Yale School of Forestry & Environmental Studies Kroon Caf

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 "#cel
Creativity$ attention to detail$ and good judgment.
% lot of time.
Some Warnings
O Most people starting new businesses are much too optimistic about the
future financial results of their business. &heir energy and enthusiasm cloud
their judgment. &hey underestimate the time it takes to get things done,
and how much things will cost 'ver!optimistic e#pectations often lead to
underestimating how much money they need to finance initial losses.
O 'nce a business really gets going (in )ear * or +,$ doubling the si!e o" the
business each #ear is about the ma$imum a good %&O reall# can
achie'e "ven growth that fast (double every year, is e#tremely difficult to
manage. -ost successful businesses do not grow faster than .//0 per year$
nor do they need to.
(etting Started
O 1inancial projections should include the following kinds of final 2output3
)ncome Statements
*alance Sheets
Sources and +ses o" %ash Statements ,%ash Flow Statements-
O &he invention of spreadsheet software has made financial statement models
easy to create and even easier to play with. 1ollow this link for a simple
projection model template.
O 4n practice$ though$ you will likely have to build your own income statement
model. &he key drivers often are uni5ue to the particular situation. )ou can
use the template model$ however$ to help calculate 6alance Sheets$ Sources
and Uses of Cash$ plus do some Statement %nalysis 7 just by inputting your
custom income statement$ and making some simple assumptions.
O 4t is usually best to do monthly projections for the first two years$ then
5uarterly after that. %dd the periods up$ and present the annual summaries to
potential financing sources.
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)ncome Statements.
Monthl# Projections Month / Month 0 Month 1 Month 2 Month 3 Month 4
5e'enues
%ost o" (oods Sold
(ross Pro"it
Sales 6 Marketing &$pense
(eneral 6 7dmin &$pense
Operating )ncome
Depreciation &$pense
)nterest &$pense
8a$es
Net )ncome ,9oss-
:e# points.
o 5e'enues 6 e$penses are independent of cash payments. 8ecogni9e them
when a transaction happens$ not when cash comes in or goes out (maybe
much later,.
o %ost o" (oods Sold are the direct costs in producing your service 7
materials$ installation costs$ customer service$ maintenance$ etc.
o 5e'enue ; %osts o" (oods Sold < (ross Pro"it
o (eneral 6 7dministrati'e are support costs$ like finance$ :8$ 4&$ top
management
o (ross Pro"it ; Sales 6 Marketing ; (eneral 6 7dmin < Operating
)ncome$ also known as 'perating Cash 1low
o 1ollowing these conventions allows for comparison of your projections with
other similar business; results.
o Depreciation e$pense spreads out the cost of property$ plant and e5uipment
7 over its useful life.
o 8&< costs=
Making 7ssumptions
O Start with the monthl# numbers "or Year /. 1or any business raising
money$ making your numbers in your first year of projections is really
important. 4f you$ as management$ miss these numbers you may
.. 8un out of money too soon$
Yale School of Forestry & Environmental Studies Kroon Caf
*. >et fired and?or
+. @ot be able to raise more money.
4f ., or +, happens$ you will probably go bust.
O %onsider the macroeconomic situation when building your projections
'verall economic growth rate of ><A during projection period
"conomic recession(s, ! timing$ duration
8ate of inflation
Bevel of interest rates
O 8ackle the )ncome Statement "irst. Aroject your number of customers
based on the key revenue driver. Aroject monthl# sales 7 for twelve
months....
Monthl# Projections Month / Month 0 Month 1 Month 2 Month 3 Month 4
%ustomers / / .. */ CD EE
5e'enues / / + F .+ *F
o @e#t$ think through the .* months of costs associated with these sales
Cost of >oods Sold 7 materials$ installation costs$ inspection$
maintenance$ regulatory costs$ billing system
Selling costs 7 sales people$ advertising$ travel$ web site
%dministrative Costs 7 -anagement$ office space$ supplies$ utilities$
insurance
o Aoints to remember
)ou may not have any revenues for the first few months 7 as you build the
system$ sign up customers$ etc. 7 but you will still have e#penses. -odel
this.
<on;t forget to figure in one!time start!up costs (incorporate$ write a
business plan$ licensing$ permitting fees$ getting regulatory approval$ etc.,
4f you have more than one product or service$ model them separately$
then total them.
6e sure to model total headcount and include cost of benefits (*/!*D0 of
salary$ typically,. )ou should allocate personnel costs into Cost of >oods
Sold$ -arketing & Sales and >eneral & %dministrative$ based on function.
8ental space can be (:eadcount # %vg. S5. 1t. Aer Aerson # G Cost Aer
S5. 1t.,
Yale School of Forestry & Environmental Studies Kroon Caf
o )our projections might look something like this
Monthl# Projections Month / Month 0 Month 1 Month 2 Month 3 Month 4
5e'enues / / + F .+ *F
%ost o" (oods Sold / / . + F .+
(ross Pro"it / / * + E .+
Sales 6 Marketing &$pense C D E H .. .*
(eneral 6 7dmin &$pense C E H .. .+ .F
Operating )ncome !I !.* !.C !.E !.E !.D
Depreciation &$pense . . . . . .
)nterest &$pense . . . . * *
8a$es / / / / / /
Net )ncome ,9oss- !./ !.C !.F !.H !*/ !.I
o &hen$ add up your .* months of projections.
7nnual Projections Year / Year 0 Year 1 Year 2 Year 3
Sales .D/
%ost o" (oods Sold EE
(ross Pro"it F.
Sales 6 Marketing ./*
(eneral 6 7dmin .C/
Operating )ncome (.I.,
'perating income is an estimate of how much money will need to raise 7 on top
of the cost of any property and e5uipment you must buy. <oes this number
make sense= %re you losing enough money (have you remembered all your
costs,= %re you losing more money than you can raise=
o 6uilding out future years$ two approaches
Continue estimating growth of customers from month to month$ 5uarter to
5uarter. Or
Aick a break!even year 7 the year your operating income e#ceeds costs
and you don;t need outside financing to survive. &ake this approach if
there is a year by which you must break even. 4f$ say$ banks or investors
re5uire that you reach break even by year three$ figure out Jhat would
this take 7 in sales=
7nnual Projections Year / Year 0 Year 1 Year 2 Year 3
Yale School of Forestry & Environmental Studies Kroon Caf
Sales .D/ I//
%ost o" (oods Sold EE +D/
(ross Pro"it E+ CD/
Sales 6 Marketing ./* .HD
(eneral 6 7dmin .C/ *./
Operating )ncome (.FH, CD
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.
Jith either approach$ remember to increase costs with sales. % common
mistake$ for e#ample$ is to forget to add personnel as the business grows.
%nd$ as personnel increases$ so may rent$ supplies$ utilities$ insurance$ etc.
O %ompare #our )ncome Statement numbers to similar companies to figure
out if your break!even$ and projections in general$ are reasonable$ Calculate
profit and cost margins by dividing all categories by sales
7nnual Projections Year 1 7s a = o"
Sales
Sales I// .//0
%ost o" (oods Sold +D/ CC0
(ross Pro"it CD/ DF0
Sales 6 Marketing .HD *C0
(eneral 6 7dmin *./ *F0
Operating )ncome CD F0
Book especially at the gross and operating profit margins$ and at the
categories of costs. %t this stage of your business$ #our pro"it margins
should not be higher than similar operations 7 nor your cost margins
lower. <oes your business differ in key respects= 4f so$ can you e#plain
why= 4f not$ you are probably being to optimistic.
4f your projections look reasonable$ smooth in the year(s, between )ear 'ne
and your projected break even year. Aroject out past your break!even year.
<o not grow faster than people will believe. Consider a D/0 annual growth
rate in revenues$ as a first cut. 8emember to increase costs as you grow.
O Ne$t, Some 7ssets
Yale School of Forestry & Environmental Studies Kroon Caf
&ransfer the 4ncome Statement totals to the model template$ or construct your
own 6alance Sheet and Sources & Uses model. &ypical key items
%ategor# Numbers &$pressed 7s. &$amples.
Cash in 6anks 0 of Sales +0 of Sales
%counts 8eceivable 0 of Sales Sales # .?F (F/ <ay &urnover,
4nventory 0 of Cost of >oods Sold Cost of >oods Sold # ./0
1i#ed %ssets 1ormula
.
)r. K Bast )r. L Cap"# ! <eprec.
'ther %ssets 0 Sales
*
.0 of Sales
%ccounts Aayable 0 of Costs of >oods Sold Cost of >oods Sold # .?F
%ccrued "#penses 0 of S&- L >&% "#pense S&- L >&% "#pense # .?.*
'ther reasonable links or relationships are possible. You want the balance
sheet to grow in line with the growth o" the business. 6alance sheets
use cash$ too.
'ne also needs to project the Capital "#penditures (Aroperty$ Alant$
"5uipment purchases, and some <epreciation "#pense. 4nclude
replacement costs for failed as well as worn out e5uipment. Set <epreciation
"#pense as a percentage of @et 1i#ed %ssets as of the end of the previous
year. &he template assumes an average rate of ./ years.
&he template model will use this information to complete a 2Sources and
Uses of Cash3 Statement and generate a large number in the 2@ecessary to
6alance3 line of the 6alance Sheet.
Necessar# to *alance is not an accounting categor# )nstead, "or each
Year, >Necessar# to *alance? represents the amount o" "inancing that
#ou need )ou must assume that you will sell e5uity or borrow debt$ or some
combination !! e5ual to the amount of 2@ecessary to 6alance.3 1or e#ample$
in the template attached$ the business needs to raise GH//$/// to finance the
first year of operations.
4f @ecessary to 6alance shows e#tra cash (versus a need for financing,$ you
can pay this out in dividends to your investors 7 or add it to your cash account
cell. &he second is probably more realistic in the case of a new business.
.
@et 1i#ed %ssets from last year$ plus Capital "#penditures minus <epreciation$ this year.
*
'ther %ssets might include prepaid insurance or rent$ intangible assets$ etc.