Entrepreneurs, as a rule, are a rare breed – that’s for sure. It takes a very special person to come up with a new invention or a new way to get things done and then to turn it into a business. Entrepreneurs notoriously work very hard and wait patiently (for the most part) for success to come. The rewards are many: bringing a new idea to customers, building a business that employs others, making a contribution to society and, of course, financial gains. There are many entrepreneurs that never become successful because they don’t understand how to run a profitable business that is attractive to investors (which all entrepreneurs will need at one stage or another during their company’s lifetime.)
Let’s take a look at the different perspectives of entrepreneurs and investors. Investors come in all shapes and sizes. There are the ones that were born wealthy and invest mainly for sport, almost as a hobby. Some investors worked very hard to build a business of their own and want to foster the same success for young entrepreneurs like they once were (think Angel investors). Then there are the investors that are businessmen, such as lenders, institutional investors and investment bankers. These are usually the hardest to win over.
It’s important to remember in all of these cases, investors may have seen hundreds of business plans, so what makes yours stand out?
It’s important to remember in all of these cases, investors may have seen hundreds of business plans, so what makes yours stand out? And what could be the most important driving factor? Investors expect a return on their investment – always. How do you prove that your company can provide that ROI?
The best place to start is to consider how a plan without a financial forecast might look to an investor. It probably looks a little like a resume without any mention of the candidate’s qualifications. Investors want to feel confident that an entrepreneur knows how to build a successful business. An excellent product is just one piece of the puzzle. The financial forecast provides a clear picture of how the rest of the puzzle fits together.
The financial forecast is the best method for an entrepreneur to demonstrate a true appreciation of the complexities of cash flow for the investor. There are a few items that always need to be listed separately:
REVENUES
– This is a key driver for the rest of the financials. If revenues double, then several other items increase along with it such as cost of goods sold and selling commissions, etc.
COST OF GOODS SOLD
– Include all of your direct costs here such as manufacturing costs, direct labor, etc.
GROSS PROFIT
– This is a key indicator of the strength of your business model as compared to others in your industry.
SELLING EXPENSES
– Include commissions, slotting costs, advertising, public relations and seriously consider how much you’ll need to spend on selling expenses to reach your revenue goals. Some consider this a dial – the more you turn up the dial on selling expenses directly translates into higher sales.
OPERATING EXPENSES
– keep your administrative overhead as low as possible. Minimize salaries for founders and executives. Founders and executives should be paid bonuses and profit sharing as the company grows.
Two year forecasts are the minimum required for bankers and lending institutions and should be monthly. Five year forecasts are a bit more idealistic, especially in years 4 and 5. However, these longer projections are necessary when you’re raising $1 million or more. When your company’s plan includes future products, it also makes sense to include a five-year forecast so that you can demonstrate the timeline and impact of adding each new product line.
In summary, the financial forecast should be realistic, sufficiently detailed and show profits as quickly as possible. The numbers should illustrate the true growth potential of your company several years into the future so that any investor will want to be part of the company’s success story.