doing+financial+projections

8/3/2019 Doing+Financial+Projections

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Doing Financial Projections

What You Need

Clear ideas about the purpose and audience for your projections.

Understanding of the key drivers of financial results for the business.

Some knowledge of accounting & financial statement analysis:

Skill in using spreadsheet software -- such as Excel

Creativity, attention to detail, and good judgment.

A lot of time.

Some Warnings

O Most people starting new businesses are much too optimistic about the

future financial results of their business. Their energy and enthusiasm cloud

their judgment. They underestimate the time it takes to get things done,and how much things will cost. Over-optimistic expectations often lead to

underestimating how much money they need to finance initial losses.

O Once a business really gets going (in Year 2 or 3), doubling the size of the

business each year is about the maximum a good CEO really can

achieve. Even growth that fast (double every year) is extremely difficult to

manage. Most successful businesses do not grow faster than 100% per year,

nor do they need to.

Getting Started

O Financial projections should include the following kinds of final “output”:

Income Statements

Balance Sheets

Sources and Uses of Cash Statements (Cash Flow Statements)

O The invention of spreadsheet software has made financial statement models

easy to create and even easier to play with. Follow this link for a simple

projection model template.

O In practice, though, you will likely have to build your own income statement

model. The key drivers often are unique to the particular situation. You canuse the template model, however, to help calculate Balance Sheets, Sources

and Uses of Cash, plus do some Statement Analysis – just by inputting your

custom income statement, and making some simple assumptions.

O It is usually best to do monthly projections for the first two years, then

quarterly after that. Add the periods up, and present the annual summaries to

potential financing sources.



Income Statements:

Monthly Projections Month 1 Month 2 Month 3 Month 4 Month 5 Month 6

Revenues

Cost of Goods Sold

Gross Profit

Sales & Marketing Expense

General & Admin Expense

Operating Income

Depreciation Expense

Interest Expense

Taxes

Net Income (Loss)

Key points:

o Revenues & expenses are independent of cash payments. Recognize them

when a transaction happens, not when cash comes in or goes out (maybe

much later).

o Cost of Goods Sold are the direct costs in producing your service –

materials, installation costs, customer service, maintenance, etc.

o Revenue – Costs of Goods Sold = Gross Profit

o General & Administrative are support costs, like finance, HR, IT, top

management

o Gross Profit – Sales & Marketing – General & Admin = Operating

Income, also known as Operating Cash Flow

o Following these conventions allows for comparison of your projections with

other similar business’ results.

o Depreciation expense spreads out the cost of property, plant and equipment

– over its useful life.

o R&D costs?

Making Assumptions

O Start with the monthly numbers for Year 1. For any business raising

money, making your numbers in your first year of projections is really

important. If you, as management, miss these numbers you may:

1. Run out of money too soon,



2. Get fired and/or

3. Not be able to raise more money.

If 1) or 3) happens, you will probably go bust.

O Consider the macroeconomic situation when building your projections:

Overall economic growth rate of GDP during projection period

Economic recession(s) - timing, duration

Rate of inflation

Level of interest rates

O Tackle the Income Statement first. Project your number of customers

based on the key revenue driver. Project monthly sales – for twelve

months....

Monthly Projections Month 1 Month 2 Month 3 Month 4 Month 5 Month 6Customers 0 0 11 20 45 77

Revenues 0 0 3 6 13 26

o Next, think through the 12 months of costs associated with these sales:

Cost of Goods Sold – materials, installation costs, inspection,

maintenance, regulatory costs, billing system

Selling costs – sales people, advertising, travel, web site

Administrative Costs – Management, office space, supplies, utilities,

insurance

o Points to remember:

You may not have any revenues for the first few months – as you build the

system, sign up customers, etc. – but you will still have expenses. Model

this.

Don’t forget to figure in one-time start-up costs (incorporate, write a

business plan, licensing, permitting fees, getting regulatory approval, etc.)

If you have more than one product or service, model them separately,

then total them. Be sure to model total headcount and include cost of benefits (20-25% of

salary, typically). You should allocate personnel costs into Cost of Goods

Sold, Marketing & Sales and General & Administrative, based on function.

Rental space can be: (Headcount x Avg. Sq. Ft. Per Person x $ Cost Per

Sq. Ft.)



o Your projections might look something like this:

Monthly Projections Month 1 Month 2 Month 3 Month 4 Month 5 Month 6

Revenues 0 0 3 6 13 26

Cost of Goods Sold 0 0 1 3 6 13

Gross Profit 0 0 2 3 7 13

Sales & Marketing Expense 4 5 7 9 11 12

General & Admin Expense 4 7 9 11 13 16

Operating Income -8 -12 -14 -17 -17 -15

Depreciation Expense 1 1 1 1 1 1

Interest Expense 1 1 1 1 2 2

Taxes 0 0 0 0 0 0

Net Income (Loss) -10 -14 -16 -19 -20 -18

o Then, add up your 12 months of projections.

Annual Projections Year 1 Year 2 Year 3 Year 4 Year 5

Sales 150

Cost of Goods Sold 77

Gross Profit 61

Sales & Marketing 102

General & Admin 140

Operating Income (181)

Operating income is an estimate of how much money will need to raise – on top

of the cost of any property and equipment you must buy. Does this number

make sense? Are you losing enough money (have you remembered all your

costs)? Are you losing more money than you can raise?

o Building out future years, two approaches:

Continue estimating growth of customers from month to month, quarter to

quarter. Or

Pick a break-even year – the year your operating income exceeds costsand you don’t need outside financing to survive. Take this approach if

there is a year by which you must break even. If, say, banks or investors

require that you reach break even by year three, figure out: What would

this take – in sales?

Annual Projections Year 1 Year 2 Year 3 Year 4 Year 5



Sales 150 800

Cost of Goods Sold 77 350

Gross Profit 73 450

Sales & Marketing 102 195

General & Admin 140 210

Operating Income (169) 45

Figuring out what your break-even year looks like, and when it will occur,

probably is the single most important part of making a good set of projections .

With either approach, remember to increase costs with sales. A common

mistake, for example, is to forget to add personnel as the business grows.

And, as personnel increases, so may rent, supplies, utilities, insurance, etc.

O Compare your Income Statement numbers to similar companies to figureout if your break-even, and projections in general, are reasonable, Calculate

profit and cost margins by dividing all categories by sales:

Annual Projections Year 3 As a % of

Sales

Sales 800 100%

Cost of Goods Sold 350 44%

Gross Profit 450 56%

Sales & Marketing 195 24%

General & Admin 210 26%

Operating Income 45 6%

Look especially at the gross and operating profit margins, and at the

categories of costs. At this stage of your business, your profit margins

should not be higher than similar operations – nor your cost margins

lower. Does your business differ in key respects? If so, can you explain

why? If not, you are probably being to optimistic.

If your projections look reasonable, smooth in the year(s) between Year One

and your projected break even year. Project out past your break-even year.

Do not grow faster than people will believe. Consider a 50% annual growth

rate in revenues, as a first cut. Remember to increase costs as you grow.

O Next, Some Assets



Transfer the Income Statement totals to the model template, or construct your

own Balance Sheet and Sources & Uses model. Typical key items:

Category Numbers Expressed As: Examples:

Cash in Banks % of Sales 3% of Sales

Acounts Receivable % of Sales Sales x 1/6 (60 Day Turnover)

Inventory % of Cost of Goods Sold Cost of Goods Sold x 10%

Fixed Assets Formula 1 Yr. = Last Yr. + CapEx - Deprec.

Other Assets % Sales 2 1% of Sales

Accounts Payable % of Costs of Goods Sold Cost of Goods Sold x 1/6

Accrued Expenses % of S&M + G&A Expense S&M + G&A Expense x 1/12

Other reasonable links or relationships are possible. You want the balance

sheet to grow in line with the growth of the business . Balance sheetsuse cash, too.

One also needs to project the Capital Expenditures (Property, Plant,

Equipment purchases) and some Depreciation Expense. Include

replacement costs for failed as well as worn out equipment. Set Depreciation

Expense as a percentage of Net Fixed Assets as of the end of the previous

year. The template assumes an average rate of 10 years.

The template model will use this information to complete a “Sources and

Uses of Cash” Statement and generate a large number in the “Necessary to

Balance” line of the Balance Sheet.

Necessary to Balance is not an accounting category. Instead, for each

Year, “Necessary to Balance” represents the amount of financing that

you need. You must assume that you will sell equity or borrow debt, or some

combination -- equal to the amount of “Necessary to Balance.” For example,

in the template attached, the business needs to raise $900,000 to finance the

first year of operations.

If Necessary to Balance shows extra cash (versus a need for financing), you

can pay this out in dividends to your investors – or add it to your cash account

cell. The second is probably more realistic in the case of a new business.

1 Net Fixed Assets from last year, plus Capital Expenditures minus Depreciation, this year.2 Other Assets might include prepaid insurance or rent, intangible assets, etc.

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