CHAPTER 19
Financial Forecasts
If you’re thinking of starting a business or expanding an existing company, you’ll need funds to finance the cost. This chapter hones down what it is you will require to launch your concept. So take a deep breath as we move into more strict rules of financial analysis.
To build an effective financial strategy to raise capital you should answer these questions:
• How much money do you need to launch a company or finance expansion?
• What are your timeframes?
• Do you need the following?
Additional fixed assets (machinery, property, or equipment and machinery).
Professional research and development.
Additional working capital.
• Where will these finds come from?
Personal or your own business.
Commercial banks and other conventional lenders.
Risk capital investors.
• Which option is best for you?
Projection Information
There is no option to raising funds. You must be able to present a clear, concise, logical, and financial projection backed by research. This is the most important key to having a chance of obtaining the capital you desire. If you don’t have financial forecast ability, hire a researcher to obtain the statistics you desire to back financial forecasts and a forensic auditor to conduct financial projects using these statistics.
Note that your forecast should be set out monthly for the first year and annually for the next 4 years and should include notes to fully support the following:
• Sales estimates and related costs.
• Administrative, production and other costs.
• Indirect costs of sales.
• Inventory costs and turnover.
• Capital expenditures.
• Gross margin.
• Annual sales growth rates.
• Interest rates on debts.
• Income tax rate payable.
• How you intend to collect accounts receivable.
• Accounts payable schedule.
• Depreciation and amortization schedules.
• Usefulness of assets.
The Income Statement (Profit and Loss)
Income projections enable you to develop a forecast of expected income to be generated each month and for the business year, based on reasonable and fair predictions of monthly levels of sales, costs, and expenses.
Total Net Sales (Revenues)
The total number of products or services that you realistically expect to sell each month at prices based on market research. Use this step to create the projections to review your pricing practices.
Estimate the returns, allowances, and markdowns that you expect, given market trends.
Cost of Sales
The key to accurately calculating your cost of sales is take all costs into account to determine total net sales. Where inventory is involved, remember transportation costs and any direct labor.
Subtract the total cost of sales from the total net sales to obtain gross profit.
Gross Profit Margin
The gross profit is expressed as a percentage of total sales and is calculated by dividing the gross profits by the total net sales.
Controllable Expenses
These include the following:
• Salary and wage expenses, including overtime.
• Payroll expenses, including sick leave, health insurance, unemployment insurance, and social security taxes.
• Outside services, including subcontracts, overflow work, and special once-off services.
• Supplies, including services and items purchased for use in the business.
• Repairs and maintenance, including regular maintenance and repairs.
• Advertising, including targeted classified directory advertising expenses.
• Car delivery and travel, including charges if personal car is used in business, including parking, tools, and buying trips.
• Accounting and legal, including professional services.
• Utilities costs.
Fixed Expenses
These include the following:
• Rent of business premises.
• Depreciation and amortization of capital assets.
• Insurance, including fire or liability on property or products and workers’ compensation.
• Loan repayments, including interest on outstanding loans.
• Licenses and permits.
• Miscellaneous, which tend to be small expenditures without separate accounts.
Income Statement Worksheet
Revenue Projection
Step 1: Calculate turnover less expenses directly related to the sales.
• Total sales = number of credit and cash sales. Also called turnover and revenue.
• Total sales less costs of sales = total net sales
• This is also called gross profit.
Gross profit as a percentage of sales = gross profit margin (%)
This also denotes how productive a company is, in two ways:
Relative to itself over the years. If the ratio improves, the company is getting more efficient.
Relative to other similar companies. If your ratios are better than competitors, your system is more efficient and ultimately places you in a position to outperform competitors, but if you are not, take note and assess how you can improve these ratios.
As this is a ratio, the solution is either that your costs are too high relative to sales or that your sales are too low to justify costs.
Step 2: Calculate gross profit less expenses
• Controllable expenses include the following:
Salaries and wages.
Legal and accounting.
Advertising and promotions.
Vehicles.
Office supplies.
Power utilities.
Other.
• Fixed expenses include the following:
Rent.
Depreciation.
Insurance.
License and permits.
Loan payments.
Other.
• The foregoing two equal total expenses.
• Gross profit less expenses = profit before tax.
This form should be used to project monthly income and expenses for year I and then to provide annual projections for the next 4 years.
The Balance Sheet
Assets versus Liabilities
Step 1: Outlining Assets List anything of value that is owned or legally due to the business. Total assets include all net values. These are the amounts derived when you subtract depreciation and amortization from the original costs of acquiring the assets.
• Current Assets include the following:
Cash: List cash and resources that can be converted into cash within 12 months from the date of the balance sheet.
Includes cash on hand and demand deposits in the bank.
Accounts receivable: The amounts due from customers in payment for products or services.
Stock: includes raw materials on hand, work in progress and all finished goods, either manufactured or purchased for resale.
Investments:
Short-term Investments: These include interest receivable and dividend income.
Long-term Investments: These include shares, bonds, and savings accounts earmarked for special purposes.
Prepaid expenses: goods, benefits, or services a business buys or rents in advance.
• Fixed Assets include the following:
Land, buildings, machinery, and vehicles: List original purchase price without allowances for market value.
Improvements to property.
Step 2: Outlining Liabilities
• Current Liabilities
Accounts payable: Amounts owed to suppliers for goods and services purchased in connection with business operations.
Notes payable: The balance of principal due to pay off short-term debt for borrowed funds. Also includes the current amount due of total balance on notes whose terms exceed 12 months.
Interest payable: Any accrued fees due for use of both short- and long-term borrowed capital and credit extended to the business.
Taxes payable: Amounts estimated to have been incurred during the accounting period.
Payroll accrual: Salaries and wages currently owed.
• Long-term Liabilities
Notes payable: List notes, contract payments, or mortgage payments due over a period exceeding 12 months. They are listed by outstanding balance less the current position due.
Step 3: Calculating Owners’ Equity
• Also called net worth, it is the claim of the shareholders on the assets of the business. In a proprietorship or partnership, equity is each owner’s original investment plus any earnings after withdrawals. In a corporation it is the capital investment paid for the issuance of stock, plus the surplus paid in by the principals, and the after-tax retained earnings.
Total Liabilities and Net Worth: The sum of these two amounts must always match that for total assets.
A cash-flow model should have monthly details for the first year of operations, followed by a summary overview of how cash flow will be in the next 4 years.
Step 1: Cash and Cash Receipts
• Start with the cash you have at the beginning of the month, called cash brought forward.
• Add cash received from cash sales.
• Add collections from credit accounts.
• Add other cash injections.
This equals total cash receipts.
Step 2: Cash and Cash Payments
• Start with cash purchases.
• Add gross wages.
• Add payroll expenses.
• Add other, which includes advertising, office supplies, power utilities, sick leave, insurance, repairs and maintenance, taxes, travel and delivery services, and unemployment insurance.
This subtotal indicates cash payments for operating costs.
Step 3: Additional Cash Payments
• Loan principal payment.
Include payment on all loans, including vehicle and equipment purchases on time payment.
• Capital purchases
Non-expensed (depreciable) expenditures such as equipment, building purchases on time payment, and leasehold improvements.
• Other start-up costs
Expenses incurred prior to first-month projection and paid for after start-up.
Should include payment for such things as owner’s income tax, social security, health insurance, and executive life insurance premiums.
• Reserves:
Insurance, tax, or equipment escrow to reduce the impact of large periodic payments.
Step 4: Total Cash Paid Out
• Add the totals of Steps 2 and 3.
Step 5: Cash Position (End on Month)
• Subtract Step 4 from Step 1.
Key Indicators and Ratios
Being able to summarize your important financial points allows the funders to get an insight into whether or not you understand how the money world operates. The financial industry judges your potential success by international standards and ratios.
If you struggle with numbers ask an accountant to calculate the following ratios:
• Current ratio (1 to 1 or better): current assets divided by current liabilities.
• Quick ratio (0.5 to 1 or better): current assets less inventory divided by current liabilities.
• Debt to worth ratio (3 to 1 or better): creditors capital to owner’s capital.
• Gross profit margin (60 percent or better): gross sales less cost of goods sold.
• Net profit margin (10 percent or better): gross sales to net income.
• Debt coverage ratio (1.25 to 1 or better): net income divided by debt payment (principal and interest).
• A/R turnover ratio (as close to 12 as possible): gross sales divided by accounts receivable.
Rainmaker Observation: There are many good computer financial programs available to assist you in formatting your projections. After you have taken a run at the numbers by yourself, it is always a good idea to have your accountant look them over.