Pro Forma Projections How to prepare reasonable projections based on your market and customers

Pro Forma Projections How to prepare reasonable projections based on your market and customers Dennis Beard, Serra Ventures, LLC EnterpriseWorks EIR Workshop Series, February 16, 2011

Workshop Agenda 2 Understand basic questions to answer before starting the process Preliminary steps in preparing projections The ABC s of preparing financial projections

About Serra Ventures, LLC and Serra Capital 3 Offering Professional Advisory Services in: Business strategy Capital formation Transitional executive leadership Organizational development EIR assistance Specializing in early stage, high technology enterprises Serra Capital provides seed and early stage funding on a selective basis Tim Hoerr and Dennis Beard, principals

Benefits of Financial Forecasting 4 A disciplined means to evaluate the cash needs of a venture. An aid to determine whether a proposed venture deserves the entrepreneur s investment of capital and effort. A means to compare the expected values of strategic alternatives. A way to demonstrate project merits to investors and to use in negotiating ownership. A way to identify appropriate benchmarks for assessing project development.

Dilbert 5

Basic questions to answer before 6 starting the process Who will be the audience for the projections? Do you have the in-house expertise in accounting, or should you hire professional assistance? What kind of data do you have at your disposal external and internal? How simple v. complex should your projections be? Should you want to create multiple scenarios: expected case, worse case, best case?

Simple income statement projections v. all-accounting-statement projections 7 Basic requirement is a 3 to 5 year income statement projection May also want to do a simple cash flow projection, deriving the cash flow statement from the income statement (this is considered a hybrid) All all-accounting-statement projection includes: Income statements Cash flow statements Balance sheets Statements of retained earnings (can be optional) Supporting schedules (depreciation, loan amortization, etc.) Footnotes (explanatory notes)

Integration of Financial Statements: 8 The Circular Flow Beginning Balance Sheet Income Statement Cash Flow Statement Ending Balance Sheet Sales Forecast Assumptions

The Cash Flow of a Business Venture 9 Infusions Capital (equity and debt) Expenditures Beginning Cash Reinvestment (to retained earnings) Employees Materials Fixed Assets Production Inventory Cash Sales Ending Cash Credit Sales Accounts Receivable Collections Equity Returns Debt Service Taxes

Preliminary steps in preparing projections 10 Step 1: Determine whether to do a simple income statement projection, all-accounting-statement projection, or a hybrid. Step 2: Make a decision on number of years to project usually three to five. Step 3: Assess quality and availability of data to support your projection. Step 4: Involve at least one other person, preferably a team, in assisting you throughout the process.

ABC s of Preparing Financial Projections 11 Step 1: Choose your electronic tool Excel or similar spreadsheet software Step 2: From your raw data and information, prepare a Table of Assumptions: Revenue, Expense, Balance Sheet Step 3: Build your projected financial statements with the Income Statement, Cash Flow Statement and Balance Sheet being driven off the Table of Assumptions

ABC s of Preparing Financial Projections, cont. 12 Step 4: Build supporting schedules Depreciation, Loan Amortization Step 5: Print draft versions of all schedules Step 6: Carefully audit and review each schedule manually recalculating to double-check Step 7: Involve at least one other reviewer to check your work

New Company Assumptions 13 Development will require 18 months, during which no sales will be made. Initial sales of $10,000 in the 19 th month. Sales will grow 8% per month in real terms for three years and at the inflation rate thereafter. Cash operating expenses during the development period of $15,000 per month, plus inflation. Inflation at 9 percent per year.

New Company Assumptions, cont. 14 A $200,000 production facility will come on line at the end of month 18. The facility is to be leased by the company for the first 5 years of operation, with monthly payments of $3,000. Gross profit of 60% of sales revenue on materials costs with trade discounts. Selling expenses of 15% of sales. Administrative expenses of $2,000 per month beginning in month 19, growing at the inflation rate, plus 15 percent of sales (including in development period operating expense total)

New Company Assumptions, cont. 15 Entrepreneur s salary of $3,000 per month through the first full year of sales (included in initial operating expenses), increasing thereafter by $500 per month. Corporate tax rate of 45%. No loss carry forward. All sales are for credit. The average collection period is 45 days. No discount for prompt payment. The inventory turnover rate is 5 times per year, measured against ending inventory.

New Company Assumptions, cont. 16 The company desires to maintain the greater of 30 days sales in cash or $10,000. All materials are purchased on credit, with terms of 2/10 net 30. The company anticipates paying in time to receive the discount. The payables period is 10 days. The entrepreneur will borrow any funds necessary at a rate of 1% per month. Initial investment by the entrepreneur of $200,000. Additional financing as needed by borrowing on a line of credit.

Income Statement Tips 17 Revenue assumptions are key on what are you basing the assumption? Don t be overly optimistic Break revenue down into categories (grant funding, product revenue, service revenue, etc.) Provide ample detail on operating expenses Build a separate schedule for Personnel/Staffing & Benefits

Income Statement 18

Balance Sheet 19

Cash Flow Statement 20

Presentation Tips 21 Try to fit each schedule to one page if possible Use consistent font treatment throughout; selective use of bolding and italics to bring emphasis Prepare summary explanatory notes to append to the presentation Excerpt key highlights from the financial projections into your Business Plan. Some examples include: Revenue, Gross Margin, Operating Income, EBITDA, Net Income, Operating Cash Flow, Debt, Equity Use Graphs to summarize key highlights of projection

Sample Graphs of Projection Highlights 22 Revenue EBITDA $2,500,000 $200,000 $2,000,000 $1,500,000 $1,000,000 $500,000 Revenue $0 ($200,000) ($400,000) 1 2 3 4 5 EBITDA $0 ($600,000) 1 2 3 4 5 ($800,000) $8,000,000 $7,000,000 $6,000,000 $5,000,000 $4,000,000 $3,000,000 $2,000,000 $1,000,000 $0 Invested Capital 1 2 3 4 5 Invested Capital

Trick and Traps of Financial Projections 23 Number one problem: overly optimistic projections Not following typical accounting guidelines to format and present your projections (they appear unprofessional and homebaked) Math and clerical errors Balance sheets don t balance The different statements don t integrate with one another Poor formatting and font use

Contact Information 24 Dennis Beard dennis@serraventures.com Tim Hoerr tim@serraventures.com 217.819.5201