financial projections for your business plan

www.lostjobstartbusiness.com

Financial Projections for your Business Plan – How

to Guide. By Feargal Byrne B.A., M.B.S.

Financial Projections for your Business Plan – How to Guide

www.lostjobstartbusiness.com – helping people who have recently lost their job to start a business 2

About this How to Guide For many people who have decided to start their own business putting together financial projections is scary. Most aspiring entrepreneurs don’t know where to start. This is understandable, because most entrepreneurs are not from a financial background. They often outsource it to an accountant and never get to grips with their financials. This is a major mistake. Understanding your financials is a key element to your overall business strategy. The good news is that anyone can do their own financial projections. The goal of this book is to show non-financial entrepreneurs how to construct financial projections for their own business. Much care was taken to make the financial models described easy and straight forward to construct. As a result, all that you need to know is how to add, subtract, multiply and divide in a spreadsheet. The book was written from an entrepreneur’s perspective. It is hoped that you will find this book extremely helpful as you build your financial projections and business plan. Good luck in your venture. Feargal Byrne



Table of Contents Introduction....................................................................................................................4 Sales Assumptions .........................................................................................................5 Expense Assumptions ....................................................................................................7 Profit/Income Projections. .............................................................................................9 Cash Flow Projections .................................................................................................11 Balance Sheet Projections............................................................................................16 Conclusion ...................................................................................................................18 Table of Figures Figure 1: Simple Sales Funnel for an Online Business..................................................5 Figure 2: Example Sales Assumptions Layout in a Spreadsheet...................................5 Figure 3: Sales Revenue layout in a Spreadsheet ..........................................................6 Figure 4: Sales Assumptions Formula View .................................................................6 Figure 5: Example of Expense Assumptions .................................................................7 Figure 6: Example Depreciation Layout in Expense Assumptions ...............................8 Figure 7: Formula View of Depreciation in Expense Assumptions .............................8 Figure 8: Profit/Income Projections Example................................................................9 Figure 9: Profit/Income Example Formula View .......................................................10 Figure 10: Seasonality Factors Example......................................................................11 Figure 11: Seasonality Factors Formula View.............................................................11 Figure 12: Cash Flow Projection Example ..................................................................12 Figure 13: Cash Flow Closing Balance Formula View ...............................................15 Figure 14: Balance Sheet Projection Example.............................................................16 Figure 15: Balance Sheet Formula View.....................................................................17



Introduction Ok, so you have a business idea and would like to write a business plan. A key component of your business plan is the financial projections. This is not as bad as it seems, because if you have a clear vision of your business model you should have no great problem building your financial projections. It’s of key importance that you realize that the number one most important thing in your financial projections is your assumptions. In order to have accurate and believable projections you must thoroughly research your assumptions. Your assumptions are the foundation of your plan. Once you can back up your assumptions you will be able to answer most of the questions that investors may pose. You should also build your projections from the bottom up. By this, I mean that you should avoid the “1% of total market share” nonsense that many entrepreneurs present. You see, your projections relate to your business strategy. As a result, your assumptions must relate to actual expenses that you will have, and sales that are likely to be made based on your strategy. You must read the annual reports of your competitors and look at the key financial indicators for your industry sector (Hints and tips on how to research your financial projections can be found at the following website http://www.lostjobstartbusiness.com/researchtips.html). However, the most important thing you can use in your assumptions is common sense. Ask yourself, are these assumptions realistic? If I were an investor would I invest based on these projections? Secondly, you need spreadsheet software. You can use Microsoft Excel or the open source OpenOffice Calc and the free Google Docs. Don’t worry if you are afraid of spreadsheets. You only need to add, subtract, multiply and divide in your projections. If you don’t know how to use a spreadsheet a simple search on Google or YouTube will throw up hundreds of tutorials on how to do the simple calculations above.



Sales Assumptions Your sales assumptions should be a reflection of your sales funnel. The further you can track back your sales assumptions the clearer they will be. You should start at the top of the funnel and work your way down to the bottom, where the sales are.

Figure 1: Sample Sales Funnel for an Online Business

The above example shows a basic sales funnel for an internet business. The following is how this sales funnel should look in a spreadsheet. A certain percentage of visitors to the website sign up to the mailing list and a certain percentage of those who sign up to the mailing list actually make a purchase.

Figure 2: Example Sales Assumptions Layout in a Spreadsheet

Sales Unique Visitors

% Sign Up

No. Sign Up

Conversion Rate No. Sales

Year 1 150000 15.00% 22500 1.00% 225 Year 2 250000 18.00% 45000 1.15% 517.5 Year 3 400000 20.00% 80000 1.25% 1000

You can see clearly how the sales figure is related to the number of unique visitors to the website. The “No. Sign Up” figure is the “Unique Visitors” multiplied by the “% Sign Up” rate. The “No. Sales” figure is the “No. Sign Up” multiplied by the “Conversion Rate”. Once you have worked out the number of units that you will sell, you need to multiply it by the price that you will charge. In this example only one product will be sold. However, if you intend to sell more products at different prices simply break the number of units into the appropriate ratio for each product.

Unique Visitors

Mailing List Subscribers

Sales



Figure 3: Sales Revenue layout in a Spreadsheet

Sales Revenue Price $ Sales - $ Year 1 800 $180,000 Year 2 1250 $646,875 Year 3 1350 $1,350,000

Below is the formula view of the example Sales Assumptions and Sales Revenue layouts shown previously.

Figure 4: Sales Assumptions Formula View

A B C D E F

Sales Unique Visitors % Sign Up No. Sign Up

Conversion Rate No. Sales

4 Year 1 150000 0.15 =B4*C4 0.01 =D4*E4 5 Year 2 250000 0.18 =B5*C5 0.0115 =D5*E5 6 Year 3 400000 0.2 =B6*C6 0.0125 =D6*E6

A B C D Sales

Revenue Price $ Sales - $ 10 Year 1 800 =B10*F4 11 Year 2 1250 =B11*F5 12 Year 3 1350 =B12*F6



Expense Assumptions It’s important to have accurate expense assumptions. In order to do this, you must already have figured out your business model. Each expense must be researched. I know that a lot of accountants recommend using the Key Financial Indicators for your industry sector. However, it’s not enough to use only these, because your business may have a different model to the industry standard. You should use the Key Financial Indicators as a check and balance after you have built you assumptions from the bottom up. The best way to build you expense assumptions is to get actual quotes. Get quotes for rent of a specific office, web hosting etc. The more specific your assumptions are, then the better your projections will be. Make sure your marketing spend makes sense in the context of your sales assumptions. Once you have compiled your projections you can use the Key Financial Indicators to pose questions to yourself on your financial projections. It’s also important that you read the annual reports of similar public companies. For each expense you should ask yourself the following - Why are my figures different to the industry Key Financial Indicators?, and probably more important - Why are my figures different to a company in the same industry with a similar business model? Also, be aware that your expense assumption section will allow interested parties to view a breakdown of the component expenses of the expense figures that you will show in the Income/Profit projections. Therefore, it’s important to make sure that each individual expense is clear and understandable. The easiest way to do this, is to show each figure that comprises the total along with a brief description. The following is an example:

Figure 5: Example of Expense Assumptions

Marketing PPC 40000 70000 100000 Misc. 5000 7000 8000 Total Marketing $45,000 $77,000 $108,000

Website Hosting 100 100 150 Domains 50 50 55 Total Website $150 $150 $205

You should reference the total figure in your profit/income projections. Note: Depreciation Depreciation is another word for usage. For instance, if you use a machine for a year the machine will have accumulated wear and tear over that year. The depreciation of the machine is the cost of that wear and tear.



You should include depreciation on your fixed assets in your expense assumptions. Don’t worry, it’s not difficult. Basically, any equipment you intend to buy that will last for more than one year should be depreciated. This is easy, you simply divide the figure that you paid for the equipment by the number of years that it will be of use to you. For instance, if you have a computer that will last you 4 years, divide the cost of the computer by 4 and that is your depreciation for each year. In the following example you can see how to work out depreciation in your expense assumptions. Computers and office equipment which have a useful life of 4 years are bought in year 1.

Figure 6: Example Depreciation Layout in Expense Assumptions

Fixed Asset Purchases Year 1 Year 2 Year 3 Computers 3000 Office Equipment 1000 Opening Assets 4,000 4,000 Total Fixed Asset $4,000 $4,000 $4,000 Depreciation Life 4 Years Year 1 Year 2 Year 3 Depreciation of Assets $1,000 $1,000 $1,000

Here is the formula view of the same layout.

Figure 7: Formula View of Depreciation in Expense Assumptions

A

B C

D

51 Fixed Asset Purchases Year 1 Year 2 Year 3 52 Computers 3000 53 Office Equipment 1000 54 Opening Assets =B56 =C56 55 56 Total Fixed Asset =B52+B53+B54 =C52+C53+C54 =D52+D53+D5457 58 *For P+L 59 Depreciation Life 4 Years 60 Year 1 Year 2 Year 3 61 Depreciation of Assets =B56/C59 =C56/C59 =D56/C59

In conclusion, the more specific you can get in your expense assumptions the better.



Profit/Income Projections. You will be happy to know that once you have finished your sales and expense assumptions the rest is easy. In summary, your Profit/Income projections are your sales less your expenses. Lay these out for 3 years. Reference the figures in your sales and expense assumptions. This allows any change in your assumptions to be reflected in your Profit/Income projections. Remember to include depreciation in your Profit/Income projections. Here is an example of Profit/Income projections.

Figure 8: Profit/Income Projections Example

Profit/Income Projections Year 1 Year 2 Year 3 Sales $180,000 $646,875 $1,350,000 Expenses Rent & Rates $8,000 $8,000 $8,000 Marketing $45,000 $77,000 $108,000 Website $150 $150 $205 Salaries $75,000 $135,000 $150,000 Outsourcing $30,000 $31,000 $35,000 Light and Heat $1,500 $1,600 $1,800 Office and Admin $370 $430 $500 Depreciation $1,000 $1,000 $1,000 Accounting and Legal $9,000 $3,000 $3,000 Total Expenses $170,020 $257,180 $307,505 Net Profit/Loss $9,980 $389,695 $1,042,495

You should show your Profit/Income projections on a different worksheet to your assumptions. Likewise, you should also show your Cash Flow and Balance Sheet projections each on separate worksheets. Again, it’s crucial that you reference your assumptions from your Profit/Income projections (See. Figure 9 Profit/Income Example Formula View).



Figure 9: Profit/Income Example Formula View

A B C D

Profit/Income Projections Year 1 Year 2 Year 3

4 Sales =Assumptions!D10 =Assumptions!D11 =Assumptions!D12 5 6 Expenses 7 Rent and Rates =Assumptions!B16 =Assumptions!C16 =Assumptions!D16 8 Marketing =Assumptions!B22 =Assumptions!C22 =Assumptions!D22 9 Website =Assumptions!B28 =Assumptions!C28 =Assumptions!D28

10 Salaries =Assumptions!B35 =Assumptions!C35 =Assumptions!D35 11 Outsourcing =Assumptions!B41 =Assumptions!C41 =Assumptions!D41 12 Light and Heat =Assumptions!B43 =Assumptions!C43 =Assumptions!D43 13 Office and Admin =Assumptions!B49 =Assumptions!C49 =Assumptions!D49 14 Depreciation =Assumptions!B61 =Assumptions!C61 =Assumptions!D61 15 Accounting and Legal =Assumptions!B63 =Assumptions!C63 =Assumptions!D63 16 17 Total Expenses =SUM(B7:B16) =SUM(C7:C16) =SUM(D7:D16) 18 19 Net Profit/Loss =B4-B17 =C4-C17 =D4-D17



Cash Flow Projections This is probably the most important part of your financial projections. Cash Flow is all about timing. It’s about when you get paid and when you pay others. The first thing you should do is lay out your seasonality factors for your business. This will reflect accurately the times of year that your business is most active. An easy way to do this is to lay out the 12 months of the year and assign a weighting to each month. All the weightings for 12 months must total 1. Here is a snapshot so you get the idea. Payment is received 30days after a sale:

Figure 10: Seasonality Factors Example

Year 1 MTH 1 MTH 2 MTH 3 Seasonality Factors 0.02 0.03 0.05 Inflows Sales 0 €3,600 €5,400

Figure 11: Seasonality Factors Formula View

After this, it’s all about the application of common sense. Think through how your business will operate and try to pin down when you will pay each expense. If some sales will not be received until the following year, these should appear in the Balance Sheet as Debtors and not in the Cash Flow. If an expense will not be paid until the following year they should appear as Creditors in the Balance Sheet and not in the Cash Flow. When you realize that the cash flow and balance sheet projections are intrinsically linked your projections will become much easier. It’s a good idea to complete your Cash Flow projections before starting your Balance Sheet. Your Cash Flow projections should look like the following example.

A B C D

Year 1 MTH 1 MTH 2 MTH 3 4 Seasonality Factors 0.02 0.03 0.05 5 6 Inflows 7

Sales 0 =B4*'Profit and Loss'!$B$4

=C4*'Profit and Loss'!$B$4



Figure 12: Cash Flow Projection Example



The most complicated part of your cash flow projections is setting up your rolling balance for each month. Firstly, you need to subtract your total outflows from your total inflows for each month. This gives you your cash inflow/outflow for that particular month. Next, underneath this, put the cash that you have at the beginning of the month. Finally, add the total outflow/inflow to the cash that you had at the start of the month (Opening Balance) in order to find the cash that you have at the end of the month otherwise known as the Closing Balance. The Closing Balance for month 12 is the Closing Balance for the year. The following is the Closing Balance formula view for the first four months of Year 1.

Figure 13: Cash Flow Closing Balance Formula View

A B

C

D

E

23 Total Outflows =SUM(B13:B21) =SUM(C13:C21) =SUM(D13:D21) =SUM(E13:E21) 24 25 Total

Inflow/Outflow =B10-B23 =C10-C23 =D10-D23 =E10-E23 26 27 Opening Balance 0 =B28 =C28 =D28 28 Closing Balance =B25+B27 =C25+C27 =D25+D27 =E25+E27



Balance Sheet Projections Your balance sheet is a snapshot of what your business owns and what your business owes at a particular point in time. For your projections it should be on the last day of each year.

Figure 14: Balance Sheet Projection Example

Balance Sheet Y/E YR 1 Y/E YR 2 Y/E YR 3 Fixed Assets $ $ $ Fixed Assets @ Cost 4,000 4,000 4,000 Depreciation 1,000 2,000 3,000 NBV 3,000 2,000 1,000 Current Assets Debtors 7,200 25,875 54,000 Cash 49,280 416,800 1,432,170 Total Current Assets 56,480 442,675 1,486,170 Current Liabilities Creditors 4,500 0 0 Total Current Liabilities 4,500 0 0 Total Net Assets 54,980 444,675 1,487,170 Financed by: Equity Investment 45,000 45,000 45,000 Net Profit 9,980 399,675 1,442,170 Total Shareholders' Equity 54,980 444,675 1,487,170

Here you show your Fixed Assets less any depreciation. The total figure for this is then added to the total figure for your current assets. Your current assets include your cash balance if it is positive, any debtors you have and anything that you have paid in advance for next year. These two figures equal your total assets. Your current liabilities are subtracted from your total assets. Your current liabilities include you cash balance if it is negative, any creditors (people who you owe money to). Basically, anything that needs to be paid but you haven’t got round to it yet. When you subtract the current liabilities from the total assets figure you will get the Total Net Assets. After this stage, you should put together the “Financed by” section of the balance sheet. This section shows the funding that the business has received.



You will have both “external” funding in the form of equity and “internal” funding in the form of retained profits. List your total equity investment along with any retained profits. Remember, that for year 2 and 3 your retained profits should be the balance (total amount) of retained profits and not only the retained profits for that year. If you have built your financial projections correctly you should see your Total Net Assets equal the total in the “Financed By” section of your Balance Sheet. After all, your balance sheet is called a balance sheet for a reason.

Figure 15: Balance Sheet Formula View



What if it doesn’t balance? Oh No!!!! My Balance Sheet doesn’t Balance!!!!!!!!!! Calm down, take a deep breath and compose yourself. Switch your brain to logical mode and start looking at your projections. Most mistakes come from your cash flow. Review every figure in your cash flow with your Profit/Income projections. If you find differences, ask yourself what’s the reason for the difference and is it reflected in the balance sheet? Some common troubleshoots are that debtors and creditors figures have not been worked out correctly. Also, the seasonality factors may not be multiplied by the appropriate month (there may be a lag of 1 month if you make sales on 30 days credit).

Conclusion Well done! you have read a “how to” guide on Financial Management and particularly one on your dreaded financial projections. It wasn’t that bad now was it? You can download the sample plan that has been used for the demonstrations shown in this book from: http://www.lostjobstartbusiness.com I hope you have found this “how to” guide interesting but more importantly, helpful.

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