Business projections modeling

overview
Doing Business 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
Excel
Creativity, attention to detail, and good judgment.


Some Warnings

Most people starting new businesses are much too optimistic
about the future financial results of their business. Their
energy and enthusiasm cloud their judgment. They
underestimate the time it takes to get things done, and how
much things will cost. Over-optimistic expectations often lead
to underestimating how much money they need to finance
initial losses.
Once a business really gets going (in Year 2 or 3), doubling the
size of the business each year is about the maximum a good
CEO really can achieve. Even growth that fast (double every
year) is extremely difficult to manage. Most successful
businesses do not grow faster than 100% per year, nor do they
need to.

Financial Projections
Financial projections should include the
following kinds of final output:
Income Statements
Balance Sheets
Sources and Uses of Cash Statements (Cash
Flow Statements)
The invention of spreadsheet software has made
financial statement models easy to create and
even easier to play with. Follow this link for a
simple projection model template.
Financial Projections
In practice, though, you will likely have to build your
own income statement model. The key drivers often
are unique to the particular situation. You can use
the template model, however, to help calculate
Balance Sheets, Sources and Uses of Cash, plus do
some Statement Analysis just by inputting your
custom income statement, and making some simple
assumptions.
It is usually best to do monthly projections for the
first two years, then quarterly after that. Add the
periods up, and present the annual summaries to
potential financing sources.

Income Statement
Monthly
Projections
Month 1 Month 2 Month 3 Month 4 Month 5 Month 6
Revenues
Cost of Goods
Sold
Gross Profit
Sales &
Marketing
Expense
General &
Admin Expense
Operating
Income
Depreciation
Expense
Interest
Expense
Taxes
Net Income
(Loss)
Income Statement
Key points:
Revenues & expenses are independent of cash payments. Recognize them
when a transaction happens, not when cash comes in or goes out (maybe
much later).
Cost of Goods Sold is the direct costs in producing your service
materials, installation costs, customer service, maintenance, etc.
Revenue Costs of Goods Sold = Gross Profit
General & Administrative are support costs, like finance, HR, IT, top
management
Gross Profit Sales & Marketing General & Admin = Operating
Income, also known as Operating Cash Flow
Following these conventions allows for comparison of your projections
with other similar business results.
Depreciation expense spreads out the cost of property, plant and
equipment over its useful life.
R&D costs?

Financial Projections
Making Assumptions
Start with the monthly numbers for Year 1. For any
business raising money, making your numbers in your first
year of projections is really important. If you, as
management, miss these numbers you may:
Run out of money too soon,
Get fired and/or
Not be able to raise more money.
If 1) or 3) happens, you will probably go bust.

Financial Projections
Consider the macroeconomic situation when
building your projections:
Overall economic growth rate of GDP during
projection period
Economic recession(s) - timing, duration
Rate of inflation
Level of interest rates
Tackle the Income Statement first. Project your
number of customers based on the key revenue
driver. Project monthly sales for twelve
months....

Financial Projections
Monthly
Projections
Month 1 Month 2 Month 3 Month 4 Month 5 Month 6
Customers 0 0 11 20 45 77
Revenues 0 0 3 6 13 26
Financial Projections
Next, think through the 12 months of costs associated with these sales:
Cost of Goods Sold materials, installation costs, inspection,
maintenance, regulatory costs, billing system
Selling costs sales people, advertising, travel, web site
Administrative Costs Management, office space, supplies, utilities,
insurance
Points to remember:
You may not have any revenues for the first few months as you
build the system, sign up customers, etc. but you will still have
expenses. Model this.
Dont forget to figure in one-time start-up costs (incorporate, write a
business plan, licensing, permitting fees, getting regulatory approval,
etc.)

Financial Projections
If you have more than one product or service, model
them separately, then total them.
Be sure to model total headcount and include cost of
benefits (20-25% of salary, typically). You should
allocate personnel costs into Cost of Goods Sold,
Marketing & Sales and General & Administrative,
based on function.
Rental space can be: (Headcount x Avg. Sq. Ft. Per
Person x $ Cost Per Sq. Ft.)
Your projections might look something like this:

Financial Projections
Monthly
Projections
Month 1 Month 2 Month 3 Month 4 Month 5 Month 6
Revenues 0 0 3 6 13 26

Cost of Goods
Sold
0 0 1 3 6 13

Gross Profit 0 0 2 3 7 13

Sales &
Marketing
Expense
4 5 7 9 11 12

General &
Admin Expense
4 7 9 11 13 16

Operating
Income
-8 -12 -14 -17 -17 -15

Depreciation
Expense
1 1 1 1 1 1
Interest Expense 1 1 1 1 2 2

Taxes 0 0 0 0 0 0

Net Income (Loss) -10 -14 -16 -19 -20 -18

Financial Projections
Annual
Projections
Year 1 Year 2 Year 3 Year 4 Year 5
Sales 150 800
Cost of Goods
Sold
77 350
Gross Profit 73 450
Sales & Marketing 102 195
General & Admin 140 210
Operating Income (169) 45
Financial Projections
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.
Remember to increase costs with sales. A common mistake, for
example, is to forget to add personnel as the business grows.
And, as personnel increases, so may rent, supplies, utilities,
insurance, etc.
Compare your Income 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:

Financial Projections
Annual Projections Year 3 As a % of Sales
Sales 800 100%
Cost of Goods
Sold
350 44%
Gross Profit 450 56%
Sales & Marketing 195 24%
General & Admin 210 26%
Operating Income 45 6%
Financial Projections
Look especially at the gross and operating profit margins,
and at the categories of costs. At this stage of your
business, your profit margins should not be higher than
similar operations nor your cost margins lower. Does
your business differ in key respects? If so, can you explain
why? If not, you are probably being to optimistic.
If your projections look reasonable, smooth in the year(s)
between Year One and your projected break even year.
Project out past your break-even year. Do not grow faster
than people will believe. Consider a 50% annual growth
rate in revenues, as a first cut. Remember to increase costs
as you grow.
Financial Projections
Next, Some Assets
Transfer the Income Statement totals to the model template, or construct
your own Balance Sheet and Sources & Uses model. Typical key items:
Other reasonable links or relationships are possible. You want the balance
sheet to grow in line with the growth of the business. Balance sheets use
cash, too.
One also needs to project the Capital Expenditures (Property, Plant,
Equipment purchases) and some Depreciation Expense. Include
replacement costs for failed as well as worn out equipment. Set
Depreciation Expense as a percentage of Net Fixed Assets as of the end of
the previous year. The template assumes an average rate of 10 years.
The template model will use this information to complete a Sources and
Uses of Cash Statement and generate a large number in the Necessary to
Balance line of the Balance Sheet.

Financial Projections
Category Numbers
Expressed As:
Examples:
Cash in Banks % of Sales 3% of Sales
Accounts
Receivable
% of Sales Sales x 1/6 (60 Day
Turnover)
Inventory % of Cost of Goods
Sold
Cost of Goods Sold
x 10%
Fixed Assets Formula Yr. = Last Yr. +
CapEx - Deprec.
Other Assets % Sales 1% of Sales
Accounts Payable % of Costs of Goods
Sold
Cost of Goods Sold
x 1/6
Accrued Expenses % of S&M + G&A
Expense
S&M + G&A
Expense x 1/12
Financial Projections
Necessary to Balance is not an accounting category.
Instead, for each Year, Necessary to Balance represents
the amount of financing that you need. You must assume
that you will sell equity or borrow debt, or some combination -
- equal to the amount of Necessary to Balance. For
example, in the template attached, the business needs to raise
$900,000 to finance the first year of operations.
If Necessary to Balance shows extra cash (versus a need for
financing), you can pay this out in dividends to your investors
or add it to your cash account cell. The second is probably
more realistic in the case of a new business.