How to Write a Business Plan: Financial Projections
In my most humble opinion, the financial projections section is the absolute most important part of your business plan. This is because if the company is not going to be profitable, investors are going to want to know about it. Further, investors are going to want to ensure that the numbers provided are accurate projections. Because of this, this section should be very detailed with supporting data.
The financial projection section should include an income statement for 3 to 5 years into the future, a balance sheet for 3 to 5 years into the future, and a cash flow statement for the next 12 months. In my experience, the starting point for your financial projections is always the cash flow statement. With this statement done, this will leave you with your first year of your income statement. Once this is complete, make sure to expand your growth for revenues for the next 3 to 5 years. Further, make sure to do research in reference to the various cost will be involved with your business.
The balance sheet is always the hardest financial statement to complete. In the statement, I always start with funds invested on the equity portion of the sheet. Then, I move towards the liability section and identify any loans that will be taken. From this, I then complete the asset portion of the sheet. In the end, a solid, reliable balance sheet will ensure that the asset side of the balance sheet is equal to the liability and equity portion.
The financial statement section is probably the most difficult section for business owners to write. There are numerous reasons for this fact. First, financial statements are mostly made in Excel. Most business owners do not even have Excel on their computer, let alone, know how to use the various functions needed to create financial statements.
Another common challenge with creating financial statements in Excel is the need to intertwine different pages. For example, when I create my financial statements, I often use one page, or tab, as an information page. The rest of the pages, located on different tabs, are tied into the information page using links and formulas. By doing this, if I change a financial figure on the information page, all of the financial statements are updated.
The financial summary should explain the highlights related to financial projections. These highlights include revenues and profits for the first year, expected profits for years two and five, and, when seeking funds from an investor, possibly the expected return on equity.
Business Plan Writing Tip:
When writing the financial summary section, first start off by explaining that the financial section of your business plan is based on research and observations. This disclaimer helps to set the stage for the reader’s understanding that the projections are just the business owner’s best guesses. Next, follow-up the statement with your findings from your financial analysis. These findings should include revenues for the first year, net profits, and the profit margin expected.
The financial projections are based on market research and empirical examination of the local retail store industry. For the next year, we project revenues of approximately $456,793. The estimated expense costs will be $217,330. After taxes, we estimate a net profit of $239,463. This leads to a profit margin of approximately 52.4%. As our brand continues to grow, second-year progression is anticipated to yield a net income of approximately $311,363. Within five years, net income should exceed $348,722.
In this example, the organization expected first-year revenues to exceed $450,000. Further, the cost involved in attaining these revenues were also shown. This helps the reader understand the potential revenue generation opportunities for the company and the needed cost to achieve the dollar amount noted. Other important aspects of the summary would include the net profits for years two and five.
The startup cost section of the business plan should include the costs needed to start the business. If the business is already established, then this segment should outline expansion costs. If funding is being sought and the money will be used for purposes other than startup or expansion, then make sure to use this section to reflect how the money will be spent. An example of this would be if a company needs funds to spend on an advertising campaign, then utilize the section to break down the costs for the campaign implementation.
|Initial Build Out||900,000|
|Retail Store Equipment||35,000.00|
|Section: Office Equipment|
When I set up my startup costs section, the first segment is always related to how much money the business owner has invested, funds needed from an investor, desired loan amount, if a loan is needed, initial buildout, and working capital, which are funds used for operations when the business opens.
It may be considered a little unorthodox to include funding with startup costs. However, by following this structure, the business owner succinctly showed funding needed and how the funds will be spent.
The rest of the sections focused on specific costs needed to start the business. The specific categories used were equipment, operations, office equipment, and other. In these categories, I strongly suggest that the cost estimates be inflated a bit. Say by 10 to 20 percent. Further, try to stay “general” with startup costs. This strategy is recommended simply because there is no way to know what your actual startup costs will be until your startup process has commenced.
For my daily revenues, I always start with estimating revenues and the cost of goods for the first day of business. Revenues are the sales price multiplied by the actual number of products or services sold. For the cost of goods, this is considered the dollar amount that the business spent to make the product or service. For simplicity sake, I always utilize a percent for the cost of goods. This helps for staying true to using averages in the financial statements.
Business Plan Writing Tip:
When designing the average daily sales segment, always use averages for everything. By embracing the concept of using averages in the financial statements, the business owner is acknowledging that the estimates provided in the financial statements are a best guess approximate as to what the business owner hopes to sell in the future.
|Average Daily Sales|
|Daily Sales||% Sales||Num.||Price||Cost||Profit||Total Rev.||Total Cost|
|1 Bed Room||20%||13||85.0||17.0||68.0||1,105.0||221|
|2 Bed Room||20%||18||105.0||21.0||84.00||1,890.0||378|
|Gift Shop Sales||50%||75||12.0||6.0||6.0||900.0||450|
In the first column, this is where I put the general categories for items or services that a business will sell. In this example, the average daily sales are for a hotel with a restaurant and gift shop. In the first section, I outline the three different types of rooms offered. Of course, there are further differentiating factors between a one-bedroom with a balcony and a standard one bedroom. However, for the sake of estimates, I use an average price for all one bedrooms. In section 2, I break up the categories into lesser revenue generators, which would be the restaurant sales and give shop sales. In this segment, I asked the business owner to estimate what their revenues will be for the restaurant and gift shop. Because these are secondary revenue generators, estimates for the total sales may be used.
The second important item in the chart above would be “% Sales.” The percent sales are used to determine the cost of goods sold. The cost of goods sold is how much a business spends in order to make a product or service. From the perspective of a restaurant owner, the cost of goods sold may be the amount spent on lettuce, tomatoes, and cucumbers. For a hotel, as noted in the chart above, the cost of goods sold may include cleaning supplies, towel replacement, and soaps.
Every business that has ever been started, that will ever be started, needs some type of labor involved. Even if the labor is only the owner, make sure to include the labor section and the expected dollar amount to be paid on a monthly basis.
|Employee||Number||Rate||Monthly Hours||Total Pay|
When I create my labor template, the first line, salary, is the amount of money the owner wishes to be compensated for their time and energy. Some business owners may argue that they will not take a salary in the first year. However, lenders and investors, almost to the person, will want to see the owner take some kind of salary when the business starts. Because of this, the salary is always the first line in all of my labor financial models.
Following this line item would be managers and employees. As you can see in the example above, the structure will allow you to enter the number of managers in the average pay rate as well as the number of employees and their average pay rate. Again, we are embracing and exploiting the concept of averages.
The monthly fixed cost segment should include any and all costs that the business will spend, continuously, on a monthly basis. Popular fixed costs may include rent, utilities, insurance, and advertising.
|Monthly Fixed Costs|
|Monthly Costs||Monthly Total|
Fixed costs are definitely a misnomer. Just because we call them “fixed costs” does not mean the costs will not change on a monthly basis. The fixed costs title is more focused on the actual items being paid as compared to the same dollar amount paid each month.
When constructing the fixed costs segment, there are a couple of different theories that may be applied to the construction of the segment. First, some business owners prefer to leave fixed cost as the same dollar amount throughout the year and then add a growth estimate for the next year.
Other business owners prefer to utilize a percent of sales approach. In this approach, costs that change on a monthly basis, such as utilities, office expenses, and “other,” would be based on a percent of sales technique. In this technique, each variable line item would be divided by sales. For subsequent months fixed costs, the line items would be calculated by multiplying the percent found in the first month for the line item by sales in the following months. This technique is known as common sizing.
Growth rates are the percentages used to increase a line item due to growth or inflation. Not surprisingly, different sections of the financial estimates will grow at different paces. From this, the need for a section related to growth rates is needed.
|Growth Rate Sales 2 & 3||3.50%|
|Growth Rate Sales 4 & 5||1.50%|
|Growth Rate Cost of Goods||1.50%|
|Growth Rate Salary||1.50%|
|Growth Rate Labor||3.00%|
My preference for the growth rates is to show different growth rates for each category. Labor is bound to grow at a different pace than say business insurance. This structure allows for the needed adjustments.
The miscellaneous information section is pretty much used as a catchall for adjusting various line items in the financial statements. This segment may include the tax rate, cost of capital for the business, franchise royalty payments, etc.
|Cost of Capital||10%|
In this section, I usually only include the tax rate and cost of capital. For most instances, the cost of capital is not really needed. However, the tax rate is essential for determining estimated taxes that the company will pay on a monthly and annual basis.
When obtaining a loan, banks often prefer to calculate the loan information using their proprietary software. However, the business owner should still use the Excel function for calculating payments and include the information in their financial statements. An important concept to keep in mind for the income statement is to make sure they subtract interest paid instead of the full monthly payment for the loan. Not only is this standard procedure for accounting, but it also helps to show increased revenues.
In this example above, a loan is expected to be taken out for $500,000. The interest rate is expected to be 7% with a term of 25 years. As a result, the business owner will be expected to pay $3,533.90 on a monthly basis. As noted above, for the profit and loss statement as well as the income statement, the monthly interest payment is the portion used. To find the interest portion, the amortization schedule is needed.
The profit and loss statement show the revenues, costs, taxes, and profits for your business. My preference is to break up the 12-month profit and loss statement into monthly segments and then total each month quarterly. By doing this, the business owners is able to see the monthly growth projections, as well as, the costs aligned with the projected revenues.
Business Plan Writing Tip:
When creating your 12-month profit and loss statement, make sure to always use Excel or some other spreadsheet. This will allow you to do calculations easily and duplicate your work month over month.
When creating your profit and loss statement, make sure to always start with your revenues and then align the cost of goods and other fixed cost with your monthly sales. By following this process, the business owner is able to see how much money the company can make and what costs are involved with the process.
|Pro Forma Income Statement Year 1 Quarter 1|
|Month 1||Month 2||Month 3||Quarter 1|
|Legal / Account||250||250||250||750|
|Pro Forma Income Statement - Common Size|
|Income Statement||Month 1||Month 2||Month 3||Quarter 1|
|Costs of goods Sold||29.62%||29.62%||29.62%||29.62%|
|Legal / Accounting||0.13%||0.13%||0.13%||0.13%|
|Earnings before taxes||15.82%||17.38%||18.89%||17.39%|
In this example, first start with the revenues that are projected for the month. In order to give first-month revenues, I always go back to my expected daily sales. Using the daily sales, I will then multiply the daily sales by 30 and the cost of goods by 30. This will give me my first-month sales and the cost of goods.
Next, identify the fixed costs aligned with the monthly sales and deduct them from the gross profits, which is just revenue subtracted by the cost of goods sold. Once this is complete, just subtract any interest expenses and taxes. This leaves the business’s net income.
To determine the second-month profit and loss, first start by multiplying the revenues by an expected monthly growth rate. Next, for costs that increase on a monthly basis, based on sales, use the common size financial document. For example, in the example above, the office expense was .4% of sales. From this, we would multiply .4% by the new revenues for the next 12-months to determine the expected office supplies costs. This practice would be used for labor, office expenses, and utilities as well. Keep in mind, for some costs, such as rent, advertising, insurance, and salary; these costs will remain the same, usually, for the first 12-months.
The income statement is simply the total of your 12 months profit and loss statements. In other words, the income statement shows the total revenues and costs for the first 12-months. Once this is complete, most income statements will then project revenues, costs, and profits for the next four years, giving the business owner a five-year income statement projection to review.
Business Plan Writing Tip:
When creating your income statement, my preference is to first construct a table showing quarterly profit and losses, as shown below. Next, total the quarterly profits and losses into an annual column. With this complete, create a table using the annual revenues, costs and include columns for years two through five. The next step is to utilize our growth projections, as noted earlier, and multiply each line item by the associated growth projection. This will result in a five-year income statement, as shown below.
|Pro Forma Income Statement Annual Summary|
|Quarter 1||Quarter 2||Quarter 3||Quarter 4||Annual|
|Legal / Account||750||750||750||750||3,000|
|Pro Forma Income Statement - Base|
|Year 1||Year 2||Year 3||Year 4||Year 5|
|Legal / Accoun||3,000||3,030||3,060||3,091||3,122|
|Earnings before taxes||659,283||903,868||1,049,074||1,104,580||1,122,756|
I started with the quarterly expected profit and loss projections that we calculated in the 12-month profit and loss section. Next, I added together the quarterly projections to come up with the first-year income statement projection. Once this was completed, I used the growth rates discussed in the growth rate section to project the next four years profit and losses in the income statement.
The balance sheet is, for the most part, not absolutely needed in the business plan. This is because the projections for balance sheet will almost always be significantly off as compared to actual results. However, for the diehard entrepreneurs looking to cover all aspects of their financial expectations, presented below is a sample balance sheet.
Business Plan Writing Tip:
When discussing the balance sheet, make sure to explicitly state that the projections for the financial statement may change based on sales, operations, and other business needs. I like to put the statement before the balance sheet because of the significant fluctuation between projected returns and the actual results in the balance sheet.
When discussing the balance sheet, make sure to highlight the cash position and retained earnings. The cash position is important because this will show the reader that you, as the owner, expect to have enough liquid assets to operate the business for the short and long term. As for the retained earnings, this section is where your net profit, minus dividends paid, ties into your balance sheet.
If your retained earnings grow at the same pace as your net profits, then this shows that your company reinvests most of the profits earned. However, if the segment grows at a significantly slower pace as compared to your net income, then investors and bankers may ascertain that significant amount of your net profits are being paid out to the founder as dividends or other owners.
|Balance Sheet - Pro Forma|
|Assets||Year 1||Year 2||Year 3||Year 4||Year 5|
|Total Curr. Assets||934,785||1,902,034||2,903,732||3,905,139||4,914,419|
|Balance Sheet - Pro Forma|
|Liabilities||Year 1||Year 2||Year 3||Year 4||Year 5|
|Total Current Liab.||135,008||149,864||152,948||156,102||159,329|
|Total Com. Equity||1,527,426||2,250,521||3,089,780||3,973,444||4,871,649|
|Total Liab & Equity||2,154,785||2,884,534||3,718,082||4,595,469||5,487,659|
In the example above, the business owner can see that the retained earnings section of the balance sheet grows significantly year-over-year. This shows that the business owner intends to reinvest a significant portion of their net profits back into the business. By doing this, the owner increases the likelihood of success in the business
Further, the example above showed the cash position grown significantly over a five-year time span. This also helps the reader to see that the business owner fully expects enough liquidity to support operations for the short and long term.