Learn the tips and tricks of creating sound financial projections and valuation for a business plan.
Entrepreneurs create business plans for a variety of reasons. Where a business plan is used to seek funding from business angels or venture capitalists, care must be taken to develop a sound financial plan. The financial section of a business plan is critical to convincing investors of a company’s potential and how the company will create a return on investment required. At the heart of a good financial plan lies the following:
- Income statement projections
- Balance sheet projections
- Cash flow projections
- Break-Even Analysis
- Valuation of the company
- Amount of funding required
- Return on Investment and payout to investors
It is convenient to assume that financial projections alone suffice but that may lead to the business plan being chucked into the trash bin by investors faster than one can say Jack Robinson. The key to keeping the attention of investors is to tailor the financial section of a business plan specifically to the investors. Ultimately, the entrepreneur should put himself/herself in the shoes of the investor – would he/she invest in the company?
In a five-part series of financial sections for business plans, first, there will be two sets of introduction to income statement and balance sheet projections. Secondly, an introduction to cash flow projections will follow. Thereafter, valuation of a company will be covered in two parts.
Analysis of historical financial statements
Understanding a company’s past is essential for forecasting its future. For that reason, an entrepreneur should begin the valuation process by analyzing historical performance (depicted in Table 1 and Table 2). Since a start-up’s financial statements are not typically designed for valuation, historical analysis can be challenging. To properly evaluate a company’s performance, it is therefore necessary to rearrange the accounting statements, dig for new information, and, where information is lacking, make informed assumptions. Only then will the company’s previous performance, competitive position, and ability to generate cash in the future come into focus.
An entrepreneur may consider software that can expedite the process of preparing and analyzing historical financials. For example, Standard & Poor’s Compustat or Thompson’s Financials offer direct export features of publicly available financial statements. Even when analyzing historical financials of private start-up companies, these databases will come in handy when comparing against similar companies in the industry.
Linking past financial performance with management’s strategies
Prospective analysis can be used to assess whether estimates and forecasts made by management are consistent with the firm’s economic position. The following questions should act as a guide:
– What are the key business risks facing the firm? How well are these risks managed?
– What are the key accounting policies and estimates that reflect the firm’s key risks?
Sample Historical Financial Analysis
Company XYZ is comprised of three divisions, namely Manufacturing, Distribution and Mastering. The individual breakdown of the respective divisions’ financial performances for 2005 was as set out below:
Table 3: Sales and GPM breakdown of COMPANY XYZ’s divisions for FY2005
Division Sales GPM
Mastering ~ S$100k (145.7%)
Manufacturing ~ S$2,000k 37.8%
Distribution ~ S$900k 51.3%
As shown above, it was observed that the low GPM for Company XYZ was caused by the Mastering division and wasn’t a true reflection of the GPM of the regular business of Company XYZ. The Chief Operating Officer (COO) of Company XYZ was replaced with a fresh face in July 2005 in order to turn its operations around. After six months of cleaning up aged debtors and creditors by the new COO, Company XYZ was in a better position to focus on generating a profitable business in 2006.