Developing financial part of the Business plan Lection 11.
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Transcript of Developing financial part of the Business plan Lection 11.
The main techniques of financial projection fall into three categories:
• Pro forma financial statements.• Pro forma statements are projected financial statements
embodying a set of assumptions about a company’s future performance and funding requirements.
• Cash budgets.• Cash budgets are detailed projections of the specific
incidence of cash moving in and out of the business.
• Operating budgets.• Operating budgets are detailed projections of company-wide
or departmental revenue and/or expense patterns, and they are subsidiary to both pro forma statements and cash flow statements.
Financial plan - Basics
• 5 year time horizon• First two help set cash flow expectations • Last three help define opportunity
• Income Statement
• Balance Sheet
• Cash Flow
• High-level summary of the growth
Financial plan - Basics (cont.)• Reasonable and defendable assumptions
– Highlight key assumptions– Have assumptions on separate tab that drive
the model– Assists in “what if” planning
• Some Key Assumptions– Price– Sales Growth– COGS
Line Items• Rent/employee/month• Equip costs/employee/month• Benefits• Bonuses/Commissions
• Commission plan• What is it versus existing players?
• Payroll Exp/month• Capital raising often results in salary increases• Change in compensation mix with later employees• Less stock heavy more cash intensive
Hints
• Headcount
• Plan slow/run like hell– Slower than expected
• Hiring• Product development• Sales/revenue
– Higher than expected• COSTS
Hints (cont.)• Investment capital is intended to fuel
accelerated growth– Expectations vs. reality– This can kill a business before it hits its stride
• Economies of Scale– Bureaucracies rule – EoS – so old economy
• Magic revenue number?• Market share in year five
Top Ten Mistakes
1. Presenting financials without ability to discuss detail if asked (the model demonstrates that the entrepreneur fully understands the full scope of the business)
2. Plan is overly optimistic. Revenue traction always takes longer. Must understand the sales qualification and challenges
3. Plan is overly pessimistic without clearly identifying upside 4. Revenue plan created solely to match the operational requirements5. Plan does not tie to pipeline, sales cycle, and ability to hire team6. Build plan to try and pump up valuation7. Failure to understand industry comparables and know the gross margins, expense
levels as a % of revenue, and operating margins 8. Failing to account for competition and its affect on prices9. Using the 1% of the market technique to justify opportunity (market size usually off
and most never get 1% of market)10. Entrepreneur does not understand cash implications and subtleties of the timing of
payments and receipts
Top Ten Things You Must Do - Company
1. Develop both a top-down and bottom-up plan2. Ramp-up of new staff must be realistic (including ramp-up and
availability)3. Quality, quantity, and stage of pipeline must be realistic4. Large deals and timeframe to close must be presented realistically5. Judgment needs to be applied to sales management6. In a small start-up, the CEO must know every major account7. Raise the right amount of money (What you need to deliver your
plan with a cushion)8. Working capital requirements must be carefully considered as they
impact CASH9. There are other ways to smooth out cashflow: AR lines, lease
Lines, debt, payables management, etc.10. Establish mentor/advisor relationships
Key questions that you should be able to answer in BP
• How much cash is in the bank?
• Forecast for the month?
• How long to cash flow break even?
• How much additional cash will be required?
• When will additional cash be required?
• What will you use the cash for?
Capital requirements
Before your business plan will be considered by investors, you must answer the following questions: How much time and money does it take to build the product? How much time and money does it take to get to a break even?
What is the total amount of funds needed by your business? Is it needed immediately or over the next two to five years?
What part of this financing is being sought from the investors or lending institution who will receive this business plan? (including the amount, terms, and any related security agreement)
What percentage of the company are you willing to give up and what is the proposed return on investment and anticipated method of taking out the investor (e.g., buy-back, public offering, sale)?
Will the capital markets finance a project of this size and duration?
Your Venture = Your project?
• NPV and IRR for your project.• Calculate WACC = ?• Determine the optimal development of
your capital structure
• r=?• ROI?
Financial information
•Should be a reflection of your business plan quantified (therefore, it must be consistent with the body of the plan) •Will help demonstrate whether your strategy is financially feasible and whether it allows you to reach your goals and objectives •Is a key indicator of the amount of outside financing necessary to support the execution of your strategy •Should include future projections which answer the following questions:
How will the company perform financially? - Profit and Loss Projections What will the company's cash position be? - Cash Flow Projections What will the company's financial position be? - Projected Balance Sheets
Financial information(cont.)
•Should include a list of significant assumptions used in any individual section or throughout the financial projections that are:
Material to the projected amounts Especially sensitive to variations Deviations from historical trends Especially uncertain
•Should include key financial ratios and should compare to competitors/industry averages. Key ratios include current, debt-to-net worth, return on equity, gross margin, and break-even point (in both sales units and dollars)
Creating Financial Forecasts
Step 1: Products/ServicesDevelopment timelineHow many products? Versions? Upgrades?Prices, discounts, price erosionSales/personCommissionsDistribution channelsCustomer support
Creating Financial Forecasts
Step 2: StaffingHow many departments?How many people to develop product?Timing of marketing and salespeople.Sufficient R&D staff for future products?Competitive salaries, benefits, commissions, recruiting.Administration Department
Creating Financial Forecasts
Step 3: Marketing and AdvertisingTradeshowsPublic relationsAdvertisingConsultantsLead time
Creating Financial Forecasts
Step 4: Other ExpensesCapital equipmentLicensing technologyPatent filingsTelecomRecruiting/RelocationTie as many expenses as possible to headcount
Creating Financial Forecasts
Step 5: Evaluate the ResultsPerform scenario analysisEvaluate your operating ratiosLook at comparable companiesDetermine your cash requirementsConsider a three month cash cushion
Building YOUR Model – Do’s and
don’ts – Sales
Do Don’t
Typically, the plan should state an average selling price per unit along with the projected number of units to be sold each reporting period. Sales prices should be competitive with similar offerings in the market and should take into consideration the cost to produce and distribute the product.
Assume that you achieve a certain percentage of market share just because it is a small percentage.
Building YOUR Model – Do’s and
don’ts – Cost of Sales
Do Don’t
Accurate unit cost data, taking into consideration the labor, material, and overhead costs to produce each unit. Be sure to have a good grasp on initial product costing so it is protected against price pressure from competitors
Assume a certain percentage for gross margin based on industry average. (while this can be a great sensitivity check…)
Building YOUR Model – Do’s and don’ts – Product Development
Do Don’t
Product development expenses should be closely tied to product introduction timetables elsewhere in the plan. Usually, the headcount should come out directly from the timeline for development.
Assume that you can have a world record in the timing of development and/or a minimal compensation to employees.
Building YOUR Model – Do’s and don’ts – S&M and G&A
Do Don’t
A detailed set of expense assumptions should take into consideration headcount, selling and administrative costs, space, and major promotions. It is useful to compare final expense projections with industry norms. All expense categories should be
considered.
Take industry/certain company ratios
Business plan presentation
Business plan
What Why HowHow much
Venture Capital Fund
Business AngelBANKS Gov, NGOs, FUNDS etc
Financial Plan - Funds Required and Their Uses
A. Current Funding Requirements
1. Amount2. Timing3. Type
a. Equityb. Debtc. Mezzanine
4. Terms
B. Funding Requirements over the Next Five Years
1. Amount2. Timing3. Type4. Terms
C. Use of Funds1. Capital expenditures2. Working capital3. Debt retirement4. Acquisitions
D. Long-Range Financial Strategies (liquidating investors’ positions)
1. Going public2. Leveraged buyout3. Acquisition by another
company4. Debt service levels and timing5. Liquidation of the venture
What Does Mezzanine Financing Mean?
• A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing is basically debt capital that gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies.
Since mezzanine financing is usually provided to the borrower very quickly with little due diligence on the part of the lender and little or no collateral on the part of the borrower, this type of financing is aggressively priced with the lender seeking a return in the 20-30% range.
Financial Data
A. Historical Financial Data (past three to five years)
1. Annual statementsa. Incomeb. Balance sheetc. Cash flows
B. Prospective Financial Data (next 5 year)
1. Next year (by month or quarter)a. Incomeb. Balance sheetc. Cash flowsd. Capital expenditure budget
2. Final four years (by quarter or year)a. Incomeb. Balance sheetc. Cash flowsd. Capital expenditure budget
3. Summary of significant assumptions4. Type of prospective financial dataa. Forecast (management’s best estimate)b. Projection (“what-if ” scenarios)