So now we do the math. You will attach actual numbers to those sales projections, advertising strategies and monthly operating expenses. You will add up the items on your wish list and learn what you can and cannot afford to do.
You will see where adjustments must be made. You will develop a budget for the project, devise a plan to finance it and greatly improve your chances of launching and sustaining a successful business. You will make your dream come true!
We’ll examine five financial documents: Pro Forma Cash Flow; Profit & Loss; Balance Sheet; Quarterly Budget Review and Break Even Analysis. We’ll also take a look at the Financial Assumptions Summary and the Summary of Financial Needs, which are required for those who seek investors or a lender.
THE PRO FORMA CASH FLOW STATEMENT
This is the monthly (or quarterly) budget for the business. If you run a household, you already know how to do this. The statement documents the expected ( projected) money that will flow into and out of your business. You as the entrepreneur will learn how much capital investment your business will need to keep the doors open and the products available for customers to purchase. Investors and lenders will know if there is enough money to operate the business and if your business is worthy of a loan.
Accounts receivable are what customers owe you as payment for services provided by your business or payment for products sold. Invoice= paycheck—with the important caveat that some customers will not pay you on time and a few will not pay you at all. Accounts payable are the bills the business must pay each month.
At the risk of sounding painfully obvious, make sure that you have a very good chance of bringing in enough money each month to cover the bills, at least after doing business for 18-24 months. Maybe this means you can’t give up your day job just yet.
If your day job is gone, then expect to dip into savings or convince friends and family to help you float the venture. I will caution you that when it comes to friends and family, money can change the relationship, sometimes not for the better.
Refer to your marketing plan before you begin the cash flow statement. Look at your advertising calendar and your desired ad campaigns, products that must be shipped, required travel to see clients, etc. Determine the selling, or variable, expenses. These change whenever sales volume increases or decreases.
Labor is a variable expense, as it is tied to the production of what will be sold. If you plan to open a restaurant and hire a chef, that employee is labor since he/she produces the product.
Get a firm grip on your Cost of Goods Sold (COGS), meaning the wholesale price or the cost of raw materials needed to produce your product. An intangible product or service also has a COGS— time and talent. Knowing COGS helps you determine a mark-up, or profit margin, that guides your pricing strategy. The objective is to not only cover production costs but also to generate money to sustain business operating costs and you as well. COGS impacts pricing, which impacts sales projections.
Fixed expenses are administrative. They don’t change much month to month. Rent, utilities, insurance, office supplies and wages to non-production employees (e.g. the sommelier at your restaurant) fall into this category.
New businesses producing the first few months of Pro Forma Cash Flow statements will be documenting start up costs. If start up costs are too heavy, trim or stagger expenses wherever practical.
Quarterly tax payments, loan payments, loan money received and planned inventory purchases are also documented in Pro Forma Cash Flow. In other words, whatever you expect to spend that month and whatever you expect to sell that month, document in this statement.
At the bottom of Pro Forma Cash Flow there is a line called Ending Cash Balance. Your mission is to have that number be positive and greater than zero.
If the numbers show that expenses will be very heavy, do not even think about increasing your sales projections to disguise a cash shortfall! Unfortunately, many entrepreneurs inflate projected sales revenue. That practice will take you straight to cash flow hell when the projected accounts receivable do not materialize. I can assure you that the accounts payable will materialize.
Your best option is to dial back on certain costs. Consider less glamorous product packaging, lower cost advertising, lowering the COGS by finding another source or using less costly raw materials, or renting cheaper office space.
Nest week, we’ll examine the P & L and the Balance Sheet.