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How to Create the Financial Projections for Your Business Plan
An Edward Lowe Quick-Read Solution
With a good business plan, you can land investors and help your company grow. Learn why thefinancial section of the plan is so important, and get tips on what information to include.
OVERVIEW
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]If you want to convince investors and lenders to commit to your vision and your company, awell-organized strategic business plan is a must. It shows the company's potential anddemonstrates how the business will create a return on the investment requested. The financialsection of that plan is critical to convincing investors that the company has reliably estimated itscosts and revenue potential and that it offers a plausible asset and debt structure.Your accounting unit will prepare your balance sheet and income statement (profit and loss), butyou'll need to know the details intimately to write the plan's three-to-five-year financial projections, to be prepared to discuss the content with potential investors, and to translate the plan into action. If you need a refresher on financials, see the Business Builders on
.This Quick-Read assumes you have a marketing plan in place with three-to-five-year projectionsfor sales and costs of sales, and a personnel plan projecting numbers of employees and wages.In this Quick-Read you will find:
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Why the financial section of the business plan is vital for both investors andentrepreneurs.
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Guidelines for preparing the financial projections.
SOLUTION
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]A well-written strategic business plan is essential to the capital-raising process for a growingcompany. Banks and investors won't provide money for an operation that doesn't have a clear plan to assure return on investment and growth. The plan helps management focus on the growthof the company and decide how that growth will be achieved.Prospective investors will be especially attentive to the financial section of the plan. Because toomuch or too little outside funding will inhibit return on investment and growth, funding needsmust be projected as precisely as possible. This requires dependable and reliable financialstatements.You'll need to prepare spreadsheets projecting monthly figures for the next year and annualfigures for the following two to four years, starting with your current income statement, cashflow statement and balance sheet. You should add rows for financial ratios that you or prospective investors are likely to care about, for example, debt to equity, assets to liabilities. If you start with the income statement projections, you'll find that the numbers are well suited for re-use in the monthly and annual projections for the cash flow statement and the annual balancesheets.Specialized business-plan software can be purchased to create pro forma (projected) financialstatements based on past financials, but you probably will be able to predict future performanceas well as the software by examining the history of each line entry to determine if it is steadilyrising or rising on a curve. Unlike most software, you will be able to factor into your projectionsvariables you know will change. (Be sure to make a note for each significant controlling factor,to explain deviations to the readers.) You may want to graph the past numbers to make the trendseasier to see.
As you draft your forecasts, do not include outside funding. Write in all the expenditures youneed to maximize realistic long-term growth, and let the projected deficit grow. The cumulativedeficit will determine just how much funding you need; and once you know that, you can decidewhere to turn for it.Your pro forma financials should provide clear answers to the fundamental questions:
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What major capital purchases will be needed? Property? Equipment? When?
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What changes will be needed in operating cost expenditures? When?
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What personnel-cost changes are expected? When?
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When will the operation break even?Once you have drafted the pro forma financials, you should look for potential problems. What if you lose your biggest customers? What if your raw goods prices rise faster than expected? Writecontingency plans, and consider adding a "contingencies" line to your balance sheet. Potentialinvestors know bad things can happen, and most will be impressed, not turned off, if you showyou are prepared for problems.The financial projections provide a valuable budget and planning tool. Try varying productiondetails. What happens if you plan to sell fewer units at higher quality and/or provide morecustomer support for a higher price? What if you lease or finance significant capital purchasesinstead of paying cash?Once you know how much money you will need and when, you can make the most effectivedecision regarding how much financing to seek from whom. Should you take out loans for specific capital purchases using the purchased property itself as collateral? Can you get by onrelatively inexpensive loans, or will you need to pursue more expensive venture capital fromoutside investors? The cost of capital will have a great effect on the remaining important projection you need to supply: the breakeven analysis.In this breakeven analysis and adjusted cash flow projections, you also should stress your planfor cashing out the investors and paying off the debt. Of all the specifics of the business,investors are most interested in their return on investment and the timing of the pay-out. Lendersalso want to know how long there will be an outstanding debt and how high it will be. Byaddressing these concerns directly and prominently, you reassure investors that you have their interests as a top priority.If you project rapid growth and good profits, graphingyour cumulative debt/cash flow situation to show your breakeven point will make the strongest possibleimpression on readers. It will make it clear at a glancewhen you will be able to pay off investors, and it willemphasize your coming financial strength.After completing your plan, have others review it beforesending it to investors. This will give you an objectiveviewpoint on how the plan will come across todisinterested individuals. Other entrepreneurs, your accountant and business advisers are in the best positionto provide constructive comments.
REAL-LIFE EXAMPLE
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Three car dealerships for the same foreign-car manufacturer wanted to merge to become moreefficient, but the automaker had never allowed such a merger before and was dubious of the benefits. The companies hired a financial adviser to create a new business plan for the threemerged dealerships to show the advantages. It included a new breakdown of ownership,organizational chart, responsibilities of executives and a marketing plan.The key to the merger's success lay in the financial section of the new business plan. Thisincluded the three company's existing financial statements as well as a projection for how profitswould increase by eliminating redundancies and expanding the particular services each excelledat (i.e., new — versus used — car sales versus sales and mechanical training for all branches). Itshowed the economies of scale that would result and forecasted business for the mergedcompany.After three meetings with the companies and going over the details, the automaker approved themerger — the first it ever had allowed. Executives acknowledged that the financial statementwas the key, as they had never seen forecasting in such detail for a proposed merged company. Infact, the merged company increased sales from $33 million to $50 million in its first year.
DO IT
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Review want ads to learn current salaries and determine your staffing and cost needsappropriately.2.Evaluate costs for expansion needs of inventory and office space. Also look at how highyour sales must be before the commitment to new overhead expenses can be offset byadditional profits.3.Use a loose-leaf format for your business plan so you can add or delete pages quickly andlimit the distribution of sections that are confidential or contain sensitive material.4.Number columns for time periods rather than using dates, which can make the business plan look outdated quickly; for example, rather than starting with columns for October, November and December, start with Month 1, Month 2 and Month 3.5.If there's an especially impressive trend you want the readers to notice, chart it.6.Do not fudge your numbers to get the bottom line you want. Your potential investors arein the business of spotting questionable projections, and when they do, they'll be goneand lost to you forever.
RESOURCES
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Books
, by Paul Tiffany and Steven D. Peterson (IDG, 1997). Not just basic, despitethe title. See especially Chapters 11-13: "Forecasting and Budgeting," "Preparing for Change,"and "Thinking Strategically."
, by Richard Stutely(Financial Times/Prentice Hall, 2002).
Internet SitesWeb articles
. Bplans.com/Palo Alto Software. (from CAC member Doug Wilson's company)
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