Financial Projections - Overview

You can’t know everything about your business or the business environment today, let alone over the next few years. However, lenders and investors will expect you to make projections about how the business will fare financially.

You will need to project for the next 12 months month-by-month, and the 2 years after that quarter-by-quarter.

Actually, the best thing that can come out of the time it will take to do your financial projections is a much deeper and clearer understanding on your part of how your business works financially. How much money will you really need to get it started and make to be profitable?

At their simplest, financial projections reflect this equation:
Revenue (sales) - Expenses (costs) = Profits

Narrative Section of your Financial Plan
Before the many spreadsheets that are typically part of your business plan, you need a page or so of written explanation about the thinking that went into developing your spreadsheets.

Many “assumptions” or “variables” go into doing a good revenue or expense projections, including:
Sales volume
Selling prices
Selling costs (how much you will spend on marketing and making sales)
Interest rates (if you are borrowing money)
Material costs
Equipment expenditures
Bad debt provisions (if you allow your customers to buy on credit)
Accounts receivables (how long it will take customers to pay you)
Accounts payable (how long it will take for you to pay your sills)
Salaries (what you pay yourself and your employees)
….and even when you open and how much cash you start out with.

There are four key areas you will want to cover in this Narrative Section to explain how your spreadsheets work:

• Discuss how you know what amounts you plan to spend on major items and explain the timing - which months the sales will be made and the cash will be spent for each item.

• Discuss how you will react if some of these assumptions prove incorrect over time. Will you have enough of a cushion financially if sales don’t come in as quickly as you expect, or it costs you more to start your business than you projected?

• A statement of what you will use the borrowed money for.

• Optional: Compare your numbers and ratios to the RMA Annual Statement Analysis figures for your industry. If there are differences between your numbers and those of your industry, you must explain why.

Statement of Funding Purpose Example:
We believe that initial funding of $156,000 will be sufficient to get ABC.com Delivery Service to initial profitability. We intend to raise this cash with bank loans, equipment leasing, and cash investment by the owners of $20,000. As part of this cash, we are looking for a start-up capital loan in the amount of $100,000.

We will secure the loans and leases by the value of the equipment and by the personal guarantee of the majority owner. Given the level of performance we anticipate in our financial projections, we believe we will be profitable after 12 months.

These are the financial documents that lenders and venture capitalists will expect you to provide as part of your Plan

New businesses:
• Proforma Balance Sheet (snap shot of the day you open for business)
• Proforma income projections (income/profit and loss statements) for three years. Give detail by month the first year and by quarter the 2nd and 3rd year)
• Breakeven analysis
• A List of assumptions and other notes
• Personal Financial Statement
Existing businesses:
• Balance Sheet (3 years)
• Income statements (3 years)
• Cash flow
• Breakeven Analysis
• Income Tax Returns (3 years)
• Capital equipment list
• Personal Financial Statement

Operational Issues

Operational issues should only be included in the business plan if they will be critical for the start-up success of the business. In general, they will only be relevant for product manufacturers, but may also be relevant for retailers who rely on suppliers.

Product-Based Businesses

Production:
• Are you making the best of available new technologies in manufacturing?
• Can you keep up with customer demand if it is 10 times your initial projections?
• Are sales going to be seasonal and are you prepared to handle labor and other issues occurring during both periods?

Materials:
• Are your major sources of supply reliable?
• Do you have back up suppliers?
• Do you have adequate internal quality controls?

Inventory and Shipping
• Can you meet your own internal shipping customer service standards?
• Do you have to stockpile inventory, or can you utilize just-in-time inventory systems to reduce costs?

Information Services
• What kind of business telephone automated attendant or answering service will you have for overloads in customer service calls?
• What kind of accounting system will you use?
• What kind of order-entry and inventory system will you use?
• Will your information services be able to provide meaningful information in a readily accessible way?

People
• Do you have a ready source a labor for your business?
• How much training do they need before starting to be productive?
• How many people do you need working at any time? Will you have more than one shift?
• What will you need to provide workers in terms in compensation and benefits?

Retail Businesses

Facility and Location:
• Is there adequate parking for employees and customers?
• Are there local ordinances and zoning requirements that will affect the business?
• Are facilities adequate for changes in the product mix?
• Do you have contingency plans to keep your business going in case of a natural disaster?

Materials:
• Are your major sources of supply reliable?
• Do you have back up suppliers?

People
• Do you have a ready source a labor for your business?
• How much training do they need before starting to be productive?
• How many people do you need working at any time? Will you have more than one shift?
• What will you need to provide workers in terms in compensation and benefits?

Information Services
• What kind of business telephone automated attendant or answering service will you have for overloads in customer service calls?
• What kind of accounting system will you use?
• What kind of order-entry and inventory system will you use?
• Will your information services be able to provide meaningful information in a readily accessible way?

Service Businesses

People
• Do you have a ready source a labor for people able to provide your type of service?
• How much training do they need before starting to be productive?
• What will you need to provide workers in terms in compensation and benefits?

Information Services
• What kind of business telephone automated attendant or answering service will you have for overloads in customer service calls?
• What kind of accounting system will you use?
• What kind of order-entry and inventory system will you use?
• Will your information services be able to provide meaningful information in a readily accessible way?

Sales Forecasting

There are many different types of marketing that work. You will need to experiment to find what will work for your business. You will also have to determine what success is for your industry and your business, and if you don’t meet it, which of the variables might be responsible.

Ideally, your business plan will describe your short and long term expectations for your revenue - increasing your sales over time, increasing profit levels, market share, customer retention, or all of the above. Objectives should be stated in clear, measurable terms, such as “$25,000 in sales this quarter, 20% growth per year, 10% market share over the next five years”

If your goal is to increase revenue by 20% this year, and your revenue was $400,000 last year, then you are looking for an increase of $80,000 annually or approximately $6,500 to $7,000 a month. How much more marketing will you need to do to increase your sales by this amount, based on your results in the past?

Once your strategies and activities are established, you will need to monitor the results of your actions on a periodic basis, and compare them to your forecasts. Any failure to meet objectives should be examined carefully and changes made to try some different activities. Describe in your business plan how you will monitor and evaluate the results of your marketing efforts. These are your tracking methods for knowing what marketing tactics are working. Ideally, you can crate a reporting mechanism to look at each activity, setting goals for each and comparing these to actual results.

If you have been in business for a while, you will need to include in your plan your sales volume in units (such as numbers of products sold of each type, and/or numbers of customers) and in dollars for the past few years to set a context for what you want to do next. If your business is new, you will still need to do a forecast (or projection) for what you expect to sell.

To arrive at this forecast, make some educated guesses at how well your marketing efforts to bring in new customers will work, and what the average size sale will be per customer.

In order to set up your company’s financials projections (which we will discuss in the next few chapters), you will need to have an idea of what your sales will be (month by month for the first 12 months, and at least quarter by quarter after that). One of the most common mistakes of business planners is to overestimate the sales for the first few months of business.

The reality is that no one knows what kind of revenue your business will have. And there is no way to project this other than to create a mathematically logical equation based on what you do know about your own planned marketing efforts and the capacity of your business. Some business plans include as many as three possible scenarios – best, most probable, and worst. This may be a good exercise for your own thinking, but you need to include the most probable for your business plan.

An example of sales forecasting assumptions for a consulting business:
“We are assuming that our direct mail effort will be 500 pieces sent a month, and at a 1.5% return, we will get 7 new customers a month. Each customer will buy an average of $2,000 in services, resulting in $14,000 of sales each month.”

One suggested way to show your three-year sales forecast in numbers after discussing your assumptions is to put them in a chart. Two examples follow:

For a restaurant:
“Patty’s Bakery will be serving breakfast, lunch, and dinner, seven days a week. Our maximum seating capacity is 60. We will assume for our sales forecast that we will be at 85% of capacity at all times, and that we have turnover of each table twice at breakfast and lunch, and three times at dinner. We have calculated our average per person bill to be $6 at breakfast, $9 at lunch, and $16 at dinner. Therefore, our average days’ receipts would be as follows:

Meal # of Customers Average bill per person Total Receipts
Breakfast 50 x 2 $6 $600
Lunch 50 x 2 $9 $900
Dinner 50 x 3 $16 $2400
Total $3900

At approximately 30 days per month, average monthly receipts would be estimated at $117,000, and yearly revenue at $1,404,000.

Sales Forecast for Patty’s Bakery
2008 2009 2010
Location 1 $1,404,000 $1,474,200 $1,547,910
Location 2 x x $800,000
Totals $1,404,000 $1,474,200 $2,347,910

We anticipate a growth rate of 5% per year based mainly on price increases, until we open our second smaller location in year three where our revenue increases dramatically.”

For a manufacturer:
“ABC Manufacturing sells two types of products. Product A is our higher priced product sold to large corporations at $500 per unit, through our own 10 sales reps. Product B is sold through retail distribution and 20 catalog companies for $99 per unit to consumers. The following are our unit and dollar sales projections for these two products.

Sales Forecast for ABC Manufacturing (units)
2008 2009 2010
Product A 1200 2400 4800
Product B 18,000 21,600 25,920

Sales Forecast for ABC Manufacturing ($)
2008 2009 2010
Product A $600,000 $1,200,000 $2,400,000
Product B $1,782,000 $2,138,400 $2,566,080
Totals $2,382,000 $3,338,400 $4,966,080

Of course, it is unlikely that either of these scenarios will play out in exactly the way it is written. But remember, your banker doesn’t know what will happen either. You must describe the logic behind your thinking and convince your financers that based on all your hard work, this is the probable outcome.