Business Plan Financial Projections: Stop Worrying About Being Right ...

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Business plan financial projections seem daunting because

they are so uncertain. This very uncertainty, however, is

what makes preparing them easy because you can't possibly be

right. You can't predict the future. None of us can. All you

can be is competent in the way you prepare your business plan

projections.

Before you finalize your business plan this year, consider

these six caveats to preparing your business plan financial

projections:

1. Don't offer pull-out-of-the-air, "conservative"

guesstimates about getting some percentage of the overall

market demand or year-over-year growth.

It is a mistake to assume that business investors will

appreciate your being conservative with your business plan

financial projections in the early years of your business.

Don't think for a Wall Street minute that presenting

"conservative" business plan financial projections indicates

"realism" to prospective business investors. Business investors

invest for one reason: to earn a return on their money. How

long the money is invested influences the amount of the return

earned. Let's say a business investor wants to triple an

investment. Well, if that investment triples in 3 years, the

return is 44%. If it triples in five years, the return is

25%. Adding just two years to the investment period nearly

halves the return! Now do you see why time is so important

to a business investor? Here are a few other examples: let's

say a business investor wants to:

Make 5 times an investment in 3 years = 71% return

Make 5 times an investment in 5 years = 38% return

Make 7 times an investment in 3 years = 91% return

Make 7 times an investment in 5 years = 48% return

Make 10 times an investment in 3 years = 115% return

Make 10 times an investment in 5 years = 59% return

So, while you may find it attractive to figure out how to

make "just a living" until the business venture proves

itself, you now understand why business investors want sales

and earnings to grow absolutely as fast as possible, without

being deceived, in your business plan financial projections.

On the whole, business investors are risk averse only to the

extent that they don't want to lose their money or tie it up

in a low return investment. Typically when you make the claim

that your business plan financial projections are "conservative",

it usually just means that you have no idea how and why you'll

achieve a certain level of sales within a certain time frame.

Interesting, these kinds of estimates, provided that you've

done some good thinking about market segments and overall

demand, often turn out to be too low. Remember, it's just as

bad to underestimate your sales, as it is to overestimate

them.

2. Avoid calculating costs as a straight percentage of

revenues.

Sure it's easier to do things this way, especially with

Excel and other business plan financial projection software.

Costs are real, however. You need to know what they are very

specifically. If you've done your homework in developing

your business plan, then you should already have this information,

or at least the basis of it. Just estimate and calculate your

costs on a product-by-product basis.

With these warnings in mind, use the following steps to

develop your business plan financial projections:

Think about what percentage of the overall market share your

competitors already own. Assume that they will continue

their present trends in growth. (Note: some competitors may

already be trending down and losing market share.) Temper

your market share estimates with some discussion of how your

entry into the market will affect these trends. Then,

estimate the percent of total, potential demand that remains

available to you.

Now, based on the limitations of your operations plans,

calculate how much of this remaining available demand you

can achieve. This is a very simple calculation. Start with

your overall productive unit capacity and factor it by the

expected yield of sellable product, then multiply these unit

sales by their respective selling prices and voila, you have

the revenue numbers for your business plan financial projections.

Let's take an example.

Your research indicates that 2 out of every 10 females age

23 to 55 will under go some type of non-invasive cosmetic

treatment in your area. Your research also shows that this

number is expected to grow 20% each year over the next 5

years. There are 40,000 females in your target market. You

identified four competitors in your target market. These

four competitors currently handle on average 6 procedures a

day. You plan to start a non-invasive cosmetic treatment

center that uses the most advanced technology and is thus

capable of performing an average of 7 procedures a day.

Using this data you calculate the following statistics

about your market and market potential:

Total market 40,000 females x 20% = 8,000 procedures per

year

4 competitors x 6 procedures x 250 days = 6,000 procedures

per year

Available procedures: 8,000 less 6,000 = 2,000 per year

Your productive capacity: 7 procedures a day x 250 days =

1,750 or 21.875% of the total market. The average selling

price for a procedure is $400. Thus, the revenue for the first

year in your business plan financial projection would be 1,750

procedures times $400 or $700,000.

Now, let's say you're were projecting 2,200 procedures per

year. This would mean that you would have to alter your

operating plan to be able to perform 2,200 procedures. You

would also have to demonstrate how you would capture an

additional 200 procedures from your competitors.

Granted this is an over simplified example, but it should

give you a feel for how this process works.

Regarding price, in most cases you should have a clear idea

of how to price your product or service. There are usually

other, similar products or services out on the market.

Unless your competitive advantage is a cost reduction and/or

unless price is a critical basis of competition, just

estimate the value of your improvement and add it on to the

average price currently offered in the marketplace. In order

to make this estimate, you'll have to be talking to

potential users. Find out what they pay now. Find out how

they feel about the current price. Ask them if they'd be

willing to pay more and how much more. If you ask enough

people, you'll get a general idea.

3. Never determine price on the basis of a margin you think

is attractive.

The market will pay you only for the value you deliver,

which is determined by the consumer paying the final price.

It's easy to make the mistake of thinking that a 20%, 40% or

even a 60% margin is great. Never considering that if the

product or service you're offering provides a real

advantage. If you do this, you may be grossly

underestimating the price you can get in the marketplace and

underestimating your business plan financial projections.

Consumers don't think in terms of margins. They could care

less about what you ought, "reasonably", to get for your

product. That's why you must find out the most that they'll

pay. This is the value of your product or service. Come up

with some reasonable basis for determining this real value.

Keep in mind the obvious: If the consumer's value on the

final product or service is less than your cost plus a

reasonable profit to keep your business growing, you're in

trouble. Your business model will not be sustainable and your

business plan financial projections useless.

Now calculate the costs of manufacturing and distributing

your product. These costs flow directly from your revenues

estimates and operations plan. How much will it cost to

purchase what equipment and materials, hire what personnel,

engage in what selling efforts, pay what accountants and

lawyers, rent what kind of space and so forth, to achieve

the revenues you're showing in your business plan financial

projections. You must be very specific. Project your costs

over time. Keep them tied to the units you need to sell to

achieve the revenues in your business plan financial

projections.

Obviously, costs and revenues work hand in hand.

4. Keep your fixed cost low.

Keep in mind that none of these revenues and the cost

estimates are going to be perfectly accurate, which means

the amount of profit or cash available to pay "fixed" cost

isn't going to be accurate either. As a result, you can lose

your shirt trying to pay for equipment, a receptionist, or

other activities that don't contribute to the sole objective

of making sales. Wherever possible, rent space, rent time on

equipment, answer your own phones, etc. To the extent that

you keep costs variable in your business plan financial

projections, you can cut back when sales are slower than

expected. It's the worst situation to have a big,

well-furnished office with an expensive secretary who

needs the job, when the money isn't coming in. High fixed

costs in your business plan financial projections also send

the wrong message to investors that you know more about the

"form" of doing business than about actually making money.

Now pull all your numbers together to prepare the financial

statements that summarize your business plan financial

projections. You need three basic statements: cash flow

analysis, income statements, and balance sheets. All of

these come directly from the above calculations. Your cash

flow analysis indicates when and what amounts of capital

infusion you'll need to start and sustain your business plan.

Make your income and balance sheet projections on the

assumption that you'll get the capital. For the first year

or two of your business plan financial projections, present

each of these statements on at least a quarterly basis.

Monthly is best. I suggest doing a 24- or 36-month projection

depending on your growth plans and changes in the industry that

you foresee. Follow these monthly or quarterly projections with

annual projections till you cover a span of 5 years.

Finally, run through some "what-if" scenarios or sensitivity

analysis. Though you business plan financial projections should

be based on your best, and best-supported estimates of costs

and revenues, you know you can't be 100% right. That's why it's

important to identify those elements or assumptions of your

business plan financial projections that you feel are most

uncertain. Write out the nature of the uncertainty and the range

you think the estimates will fluctuate up or down. Then change

the estimates accordingly and re-run all your statements.

Pay close attention to how your business plan financial

projections, especially cash flows, change when you change

each assumption. This will help you determine how much

"cushion" you have available and, if business isn't going

according to plan, at what point cash will become an issue.

5. Do not simply assume that costs and revenues may be

"off", up or down, by some percentage.

Again, I know that Excel makes it easy to do this. For all

the same reasoning as above, stay focused on the assumptions

and details that make up your business plan financial projections.

It's the details you need to examine for their sensitivity and

their impact on the bottom line. You only need to alter those

specific items that you're most uncertain about. If it's revenues

that you're worried about, is it the price, the volume, or

both that concerns you most? How big a swing in the estimate

are you worried about, in what direction and why? If it's

your cost projections that are keeping you awake at night,

which cost elements and why? Things like rents and labor

costs can be determined fairly accurately. But maybe you're

unsure about materials or labor availability or how

efficiently you can produce your products or provide your

services. Maybe you'll have to pay extra to ensure their

availability. This kind of thinking forms the basis for running

"what-if" or sensitivity analysis on your business plan financial

projections.

6.Do not include every possible business

plan financial projection scenario in your business plan.

Both you and your investors need to know what aspects of the

business plan financial projections are most uncertain,

represent the most risk, in what direction, why, and how

they affect the bottom line. Having hundreds of alternative

scenarios to sort through is like a man with two watches

showing two different times... he never knows what time it is.

Lots of alternative business plan financial projections also

indicate that you're not too sure about anything. This is an

impossible way to communicate with business investors, manage

your business, or make important decisions. It's much more

effective to identify the risky areas of your plan, tell why

and how they impact the bottom line and what actions you

plan to take if they occur. This helps you and your business

investors stay focused on the high impact areas and to think

clearly about whether other factors should be considered as

well. It also lends more credibility to your talents and

increases the likelihood of your plan's success.

Finish this discussion with a summary of the critical

aspects of your plan and related contingency plans. If

you've followed all these steps, then you can figure out

what you'll do if your actual performance turns out to be

different than your business plan financial projections.

Remember, you're purpose is to demonstrate to business investors

that you're competent; worrying about protecting their investment

and running a business, not just flying by the seat of your pants.

Mike Elia is a chief financial officer and an advisor to venture capitalists and leverage buyout specialists. For more information about business plans and raising capital for your business or to review his business plan manual, visit Business Plan Secrets Revealed.

Working capital: financial options for small and medium-sized enterprises

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Introduction

Large companies have always had a number of options that they could depend on to raise capital for their businesses. The have always had access to a number of alternatives such as selling stock, issuing bonds, bank loans and accounts receivable financing among others. Looking at the other side of the coin, smaller companies, those that have between $20,000 and $500,000 of yearly revenues, have always had a challenge trying to find capital to operate their businesses.

The lack of access to capital has prevented many small businesses from growing and capitalizing on the many opportunities that are available to them. It is not uncommon for small companies to reject large deals or opportunities because they do not have the necessary capital to obtain the resources to service the account. However, even when small businesses do take on large contracts, they find that they are never paid immediately upon delivery of services. Most contract terms demand that the supplier provide 30 to 60 days for the customer to pay their invoice - in effect, forcing them to extend them with supplier credit. The lack of adequate capital resources, along with the necessity to offer commercial credit to clients, creates a "perfect storm" that prevents small businesses from growing and that is very difficult to avoid.

A number of these issues could be sidestepped if the company had immediate access to working capital. Working capital could enable the business to add employees and resources to serve new clients and larger contracts. It also enhances a company's ability to extend 30 to 60 day payment terms to their customers.

This paper outlines the most common sources for working capital and provides an evaluation of each source. Each source has also been assigned a score, which summarizes the availability and flexibility of the source.

Scoring System

Each working capital source that has been evaluated has been given a score from 1 to 10. The following features where considered when assigning a score:

Accessibility to small businesses Requirement complexity (e.g. do they require significant financial reporting?) Flexibility Payment terms

A higher score indicates that the source of capital has a positive outlook on a number of these criteria and is available to small businesses. A lower score indicates that a particular source of capital may not be best suited for most small businesses.

Financial Options

Venture Capital - Score: 1

Many books and publications tout the benefits of obtaining venture capital to finance a new or ongoing operation. Venture capital is an option for small companies that have a seasoned management team and very aggressive growth plans, however, venture capitalists will rarely invest in small businesses that have no intention of going public. The venture capitalist objective is to invest in a company for a short period of time - say 5 years - and then cash out of the business while making a significant return on their investment.

Angel Investors - Score: 2

An Angel investor is a wealthy individual or group of individuals that typically invest in pre-venture capital companies. That is, companies that don't meet the current requirements of a venture capitalist but that could meet their requirements with a capital and management influx. However, you should not rule out angel investors completely since there are angel investment groups who focus on the growth of certain communities and will invest in small businesses. The best way to find an angel investment group near to you is to search them on the Internet using a search engine such as Google (www.google.com).

Banking Institutions - Score: 4.5

Most small businesses owners will first approach their bank to try and obtain a loan or line of working capital. However, unless the business has been in operation for a number of years, has substantial assets and all the appropriate financial records, their chances of obtaining any financing are minimal. Banks, however, can provide lines of credit if the business owner personally guarantees them. This means that the business owner will be personally liable for the repayment of these loans. These lines of credit can provide the business with the needed working capital; however they can be very risky, especially if the business does not produce the expected results and the owner is unable to repay the bank. Business owners should use this method of financing very cautiously.

Credit Cards - Score: 5

Much like bank lines of credit, many business owners use their credit cards to fund their businesses. Credit cards offer the ability to make purchases or obtain cash advances and pay them at a later time. It should be noted that credit cards can be a very expensive source of funding. Although most credit cards have reasonably low interest rates for purchases, their cash advance rates can be as high as 17% to 19% due to greater delinquency rates. Furthermore, most credit cards will charge you 2% to 4% of the face value of a cash advance as a "fee". Much like bank lines of credit, the business owner personally guarantees payment of a credit card. Thus, this method of financing can be very risky if the business does not produce the expected results and the business owner cannot repay the credit card company. Business owners should use this method of financing very cautiously.

Home Equity Lines of Credit- Score: 5.5

Business owners who are also homeowners have the option of tapping into their home equity to finance their ongoing business operations. Home equity loans and lines of credit have many advantages, such as low interest rates and the possibility of having some portion of it deducted from taxes . This method of financing gained a lot of momentum between the years 2000 and 2004 when interest rates where at their lowest point in decades and real estate was appreciating in value. A major disadvantage if this financing method is that it directly places the business owner's home at risk. In fact, the business owner is placing a bet - with their home as the potential wager - that the business will succeed and will be able to repay the loan. Much like lines of credit, business owners should use this method of financing very cautiously.

Small Business Administration - Score: 7.5

The US Small Business Administration (www.sba.gov) provides a number of very viable options to finance business operations. Although the whole scope of SBA services is beyond the scope of this paper, the SBA provides a "Microloan" program. The program objective is to stimulate micro-enterprises and provides loans of up to $30,000 to small businesses. These loans are usually provided through a financial institution or a bank. They have higher interest rates than traditional loans, but their requirements are more flexible, making them more accessible to small business owners.

Founders, Friends and Family - Score: 7

Friends and family are one of the most conventional ways of financing small businesses. Many entrepreneurs have been able to leverage existing relationships and obtain funding, either as a loan or as a capital investment, for their businesses. Although this source of funding can be easier to obtain that others, it does have some inherent problems. First, the business owner runs the risk of placing the relationship in jeopardy if things do not go as expected and the business defaults. Furthermore, these transactions are usually done with little formality and without written agreements, further complicating matters. If you elect to use this funding option, you should consult an attorney and draw some formal documents that describe the intent and responsibilities of each party.

Accounts Receivable factoring- Score: 8

Accounts receivable factoring, also known as invoice factoring, has been a source of working capital for large companies for many decades. It is now becoming mainstream and available to mid-size and small businesses. Factoring enables a company to sell their slow paying accounts receivable to a financial company, who in turn pays for the invoices within a day or two. After the sale, the financial company waits to be paid for the invoices. A key feature of factoring is that the factor will take the credit strength of the business' customers, as it's main consideration. Until recently, accounts receivable financing was out of the reach of the small business owner. However, enhancements in technology have now turned this method of financing into a viable alternative for small businesses. This means that a small company with little or no credit can leverage a strong roster of clients, sell their invoices and get funding very quickly. Factoring should be considered as an option for businesses that sell products or services to other businesses, rather than to consumers.

Conclusion

Obtaining working capital for their businesses is one of the most important decisions that a business owner can make. Like all important decisions, it should be carefully thought out and deliberately executed. The old adage that "the best time to look for capital is when you don't need it" is still true. You should spend some time researching the all available options for your business ahead of time, so that you can be ready to "tap" your war chest when the right opportunity arrives.

DISCLAIMER

This paper is written to provide small business owners with an overview of the financial options that are available for their businesses. However, this paper does not intend to provide financial or legal advice as only qualified professionals can do so. The author and Commercial Capital LLC disclaim all liabilities arising from the use of the information on this paper. Please consult a professional before making an important decision about your personal or business finances.

Invoice Factoring Group

Invoice Factoring Group and its small business factoring subsidiary can provide you with factoring and purchase order financing quotes at no cost to you. Marco Terry, its president, can be reached at 866-730-1922.