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How to Construct Financial

Projections for

ENTREPRENEURSIntroduction

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Scary Huh?

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.

Pic: http://www.flickr.com/photos/stage88/3325271588/They often outsource it to an accountant and never get to grips with their own 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. In this presentation, we will cover how to construct your sales and expense assumptions then how to tie these in to your income, cash flow and balance sheet projections.

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Financephobia?

Not familiar with spreadsheets and suffering from a mild dose Financephobia? Don’t worry, all need to know is how to add, subtract multiply and divide. I have designed this system, of constructing financial projections, to be very simple yet extremely effective.

“We will get 1% of the total market share...”

The first thing we are going to look at, are your sales assumptions. You should avoid the cliché “percentage of the total market” approach. Instead, build them from the bottom up.

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At this point, you need to have a clear idea of your business model especially your sales funnel.

Basically, at the top of your sales funnel are people who walk into your shop, unique website visitors, people who call your sales hotline, people who agree to a free consultation etc. At the bottom is people who have bought your product or service.

Industry Journals

Competitor’s Annual Reports

Internet Forums

Online Questions

BlogsMarket

Research Reports

Observation

You must identify realistic conversion rates for each part of your sales process. Read industry journals, forums, post questions online, observe similar websites, shops, businesses. Come up with a realistic starting point. When you are up and running you can revise your conversion rates to what you are actually achieving. The key, at the start, is to use reasonably realistic assumptions. The more accurate you can get the better.

Google Traffic Estimator

In this example, lets assume that the business makes sales on their website. We will use Google Traffic Estimator to estimate traffic along with the cost of achieving that traffic. The traffic estimate goes into the top of your sales funnel and the cost, which is also displayed in the estimate, goes in as as marketing expense. If you have multiple sales avenues do a sales funnel for each. For this example, we are just going to focus on one for clarity sake. If we get organic traffic it’s a bonus. However, the reason why we don’t include an assumption for it, is that it’s very hard to estimate. If organic traffic is achieved when the business is up and running then it can be included in revised projections. Before you start, it’s just too much guess work.

15%

1%

Example Sales Funnel

We have read in a trade journal that typical conversion rates in the industry are 22% for mailing list sign up and 1.5% conversion from mailing list sign-up to sale. However, we must remind ourselves that this is for established websites that have been analysing website data and constantly improving over a number of years. A start-up will naturally have a lower conversion rate because it has not yet refined it’s sales funnel. Lets assume a 15% mailing list subscription rate and that 1% of mailing list subscribers buy the product. This seems achievable when compared to the industry average. These conversion rates will improve as the business gets better at selling.

So let’s take these conversion rates and apply them to our sales funnel. Unique visitors at the start convert at 15% to the next stage which is the mailing list. Then 1% of mailing list subscribers convert to sales. Now we have the total number of sales.

v

225 $800X = $180,000

Year 1 Sales is worked out like this:

Now lets multiply this by the sales price. When you use a spreadsheet multiply the cells together because you can change them later and the model will automatically re-calculate everything.

This is what your Expense Assumptions listshould look like:

Now your expense assumptions. This is easy, because you need to get actual prices and quotes. Go online and pick up the phone. Do not guess. Get the quotes. You have no excuses. Just do it.

Asset Value / Useful Life = Depreciation

Workings for Depreciation in Assumptions

One thing you should be aware of is depreciation. Include this in your projections. It’s about the useful life of your assets like machines and trucks and items like that. Anything that is going to last for more than one year needs to be depreciated to show the amount of use that was used up in that year. Simply put, if a machine has a four year useful life then you will use a quarter of it’s value in one year. That’s the depreciation. This will be included later in the income/profit and loss projections.

Referenced from assumptions page

Once you have this done, you should move on to your income/profit and loss projections. Here do your projections for three years. Five year financial projections have been ditched for three year financial projections by most entrepreneurial theorists because it’s just too difficult to be accurate five years out. Here you should reference your sales from your assumptions page. Don’t type the number reference the cell in the assumptions page. Do the same for your expenses.

Sales - Total Expenses = Profit/Loss

Now, subtract the total expenses from the total sales to get the profit or loss for each year. To think that before you have seen this presentation you would have paid thousands of dollars to an accountant for this. See, once you have created your assumptions the rest is easy. Okay, just remember that when you are doing multi year Income/profit and loss to include the retained profit in your balance sheet. This is carried forward to the next year.

Cash Flow Example

Let’s move on to your Cash Flow. This is how you monitor what your bank balance will be. It’s very important. You must work out when payments will be made and when you will receive payment for sales. Now as a start-up, you will probably have to pay upfront and receive payment 30 days + or more after sales are made. You will have to plug the gap in your bank account that this will create. How you do this depends on the type of business you are involved in.

Cash Flow Example

Total Inflows - Total Outflows = Total Inflow/Outflow

Total Inflow/Outflow + Opening Balance = Closing Balance

Any sale that you have made in the income/profit and loss projection that will not paid in the cash flow for that year will go into the projected balance sheet as a debtor. Likewise, any expense that appears in your income/ profit and loss projections should appear as a liability in the projected balance sheet. For clarity sake tax is not included in this example. Make sure that you have enough cash to pay any taxes you may have incurred.

Balance Sheet

Moving on to the final element of our projections, the Balance Sheet.

Balance Sheet

What your business owns

What your business owes

A Balance Sheet lists what the company owns and owes at a particular point in time. You will project what you think your Balance Sheet will be on the last day of each year.The Balance Sheet should be the last thing that you do in your financial projections. Basically, your Balance sheet will show your fixed assets less depreciation along with the difference in Profit & Loss (Income Statement) and the Cash Flow projections in the form of current assets or liabilities.

Balance Sheet

See, it’s balanced!Balancing this, will be what has financed your companies activities such as any investment, long term debt, plus the rolling Profit & Loss (Income Statement) balance that you keep in the company (this is called reserves).

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Check out http://www.lostjobstartbusiness.com/ for free ebooks, presentations, videos, hints and how to guides on how to start a business after you have lost your job.