Sunday, June 26, 2011

Financial Projections - Bring out the crystal ball

Financial projections, the backbone of any new venture. When all is said and done, the business plan polished, the website up, the office space rented, what most investors and outsiders will focus on is the numbers. Will the company make money? Are the projections realistic? When does it break even?

So how do you put together a reasonable, yet conservative, yet attainable, yet attractive 5 year financial forecast? Seems like an impossible feat to balance all the requirements. With reasonable assumptions, a straight forward model that captures all of the moving pieces of the company, and easy to change inputs that flow through the model, you will be well on your way to demonstrating the potential of your venture.

Assumptions - where it all happens

The use of an assumptions tab, one central location for all inputs into the model, will make your model dynamic, easy to change, professional, and understandable. Someone can look at one page, see all the inputs and how they relate to the final numbers, and quickly decide if everything looks reasonable.

When the assumptions are built properly, you will have put thought into every line on the P&L and Balance Sheet, as well as have some sense as to any investment funding needed, what amount of the equity you are willing to sacrafice, how long it would last, and what the future funding requirements will be. All going to plan of course.

Common Modeling Mistakes

Below is a list of things I see time and again in others models. Not that everyone should be an Excel expert, but avoiding these pitfalls will add to the credibility of your model, and ease of use.

Embedding data into formulas

I've seen lots of models built by other financial types as well as entrepreeneurs. The biggest mistake that is quickly apparent is embedding data into formulas. If revenue will be $20 per unit, don't hardcode $20 into each months revenue formula. Instead an input on an Assumptions tab would be Revenue Per Unit: $20, and the sales calculations all refer to this cell. Down the road when you realize you want to charge $25 per unit, it's a lot easier to change 1 cell vs. 12 months X 5 years. Also hard coding numbers into formulas creates an inevitable error down the road when some formula doesn't get updated like it should.

Projecting over a million in Revenues Year 1

I've yet to see a startup hit over $1 million in revenues in its first year. Investors have been around the block, and the further north of $1 million your projections go for year one, the less credible they become.

The financials all have to tie together in the end

Accounting 101: Debits = Credits. Balance sheets have to balance, cash flow statements have to reflect the same cash balances that are on the balance sheet, net income needs to match the equity section, etc. A properly built model will link all financial reports together in a way that when a change is made, all financial reports reflect the change and stay in balance relative to the others.

For example, if you change an expected investment of $100,000 to $200,000, not only does the equity section change on the balance sheet, your cash position as well as your cash flow statement would also.

Presentation goes a long way

Excel is a powerful tool, make use of all the formating capabilities. It is difficult to follow spreadsheets that have inconsistent formatting tab to tab, use several colored cells, several fonts, or worse no distinguising headings. When Revenue, COGS, Operating Expenses and all the subtotals are one long list with no bolding, offsetting, subtotal lines, etc, it looks unprofessional and difficult to really grasp what the results are.

As always, if you have questions, concerns, or need to call in the pro to help you build your financial model, get in touch with me, Chris Benjamin the Rogue CFO!

Chris Benjamin, Rogue CFO

No comments: