Financial Projections (1)

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Financial Projections (1) Assumptions and Cash
Flow

• MHR 308
• Summer 2002

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Financial Reporting

• Accrual Method
• Used in typical financial statements and what you
  learn in accounting courses
• Takes into account both payments and receipts
  earlier and later than they are due
• Recognizes a sale (revenues) before money is ever
  received
• Cash Basis
• The only way to keep accounts when cash flow is
  critical
• The only real focus for financials in business
  plans

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The Key Principle

• When constructing cash flow projections
• Note the amount and month in which cash is
  received, not necessarily when the sale is made
• Note the amount and month in which a bill is
  actually paid, not necessarily when it should be
  paid
• Actual cash inflows become your revenue forecast
• Actual cash outflows (expenses) become your
  monthly budget

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Examples

• Say insurance for your business costs 2,400/yr
• The temptation is to expense 200/month
• Instead, estimate whether you will pay the
  premium in one, two, or three installments, and
  in which month you will make those payments
• Need help from an accountant at tax time?
• Estimate the fee, but dont expense it equally
  over every month
• Instead, you will pay it all at once in April
• Or, if you wish, pay it in May or June (you
  decide)

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Receivables Aging

• If your previous experience or that in your
  industry shows that some people pay late
• Estimate who pays how late
• For example, 40 pay within 30 days, 30 pay
  30-60 days, 25 pay 60-90 days, and 5 never pay
• Build in these receivables into your revenue
  model
• It will reflect actual rather than assumed
  revenues

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Receivables Aging (cont.)
1 2 3 4 5 6 7
Revenue 1,000 1,200 1,400 1,600 1,800 2,000
Formula 40 30 25
Actual Revenue 400 300 250 640 480 400
480 360 300 720 540 450
560 420 350 800 600
Total Revenue 400 780 1,170 1,360 1,550 1,740 Etc.
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Salaries and Wages

• Salaries are for managerial and supervisory
  positions
• Paid monthly but based on an annual salary
• Decide on a structure that is competitive in the
  industry
• Typically includes 15-25 in addition for
  benefits
• Vacations, sick leave, health plan, pension,
  disability, etc.
• Dont forget to pay yourself!
• Wages are for hourly workers or those paid by
  piecework
• Typically do not include benefits
• You MUST include payroll taxes for all employees
• Subcontractors (e.g., consultants) are paid no
  benefits and you pay no payroll taxes for them

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Assumptions

• It is impossible for you to create cash-flow
  projections without making assumptions
• Because it all happens in the future
• For each line of revenues and expenses
• Explain how you got the numbers
• Explain why numbers get larger or vary from month
  to month
• Create separate schedules (tables), e.g.,
• Staffing and salary structure
• Revenue model (unit sales, prices, revenues)

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Typical Format for Projections
1 2 3 12 Total
Total Revenues 0 6,900 8,200 . 16,800 109,700
. .
Total Expenses 8,200 8,000 9,100 . 12,300 98,500
MonthlySurplus (Loss) (8,200) (1,100) (900) . 4,500 11,200
Cumulative Surplus (Loss) (8,200) (9,300) (10,200) . 11,200
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Requirements

• Two years worth of projections, by month
• One year with totals should fit one page
• Use clear headings, e.g., Year 1, Year 2
• Do a second set called Worst Case Scenario
• Also two years worth, by month
• Be clear how this set differs from the one above
  (the Most Likely Case)
• The maximum negative cumulative amount here
  denotes the initial capitalization the business
  needs
• Include assumptions for both sets in your
  Financial Plan

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Outputs of Financial Projections

• Estimated revenues, Years 1 and 2
• Estimated profit before interest and taxes
  (surplus), Years 1 and 2
• Initial capitalization required
• Breakeven Month, most likely case
• Estimated ROI (using estimated initial
  capitalization required as the investment), Years
  1 and 2
• The revenues, profits, and breakeven month can
  become objectives for your enterprise

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Any Questions?