Financial Projections: How to do them the right way

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Financial Projections How to do them the right
way

• Entrepreneurship
• Dr. Jeff Shay

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Financial challenge

• Accounting classes teach you how to analyze
  already existing financial statements
• Finance classes teach you how to develop pro
  forma statements but usually provide you with the
  numbers
• Entrepreneurship classes require you to develop
  the numbers

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Financials for the business plan

• Assumptions page
• Sources and Uses of Funds
• Sales forecast
• Income statement
• Additional
• Can modify the income statement to illustrate
  Cash Flow
• Balance Sheets

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Getting started with the end in mind

• Potential investors and lenders want financial
  statements that
• Are based on logical reasoning and realize that
  there are limitations for start-up businesses
  because there is no historical basis for
  projections
• Can be easily modified
• Are well organized and easy to navigate around

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Responding to investor and lender needs

• Use separate sheets for each set of financial
  statements (i.e., assumptions, income statement
  year 1, etc.)
• Make assumptions page as elaborate as possible

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Step 1 Develop your assumptions page

• Assumptions are the foundation for your financial
  calculations
• You should make the assumptions page as elaborate
  as possible so that you can change one number and
  have it affect all of the other financials
• Be prepared to add to assumptions page frequently
• What should you include
• Selling price, cost of goods sold , rent,
  equipment costs, etc.

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Step 2 Start a Sources and Uses of Funds
Statement

• Brainstorm with your group and develop a list of
  the sources and uses of funds for your new
  business venture
• Sources All possible sources of money and the
  amount that you believe the source would provide
• Uses All expenditures that will be necessary to
  get the business started (i.e., inventory,
  equipment, rent, etc.)

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Step 3 Develop a Sales Forecast

• Determine what you can expect to sell during
  specific periods of time
• Breakdown to day of week, time, month, etc.
• Examples car wash and restaurant
• Also include the following
• Start-up factor
• Seasonality factor
• Worst, Likely, and Best Case Scenarios

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Consider specific scenarios

• Worst Case Most Likely Best Case
• 1.
• 2.
• 3.
• 4.
• 5.
• Total

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Whats wrong?
You have been asked to look at the following
sales forecast for company X. The sales are
reported for each of the first twelve months of
operations. Is there anything wrong with this?
Sales Forecast Year 1 (000)
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Start-up and Seasonality Factors
Sales Forecast Year 1 (000)
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Step 4 Develop Income Statements

• Use the sales figures that you have from your
  Sales Forecast
• Develop a list of relevant expenses for your
  specific business
• May want to examine financial statements for
  similar companies
• Consider calculating expenses as a percent of
  sales
• Develop the Income Statement for Year 1 by month
• Income Statements for Year 2-3 or 5 by year

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Income Statement

• Total Sales
• minus
• Total Expenses
• equals
• Profit (Loss)

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Short Form PL

• Total Sales
• Less Cost of Goods Sold
• Gross Margin
• Operating expenses
• salaries
• space costs (rent, utilities)
• advertising/PR
• Other expenses
• Total Expenses
• Net Profit (Loss) pre-tax

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Expense Projections

• Salaries, FICA, benefits
• Rent Utilities
• Legal Accounting
• Insurance
• Postage, Phone etc.
• Advertising/Promotion
• Travel and Entertainment
• Debt service
• Office expense
• Miscellaneous
• Taxes

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Step 5 Develop Cash Flow Statements

• Cash flow is the most important financial
  statement for small businesses
• Actually quite simple to develop
• Use all the accounts found on your income
  statement but
• Take out any non-cash items such as depreciation
• Add in any capital expenditures such as buying
  new equipment at the business start-up and for
  growth
• Add in capital received from financing

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Cash Flow Statements

• Start off with Year 0 to account for the
  financing you receive and the non-operating
  expenditures that you make to get the business
  started
• Use the cash flow to determine how much
  additional capital that you need for the business
• Your cash balance should never go below 0
• Not required to be extremely elaborate at this
  time but realize that in the future you would
  need to account for A/R and A/P cycles and other
  critical aspects of a cash flow

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Managing Cash

• Cash comes in
• net from operations
• new debt
• sale of fixed asset
• new investment

• Cash goes out
• debt retired
• new fixed assets
• dividends
• stock redemption

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Cash from Operations

• Operations Collected
• Less paid to
• suppliers, labor, taxes etc.
• Operations net

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Step 6 Balance Sheets

• For our project, I encourage you to develop
  balance sheets for each year
• Balance sheets can be as simple as you want
• Realize that balance sheets are often the most
  difficult of the financial statements
• You will need to incorporate data from all of the
  previously described statements

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What do you really need?

• Bare Bones Reasonable Optimal

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Balance Sheet

• Assets and Liabilities Net Worth are always in
  balance -- by definition.

Liabilities Net Worth
Assets
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Assets (What You Own)

• Current Assets
• Highly liquid cash and near-cash, notes,
  accounts receivable
• Less liquid but current inventories
• Fixed Assets
• Illiquid real estate, equipment
• Other Assets
• Good will and other intangibles

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Liabilities (What You Owe)

• Current Liabilities (come due within one year)
• Taxes, Accounts and notes payable, accrued
  expenses
• Current portion of long-term debt
• Long Term Liabilities
• Mortgages, trust deeds, long-term loans
  (equipment or other) net of current portion of LTD

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Net Worth (Owners Equity)

• Net Worth Assets minus Liabilities
• 1. Paid-in or invested capital
• 2. Retained Earnings
• 3. Other equity

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Step 7 Additional analyses

• Investors and lenders want to know what it will
  take for you to be successful in your new venture
• Break even analysis and other financial ratios
  will help them determine your ability to be
  successful and to meet your financial
  responsibilities

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Break-even Analysis

• S FC GM
• Where S Sales at which you make neither a
  profit nor a loss
• GM Gross Margin expressed as a percent of Sales
• FC Fixed costs in

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Break-even plus Profit

• S (FC P) GM
• Where S gross sales to make desired profit
• P desired profit
• GM gross margin expressed as a percentage of
  sales
• FC Fixed costs in

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Fixed versus Variable Costs

• Fixed Costs
• Any cost which is independent of the sales level.
• Examples
• rent
• salaries
• insurance

• Variable Costs
• Any cost which rises or falls with the level of
  sales.
• Examples
• cost of goods sold
• sales commissions
• delivery expense

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Financial Ratios

• Current ratio
• Inventory turnover
• Asset turnover
• Return on investment
• Return on assets
• Any others?

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Review Specific Statements

• Revenue Statement or Sales Forecast
• Optimistic, Pessimistic, Likely
• Derivation
• Income Statement
• Derivation (new altogether versus new existing)
• Dont try to reinvent the wheel
• Balance Sheet
• Time zero affect
• Cash Flow - the most important

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The Right Way

• Create assumption page first
• Everything relates back to that assumption page
• Understand interrelationships between
  assumptions, sales, income projection, balance
  sheet, and cash flow
• Understand relationship between specific line
  items within and across different statements

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Advice on Financial Data

• 1. You provide the ideas and insights. Get your
  accountant to put the numbers together.
• 2. Understand how the financial statements
  provide operating information.
• 3. If you use only one financial statement, use
  a MONTHLY CASH FLOW BUDGET.
• 4. Bankers like facts and hate surprises.

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Two Mottoes

• When youre on the road, youre revenue. When
  youre in the office, youre expense. Peter
  Worrell, Investment banker
• 90 of success is simply showing up. Woody
  Allen, Philosopher