Cash Flow Planning: Expenditure and Dealing with Deficits

Having looked at income, we now turn to expenditure. Here, there is tends to be more certainty, especially with regard to fixed costs (the costs we incur whether or not we have any work). For example, we know what rent or rates we are going to pay. We know what our utility bills are going to be. We know how much we’re paying for our phone. All of these tend to be regular payments that can be entered into the monthly columns.

Of course, if we are working from home and charging a proportion of the household costs to the business, we can choose to do this annually rather than monthly — or even to waive the charge altogether until the business is established. But if we do this, we have to remember we are giving ourselves a false picture when assessing how successful we have been.

The variable costs (those associated with a particular piece of work) are a little more difficult but for each income figure we enter, we should be able to estimate the related costs. These need to be entered at the time they are incurred (or at least paid for) which will often be before the income arrives.

To finish the statement, we need an opening balance for the beginning of the year and a carried forward figure at the end of each period (month). Remember that we do not start each month afresh. If we have a deficit at the end of one month, that is the opening balance at start of the next month.

OK, I think it is now time for a picture, or at least a chart. Let’s have a look at an example (and remember, the only purpose of these numbers is to illustrate the points, so we shouldn’t get hung up on whether they make sense individually or not).

Example 1 (click on chart to enlarge)

In this example, we have the four different income streams: six articles paid monthly between August and January; Amazon sales which come in bimonthly from October onwards; direct sales to the public which vary depending on events per month; and fees for running a writing course every two months. We see that the income varies between £20 and £370 per month.

For expenditure, we have a regular monthly contract for phone and internet; we have mileage costs and printing costs associated with the course, the former occurring in the same month and the latter a month earlier in each case; and we have a regular ‘drawing’ to cover our personal expenses. Whether this is a salary that we are paid as an employee of a limited company, or whether it is a drawing we make as a sole trader is irrelevant here. This is the money we need to live (and again - these are examples only, not real figures). We see that our total expenditure is fairly fixed at between £550 and £580 per month.

We have started the year with an opening balance (i.e. funding) of £4000. At the end of the year, our closing balance is zero. This means that we are projecting a loss of £4000 during the year. But remember, we are talking here about cash flow. What this tells us is that if we start with £4000, we will have enough cash to last the year but that we will need to sort out more funding (or raise income, or reduce expenditure) at the beginning of the next financial year.

Let’s suppose we don’t have a £4000 pot to start the year off. What happens if we only have £3000?

Example 2 (click on chart to enlarge)

 

In this case, our cash flow goes negative in December and we need to find more funding at that point but we have demonstrated that we can start with a smaller pot and keep the business running.

If we have our cash flow set up in a spread sheet, as I’ve shown here, it’s very easy to play the ‘what if’ game by changing some of the figures and seeing what the effect is on the bottom line. For example, try pushing up the income or reducing the expenditure to see what happens. This is also useful for crystallising exactly what we need to do to make the business a success.

As always, note that I am not an accountant or a lawyer, just a long-term business owner, talking about my own experience. If you are unsure about anything, always take advice from an appropriate professional.

Accounting Statements: Profit and Loss

As I said in the introduction to accounting statements, the profit and loss (P&L) statement provides an historical picture of how our business has performed over a given time period. It is calculated annually, at the end of a financial year, but may also be calculated on a monthly basis if we wish to have more detailed knowledge of how we are doing.

The financial year is not necessarily the same as the calendar year (January to December), although in some countries, it is exactly that. In UK, a limited company may use any year end date they wish, although 31st March is the most common one since it co-incides with the tax year. Whichever year end we pick, we still have to fit in with the HMRC timetable for PAYE, National Insurance and tax returns, all of which operate on the year April to March. If we are self-employed, our year end will be 5th April, in line with the individual tax year which starts on 6th April each year.

If we do want monthly statements, then we are probably at the point where a computerised system is appropriate. It is not a necessary part of running a business to know how to construct financial statements, but it is essential that we know how to interpret these statements and understand what they are telling us. That’s the aspect from which I’m approaching these articles.

In previous articles, we’ve already looked at the P&L equation: I (total income) - E (total expenditure) = profit (if I is bigger than E) or loss (if E is bigger than I). This time, we’re going to look at this in a little more detail and cover five lines on the statement instead of the three quoted above.

Total Income

As the term suggests, this is the total amount of money that has been invoiced in the year. Note the use of the word ‘invoiced’. It’s more than likely that not all the money has been received yet, especially for any invoices raised in the last month, but everything earned in a financial year should be accounted for. Total income is also sometimes called Turnover, Revenue or Sales. It is a measure of the total amount of business we have done in the year.

Direct Expenses

This is the expenditure incurred directly in doing the business measured above. It is the cost of printing our book (but we can only include the cost of copies that have actually been sold); the postage for distribution of specific copies of our book; the travel costs incurred in presenting a training course or a paid-for appearance. We should ask ourselves the question: would those costs have been incurred if that piece of work had not been carried out. If the answer is ‘no’, then those are direct expenses. They are also sometimes called Variable Costs since they vary with the level of business or the Cost of Goods Sold.

Gross Profit

When direct expenses are deducted from total income, the resulting figure is called gross profit. In traditional businesses like manufacturing, it is a measure of how efficiently labour and materials are utilised. In our writing business, we don’t include labour costs unless we sub-contract out a specific piece of work, so it’s a measure of how efficiently we use the materials and other resources that go into generation of our income. There is no right answer to the question: what is a good percentage gross profit; it varies with circumstances and the type of business. However, I would suggest it should always be a positive number. In other words, we should always generate a gross profit, no matter how small, in our business. Otherwise, we might as well set fire to our money or (preferably) give it away. There may be times when we choose to sell our goods or services at cost (for example if we speak at an event for expenses only ) or even make a loss (for example by donating copies of our books for a raffle) but that’s not a sustainable business model in the long-term.

Indirect Expenses

There are all sorts of other expenses we incur running our business but which cannot be associated directly with any one income stream. For example, the cost of running our office, whether it is part of a serviced building or our back bedroom; marketing costs (business cards, book marks, adverts); Internet and phone charges; and most important of all, what we pay ourselves. We should ask ourselves the question: would those costs have been incurred even if no work had been carried out. If the answer to this question is ‘yes’, then we are looking at an indirect cost. They are sometimes called Fixed Costs or Overheads since they are independent of the level of business.

Net Profit

When the indirect expenses are subtracted from the gross profit, the resulting figure is called net profit.  Mathematically, the same figure is obtained by subtracting total costs (direct and indirect) from total income. So net profit, which is sometimes referred to as bottom line, is a measure of the overall success of the business in financial terms (I fully accept there are other ways of measuring success).  In formal company accounts, net profit is further sub-divided into net profit before tax and net profit after tax. I’m not going to go into tax, as it’s a highly complex area, apart from making the point that while not all income will be taxable, not all expenses will be tax-deductible. This is an area where I believe it pays to take expert advice.

Unlike gross profit, it is very likely that in the early years of a business, net profit will actually be a negative figure (more correctly called net loss) and so long as we have funding available to cover the short-fall, that’s perfectly acceptable. And that’s where cash-flow comes in. We’ll talk about that next time.

As always, note that I am not an accountant or a lawyer, just a long-term business owner, talking about my own experience. If you are unsure about anything, always take advice from an appropriate professional.

Keeping Financial Records: Expenditure

Last week, we looked at how to keep records of income; now we’re going to look at recording our expenditure. Then we’ve got the two sides of the equation: we need to know what money came in (our income) and what money went out (our expenditure). The difference between the two is our profit or loss. If our income is greater than our expenditure, we have made a profit. However, if our expenditure is greater than our income, we have made a loss.

So let’s think about how our expenditure is recorded.

As writers, our expenditure can go in lots of different directions. Here are a few I thought of and there will be others you can list too:

·       The cost of printing our books, if we publish independently; I’m not just thinking about the costs of the physical books, but the cover design, services of an editor or proofreader; the purchase of a block of ISBN numbers etc.;

·       The purchase of books or magazines relating to our business and bought for the purposes of research;

·       Competition entry fees;

·       Train fares or mileage for travelling to courses or workshops, whether as the teacher or as the student;

·       The money we pay ourselves (whether that’s a PAYE-managed salary within a limited company or personal drawings if we are self-employed);

·       Bank charges and accounting/book-keeping fees;

·       The costs of running an office (and as business people, we do have an office, whether it’s part of a serviced building; the back bedroom; or a corner of the kitchen table): paper for the printer; postage for sending out copies of our books, competition entries or submissions to agents; charges for our website; fee for renewing our antivirus software etc.;

·      Capital purchases such as our laptop, printer, desk and filing cabinet.

Many of these payments will be made by cheque, internet payment or credit card and will be accompanied by an invoice or a receipt from the seller, so there is an immediate paper trail. Others will tend to be cash payments, especially if it’s for a small amount. All businesses should be able to provide a receipt on request; we need to get into the habit of always asking for one, even when it’s just a short taxi ride from the station to a conference location, or a quick sandwich grabbed during the lunch break on a course.

We looked at invoices and receipts in last week’s article. The only difference between income and expenditure is that in the first, we issue the documents, whereas in the second, the documents are issued to us. The documents themselves will be the same. And remember they will range from a formal invoice from a printer to a scrappy till receipt from a coffee bar. So once again, when it comes to sorting out our total expenditure for the business, we will be faced with a complete mix of different types of record.

As with income, all the bits of paper need to be collated in order to calculate total expenditure. It is also useful at this stage to group expenses together under different headings: direct expenses; wages; office expenses; professional fees etc. Our options were spelled out last time, but bear repeating: we can give the job to the accountant to do for us at the end of the year, which is effective but costly. We can give it to a book-keeper, either monthly or at the end of the year; again, this is effective and less costly than an accountant, but still means paying out money. Or we can do it ourselves, either monthly or at the end of the year. This option may be effective, depending on our abilities with numbers, and is the least costly in terms of actual expenditure, but it is costly in terms of our time.

Once again, I’m going to assume we decide to do it ourselves on a monthly basis, while the task is smaller and our memory is fresher. We will be listing all items of expenditure in one place. Let’s look at what that might look like for our three types of financial system:

·       Paper-based: a simple cash book with appropriate layout can be bought from any stationers. An A4 hard backed notebook will do the job just as well, but the columns will have to be drawn in. Start each month on a new page. List the expense items in date order (which helps when reconciling the bank statement) and put a total at the bottom. If you are grouping expenses as this stage, have a separate column for each category of expense and total each column separately as well In theory, you can use the same page as the income record, but it’s probably simpler and neater to use a different book, or a different section of the same book.

·       Spreadsheet: Use one spreadsheet for all the accounts, but use a separate worksheet for each type of transaction (income, expenditure etc). List the expenses in date order and use the software to calculate a total at the bottom. As above, use separate columns for different categories of expense.

·       Commercial software: Each transaction will need to be converted to an expense payment to enter it into the system. If the supplier has issued an invoice, this needs to be entered and then the payment is accounted against it. If there are a lot of small cash transactions, it can be time-consuming and unnecessary to enter each one separately. My solution is to pull these all together on a monthly basis as a single invoice, itemised line by line within the document. The software has the provision for allocating a category to each expense and the facility for producing reports on each category as required.

Using any of the above systems on a monthly basis means that at the end of the year, there will be just twelve figures per category of expenditure to collate in order to identify total expenditure.

For non-receipted expenses, such as mileage, it is important to keep a written record. Every year I promise myself I will put a book in the glove-compartment and record every journey at the time it occurs; and every year the system collaspes quickly or never gets started. Luckily, I keep a detailed appointment diary and have a reasonably good memory. At the end of each year, I list all my journeys and calcualte the mileage using Bing Maps, but it takes me ages. Doing it on a monthly basis (or better still, journey by journey) would be a much more effective approach.

Closing notes: This article is about recording expenditure. Some of that expenditure will be tax-deductable, some may not be. No distinction is made here between the two. At this point, we are only looking at what records we need to keep. What we do with them later is a whole different subject.

As always, note that I am not an accountant or a lawyer, just a long-term business owner, talking about my own experience. If you are unsure about anything, always take advice from an appropriate professional.

 

Tax Matters

[This week’s post is specific to the UK; the principles apply in most countries but the specifics vary, so non-Brits need to review the requirements with your national authorities]

In my experience, no-one likes paying taxes. (If there’s anyone out there who disagrees with this, leave a comment and we’ll debate the question.) However, it’s the law of the land that if you earn money, you have to pay tax on it. I was once approached by an irate writer who said “but it’s only a hobby”. I’m afraid HMRC doesn’t recognise the distinction.  But in our case, we’re writing as a business, not a hobby, so there’s no question about it: we need to understand the tax systems as they apply to us.

This is just an overview of the topic. For detailed information, consult an accountant or go direct to the relevant authority. I find the HMRC website very useful; better still, ring one of the specific helplines.

There are four main types of tax to think about: income tax, corporation tax, value-added tax (VAT) and national insurance.

Income Tax

·       This is paid on our income, after deduction of expenses and allowances;

·       This tax applies to everyone. Employees (including Directors) of limited companies pay via the Pay as You Earn (PAYE) system, in monthly amounts. Self-employed people pay via the self-assessment system and usually make two payments per year;

·       There are different rates of tax, depending on income.

Corporation Tax

·       This is the tax on company profit after all expenses, including salaries, pension contributions etc have been made;

·       This tax only applies to limited companies; it is paid annually in retrospect following completion of the annual tax return;

·       There are different rates of tax, depending on the level of profit, but no tax-free allowance.

Value-added Tax (VAT)

·       If a company or a self-employed individual is registered for VAT, they must charge it on all sales made;

·       VAT registration is mandatory above a certain income level (currently £77,000 in UK); and while that is not likely to worry many of us, especially in the start up phase of our business, it is important to know that VAT registration is optional at any level of income;

·       VAT is charged at different rates for different goods and services (20%, 5%, and 0%). Hard copy books are zero-rated (although e-books are currently charged at the full 20%);

·       If a company or an individual is registered, VAT must be charged on invoices;

·       But [and this is probably the most important point in this whole article] if a company or an individual is registered, VAT on all payments can be claimed back from HMRC;

·       Let me say that once again: if we are registered for VAT and selling books, our sales incur a zero rate — so no downside for our customers — but all VAT that we pay on stationery, printer cartridges, office furniture etc can be claimed back;

·       If we are selling ebooks via Amazon, they charge VAT and handle it for us;

·       There are special schemes to make administration of VAT simpler, depending on the size of the business (measured by gross income level).

National Insurance

·       This is the tax that builds our entitlement to certain state benefits including state pension;

·       Class 1 contributions are paid by both employed earners and their employers within the PAYE system; this is a big expense and is possibly the biggest disadvantage of a limited company;

·       Class 2 (an initial flat-rate) and Class 4 (additional rate, based on level of profit)   contributions are paid by the self-employed;

·       There are exemptions available for anyone on low earnings, but these need to be applied for, not assumed.

[As always, note that I am not an accountant or a lawyer, just a long-term business owner, talking about my own experience. If you are unsure about anything, always take advice from an appropriate professional.] 

Business Structures

One of the questions to be resolved when setting up any small business is which structure is the most appropriate? There are a number of options including: self-employment; partnerships; limited liability partnerships; and limited companies. I’m going to look at the first and the last of these, as the two options that most independent writers would consider when putting their writing on a business footing.

 

Key points of self-employment (also called sole trading) in the UK are as follows:

• There is no financial separation between the individual and business

• There are no formal positions in the company

• There is a need for registration with the tax authorities within 3 months of starting trading
• Tax on earnings is paid through Self-assessment and National Insurance
• Personal drawings (salary) are taken after tax has been deducted

Key points for a limited company in the UK are as follows:

• The company is a separate business entity with finances separated from the individual
• The company needs one or more directors plus a company secretary (although these can be the same person)
• The company must be registered at Companies House (and annual returns must be made) plus tax authorities
• Individuals are employees and are paid salaries from pre-tax profits (including Directors)
• Individuals’ income tax is paid through the PAYE system
• Dividends are paid after corporation tax deducted.

The advantages of self-employment include it being a cheaper option with less administration and benefits such as the availability of free banking. The disadvantages include the fact that all the assets (personal and business) are at risk and it may be more difficult to raise finances if required.

The advantages of a limited company include separation (and therefore some protection) of personal assets plus the possibility of an enhanced image with potential clients. The disadvantages include increased levels of administration and higher costs.

The choice that any writer makes on business structure will depend on their individual circumstances. I have run a limited company for twenty years, associated with other activities, and have simply added my writing to the mix. My systems are established and simple to operate; for me, it was the obvious choice. That would not necessarily be the obvious route for a new business.

Note: I write these articles as an experienced small business owner, hoping to clarify issues for writers starting down the journey towards running their own business and to help identify questions that need to be asked. I am neither a lawyer, nor an accountant. All the issues covered above can be complex (especially those relating to tax matters). ALWAYS take professional advice before deciding which route to take.

Giving It Away: Should We Write For Free?

[By pure co-incidence, fellow-writer Patsy Collins has also been blogging about the same topic this week, although she is talking about the provision of free books for Kindle. Read her article here.]

If there is one subject that seems to cause more conflict among writers than any other, it's the question of giving our writing away for free. I've seen some quite vicious arguments break out on some of the forums (and as writers, we all know how to use our words as weapons, don’t we?) each time the question is raised. At the one extreme, there are some people who believe that we should never write anything for nothing; we may be craftspeople, but we still have to pay the bills; publishers and printers all get paid, so why should writers be any different? At the other extreme, there is a view that the words are more important than the money and that we should use any and all opportunities to get our writing published — even if we have to pay for the privilege rather than the other way around.

Personally, I sit somewhere in the middle — and as always, I am looking at it from the point of view of a business-woman as well as a writer. We should never be ashamed to expect payment for our writing. It may take thirty minutes, an hour or a day to write something; but it has taken twenty, thirty or more years to learn how to write that something.

However, very few of us only do one type of writing all the time. We tend to write in different ways for different purposes. For example, here are some of the ways in which we might write. Most, but not all, further our businesses, although not all of them do so with direct financial returns. The key thing is to understand which is which and to decide whether each individual piece of writing is worth it or not.   

·       Articles for newspapers and journals are generally written on commission. Hence we have a formal or informal contract and an expectation of payment on delivery or on publication. (Don’t forget to send an invoice with the piece.)

·       Non-fiction books and fiction books by established authors are generally written on commission. We would expect a formal contract and, if we are lucky, an advance paid at time of contract and/or delivery of the manuscript. Further payment will depend on sales of the book, although we will not be asked to pay back the advance if the book bombs.

·       Fiction books, for first-timers, are generally written on spec. We are continually being told that this is not the way to a fortune, unless we are very good and very lucky. Hence this would come under the heading of potential financial returns.

·       To succeed as a writer these days, we all need to develop our ‘platform’. Increasingly this implies engagement with social media plus blogging.  No-one is going to pay me for writing this column (and nor would I expect them to) but if it brings my name to the attention of more potential readers, it is beneficial for my business.

·       Like musicians, writers get better with practice. When I first started writing creatively, I spent some time working on articles for one of the dreaded content sites. I never expected to make much money from those articles (and my expectations were not exceeded) but working out how I could improve my writing and watching my ratings to see what worked and what didn’t was a valuable exercise.

·       All businesses need planning and development. We covered planning in an earlier article. Development might include writing proposals for articles or books. Not all of those pitches will be successful, but the more we do, the ‘luckier’ we become. We would never expect to get paid for these proposals (I’m always suspicious of anyone who offers me a ‘free quotation’ — what else should it be but free?) but they are an important part of growing our business.

·       Writers get all sorts of requests to provide their work for free. And we always have the option of saying no. But sometimes we might want to say yes. I write for and publish Chudleigh Phoenix, a small local community magazine. It has no funding, so my co-editor and I don’t get paid. But that’s our choice — and I make sure it doesn’t eat into too much of the time that I need to devote to my business. (I also make sure that the readers of the magazine know about my books and short stories as well, so even my ‘donated’ writing can benefit the business in some way.)      

Thinking About Finances

One phrase that is often quoted by experienced business people is: turnover is vanity; profit is sanity. The long-term objective of any small business is to be successful, otherwise why do it? In the context of this article, I’m going to define success as profitability.  (I know that’s not by any means the only measure of success, but it’s the one I’m dealing with today.)

So, in all businesses, and writing is no different to other businesses, there is one important equation:  income minus costs equals profit. 

The financial advice most appropriate for us as small business owners will often depend on the stage we have reached on the life-cycle of our business. If we are just starting out then our financial priorities and expectations will be different from when we have an established or mature business. 

Today we’ll look at the start-up situation. Starting out is a difficult period. 

·       We have to identify an aspect of our writing that is saleable and which we can deliver.  We may have to experiment or do some development before we get it right.

·       We have to identify our potential customers and get the message out to them that we are around.

·       We need systems in place to make sure we get paid for our writing.

These activities may take some time to get through and need to be completed before we can expect any income.  Therefore we need to think about interim funding options. 

·       Do we have savings or investments we can rely on? 

·       Do we have other members of the family who can help? 

·       Are there any grants or other types of financial support available?

·       Do we need to take out a bank loan? 

The bank loan option should be the one of last resort.  It’s a mistake to take on an additional financial commitment, such as an interest payment, before we know whether our business will succeed or not.

At this stage, our own wage is the last thing on the list.  Although, if we have any staff associated with this business, we have to make sure their wages are paid — even if ours aren’t. (This would include the support team like child-minders or cleaners that we use to clear our own time for writing.)

Despite my opening comments about profitability, at this early stage, just being able to pay the bills and keep the business open can be considered a measure of success.  [Unless we are very lucky this is certainly not the time to be thinking about company cars, health insurance or membership of the local golf club.]