,934.

 

BRINGING THE BUDGET TO LIFE

So now at the start of the financial year, we have the first two months’ purchase targets – this is a very valuable number to keep in mind as you start purchasing.

Getting to the end of the first month (April), we can now bring the budget to life and use it as an effective financial management tool.

For example, the actual sales for the month were $250,000 and the actual orders placed $220,000 at cost.

Then how do we use these two pieces of financial information to improve cash flow?

Easy – we do what I call “The 1 Minute Report” (the following is for April):

  • Budgeted sales $260,000
  • Actual sales $250,000
  • Difference $10,000
  • @ Cost of sales target (70%, calculated as 100% minus Gross Profit margin target of 30%) $7,000

What this last number shows is that we have $7,000 more stock at cost in the store because we have not reached our sales target (remember, stock is always recorded at cost).

The second part of “The 1 Minute Report” (also for April) shows how we did purchasing against the purchase target set of $162,334.

Actual orders for the month of April totalled $172,334 so we over-purchased by $10,000 at cost.

And, because we missed sales at cost by $7,000 and over-purchased by $10,000, we have $17,000 more stock on the shelves than we expected.

 

MANAGE WHAT YOU BUY AND WHEN

So, it is the 1st of May – what do we do? Well most readers would not know that they are $17,000 in the hole. But, if you have this information, a simple way to get back on track is to manage the one thing you can manage in your store, what you buy, when you buy and how much you buy!

The solution is on the 1st of May to take the targeted purchases for May $125,934 less $17,000 and revise our purchase budget for the next 30 days to $108,934.

That is how a budget improves your cashflow… (By the way a simple to open to buy budget template is available on my website.)

And remember – if you don’t budget you cannot measure!

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Peter Cox is a senior consultant for Macquarie Advisory Partnership based in Sydney. He has over a decade of experience training and consulting in the retail hardware industry. He conducts key-note addresses, and management and sales workshops, which are aimed at improving profitability and liquidity in one of Australasia’s most competitive retail environments. Phone 0061 438 712 200 or visit www.petermcox.com.au

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