Creating a company usually goes hand in hand with drafting a balance sheet forecast, especially if you’re seeking a banking loan to get you off the ground.
So what are balance sheet forecasts and why are they important? How can entrepreneurs use them in the ongoing management of their business finances?
Follow us as we explore the mechanics of this key document for company creators. 👇
There are some documents that are central to a solid business plan and one that is not to be overlooked is the balance sheet forecast. In a three-statement financial forecast, it sits alongside a cash flow forecast and an income statement projection.
For entrepreneurs creating a new company, these documents will contain the data needed to determine the financial viability of the project.
A balance sheet forecast includes estimates of both assets (the resources at the company’s disposal), sometimes referred to as “active” assets and liabilities (what a company owes in debt, supplier payments, subscriptions, expenses etc.), otherwise known as passive assets.
This financial table provides you with your company’s key figures while also demonstrating its intrinsic value - something that can prove quite useful when securing funding - at a glance.
Although balance sheet forecasts play a crucial step when creating your company, they also have their place when you close your books at the end of the year. It’s essentially a snapshot of your business’ total assets at a given moment.
The balance sheet forecast has several uses.
1. It allows you to determine the overall coherence of your business project before even launching the company. Building out a business plan and a balance sheet forecast gives you the opportunity to identify any possible inconsistencies in your financial projections, like having too little runway. By course-correcting your company creation plan early on, you’re laying a solid foundation from which you can sustainably run your business.
2. It determines the viability of your business venture. Whether you’re just starting out your business, or you’re in the process of scaling up, banks or investors rely on your business plan - and therefore your balance sheet forecast - to see if your project has legs.
3. It’s one of the primary tools you can use to monitor your finances when managing your business. It isn’t much use to build out a balance sheet forecast when preparing your business plan only to lay it to the side once you get things up and running. Instead, have this tool serve you: by progressively reworking your balance sheet forecast (at the close of every financial year, for example), you get a concrete sense of how your forecasts match up to your actual business revenue. This allows you to further fine-tune your projections over time.
As we mentioned before, a balance sheet forecast is like a freeze frame of your company at a given moment. But how do you interpret it? We need to take a closer look at the resources entering and leaving the business, also known as the active and the passive assets, respectively.
The active and the passive make up the two halves of the overall assets a company has. They’re generally displayed side by side on a balance sheet to evaluate the company’s value by clearly outlining where the money comes in (and goes out).
Some useful things to keep in mind before starting your balance sheet forecast:
1. The total of the active and the passive assets have to reconcile (i.e. cancel one another out). If that’s not the case, then it means there’s an entry error.
2. Convention dictates that the entries be sorted by increasing order of liquidity. At the bottom you ought to be able to identify the most available resources short-term.
3. VAT is separated into two categories with passive assets: VAT due and VAT collected.
Active assets: how a company uses its resources
In balance sheets, active assets have positive value. They translate to what a company has in its possession. There are two types of active assets: fixed (like equipment, for example) and current (like stocks, bank balance, etc.).
Active assets in your business’ balance sheet forecast therefore need to have the following distinctions:
- Fixed assets
Fixed assets are assets that your business owns and are considered useful for its day-to-day operation for a period of over 12 months. There are three subtypes of fixed assets out there:
- Tangible assets: computer equipment, vehicles, machines, real estate, etc.,
- Intangible assets: business capital, contracts, patents, software, etc.,
- Financial fixed assets: loans, stock options, financial securities, etc.
- Account receivables and stock
These make up part of the current assets, i.e. they’re in the business’ possession for less than 12 months. In this subcategory you’ll find:
- Account receivables: advance goods and/or services rendered to customers, pending invoices, etc.,
- Stock: raw materials, merchandise, etc.
- Bank accounts and cash flow
These are also considered current assets. Within this subcategory there are:
- Bank accounts and cash: liquid funds that are available on the business’ bank account (also known as liquid assets) that are immediately accessible,
- Transferable securities (in French, les valeurs mobilières de placement or VMP): financial assets that are purchased for quick resale that offer gains, like stocks or bonds.
Passive assets: where your business resources come from
When drawing up a balance sheet, passive assets are counted as having negative economic value. They’re considered outgoing resources because they come from creditors and will eventually need to be reimbursed. You should organize them on the balance sheet by order of the debt’s due date, with the furthest date being at the top of the list. Just as with active assets, there are fixed and current passive assets.
When putting together your balance sheet forecast, you need to distinguish the different types of passive assets in your company’s possession:
- Equity
Meaning the share capital that was deposited by you and your associates when you created your company, as cash or non-cash contributions. This also includes the results of the previous fiscal years and reserves (previous years’ dividends that haven’t been paid out yet).
- Financial debt
These debts come from securing financing for your business (operational needs and investments). These can come from bank loans or financial markets.
- Supplier debt
Depending on the industry, your business might need to buy merchandise in order to operate. Most of the time you can negotiate an extended payment deadline (which can vary in length) with your suppliers. Any outstanding dues that have yet to be paid fall into this subcategory.
- Tax and social charges debt
This encapsulates all the money your company owes to the any social or tax authorities: VAT, corporate property tax (CFE), social charges on employee salaries, corporate tax, etc.
- Banking overdrafts
Some financial institutions allow you to withdraw or spend more money than is currently in your account. In a way, this counts as short-term financing for your business. These entries would sit at the bottom of your list since they need to be reimbursed in a short amount of time.
Good to know: balance sheet forecasts are often too optimistic, which could potentially put you in a tricky position if you’ve overextended your funds. That’s why it’s generally a good idea to make a second balance sheet forecast - one that’s a bit more pessimistic - to balance out your projections.
Making a balance sheet forecast is essential. But perhaps even more important is extracting the right information from it to guide how you manage your business finances.
You can get three key ratios from your forecast:
- The working capital requirement (in France, le besoin en fonds de roulement or BFR): this is the difference between your business’ incoming and outgoing funds. To calculate this, you need to subtract your supplier debt from your stock and accounts receivable.
- Working capital: this corresponds to the amount of resources your business needs to function on a day-to-day basis, e.g. paying suppliers, employees and their social charges. There are many ways to calculate this, namely by subtracting your short-term debt from your current active assets.
- Net treasury: these are liquid funds that can be used on short notice by the company. You’ll get this number by subtracting the working capital requirement from the working capital.
Balance sheet forecasts are often seen as just a necessary part of a business plan. While that may be true, there’s also much more to them than that. They can serve as a powerful tool to monitor the financial health of your company, and give you key figures at a glance. And when updated regularly, they can also help you track how your company is evolving over time, and set the tone for future projections in the years to come.
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