Financial Projections (1) – Assumptions and Cash Flow MHR 308 Summer 2002

Financial Reporting  Accrual Method –Used in typical financial statements and what you learn in accounting courses –Takes into account both payments and receipts earlier and later than they are due –Recognizes a sale (revenues) before money is ever received  Cash Basis –The only way to keep accounts when cash flow is critical –The only real focus for financials in business plans

The Key Principle  When constructing cash flow projections –Note the amount and month in which cash is received, not necessarily when the sale is made –Note the amount and month in which a bill is actually paid, not necessarily when it should be paid  Actual cash inflows become your revenue forecast  Actual cash outflows (expenses) become your monthly budget

Examples  Say insurance for your business costs $2,400/yr –The temptation is to expense $200/month –Instead, estimate whether you will pay the premium in one, two, or three installments, and in which month you will make those payments  Need help from an accountant at tax time? –Estimate the fee, but don’t expense it equally over every month –Instead, you will pay it all at once in April Or, if you wish, pay it in May or June (you decide)

Receivables Aging  If your previous experience or that in your industry shows that some people pay late –Estimate who pays how late –For example, 40% pay within 30 days, 30% pay days, 25% pay days, and 5% never pay Build in these receivables into your revenue model It will reflect actual rather than assumed revenues

Receivables Aging (cont.) Revenue1,0001,2001,4001,6001,800 2,000 Formula 40%30%25% Actual Revenue Total Revenue ,1701,3601,5501,740Etc.

Salaries and Wages  Salaries are for managerial and supervisory positions Paid monthly but based on an annual salary –Decide on a structure that is competitive in the industry Typically includes 15-25% in addition for benefits –Vacations, sick leave, health plan, pension, disability, etc. Don’t forget to pay yourself!  Wages are for hourly workers or those paid by ‘piecework’ Typically do not include benefits  You MUST include payroll taxes for all employees Subcontractors (e.g., consultants) are paid no benefits and you pay no payroll taxes for them

Assumptions  It is impossible for you to create cash-flow projections without making assumptions –Because it all happens in the future  For each line of revenues and expenses –Explain how you got the numbers –Explain why numbers get larger or vary from month to month  Create separate schedules (tables), e.g., –Staffing and salary structure –Revenue model (unit sales, prices, revenues)

Typical Format for Projections 123…12Total Total Revenues06,9008,200….16,800109,700 …. Total Expenses8,2008,0009,100….12,30098,500 Monthly Surplus (Loss) (8,200)(1,100)(900)….4,50011,200 Cumulative Surplus (Loss) (8,200)(9,300)(10,200)….11,200 Breakeven Point

Requirements  Two years’ worth of projections, by month –One year with totals should fit one page –Use clear headings, e.g., Year 1, Year 2  Do a second set called “Worst Case Scenario” –Also two years’ worth, by month –Be clear how this set differs from the one above (the “Most Likely Case”) –The maximum negative cumulative amount here denotes the initial capitalization the business needs  Include assumptions for both sets in your Financial Plan

Outputs of Financial Projections  Estimated revenues, Years 1 and 2  Estimated profit before interest and taxes (“surplus”), Years 1 and 2  Initial capitalization required  Breakeven Month, most likely case  Estimated ROI (using estimated initial capitalization required as the investment), Years 1 and 2 The revenues, profits, and breakeven month can become objectives for your enterprise

Any Questions?