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Persuasive Projections
By Paul A. Broni
Predicting the future is never easy. But
by following these dos and don'ts for financial projections,
you can avoid some common mistakes
It doesn't matter
whether you're applying for your first bank loan or your fifth,
or whether you're seeking venture capital or debt financing.
Sooner or later, you'll have to prepare a set of financial
projections. Lenders will look for a strong likelihood of
repayment; investors will calculate what they think is the
value of your company.
In my past 10
years both as a banker and as a financial consultant, I've
seen many entrepreneurs -- despite the best intentions --
make mistakes on their projections. The good news is that
the most common mistakes are easily preventable if you know
what to look for. Here are my top dos and don'ts:
- Don't
provide only an income statement; include a balance sheet
and a cash-flow statement, too. It's understandable
that you're focused on sales and net income, but your banker
or investors will also want to know how much money you intend
to leave in the business as retained earnings and how much
additional debt or equity financing you'll need -- if any
-- to grow your company.
- Do provide
monthly data for the upcoming year and annual data for succeeding
years. Many entrepreneurs prepare projections using
only monthly data or only annual data for the entire three-
or five-year period. Don't. Use monthly data for the first
year. After that, use annual data. The financial results
of your first year will probably end up being different
from your projections, so there's no point in thinking that
you can accurately forecast monthly results for the years
after that. This is an instance where less is more.
- Don't
provide more than three years' worth of projections unless
your lender or investor has asked for them. This is
an extension of the less-is-more concept. Let's face it:
it's a stretch to accurately forecast your company's sales
or net income for even three years out. Only in cases in
which you're looking for long-term financing for equipment
or real estate is it likely that your banker will want longer-term
projections.
- Don't
provide more than two scenarios in your projections.
Loan officers and investors are already drowning in paperwork,
so do what you can to make their lives simpler. We've all
seen projections with the following three scenarios: base
(or likely) case, worst case, and best case. I've also seen
super case and break-even case. My advice is to prepare
just the base case and the break-even case. The base case
should show what you realistically expect the business to
do; the break-even case should show how low sales could
go before the business begins to lose money.
- Do ensure
that the numbers reconcile. Everybody knows that assets
must equal liabilities plus equity. But all too often entrepreneurs
will simply plug a figure into the equity slot to make things
settle up. That's wrong. If your bank is doing its homework,
your banker will check the math. If the equity numbers don't
add up from one period to the next, you'll be asked to explain.
Even though everyone makes mistakes, that's one you want
to avoid because it makes you look sloppy. Also, if after
the mistake is corrected your company has a smaller net
worth than you originally presented, your banker or investor
may think you were being intentionally misleading. Not good.
- Don't
be too optimistic about sales growth or gross and operating
profit margins. All bankers and investors want to do
business with ambitious entrepreneurs, but there's a big
difference between a realistic business plan and fantasy.
While it's true that companies that have low revenues can
grow their sales quickly in percentage terms, it may not
be realistic to assume, for example, that your business
can double in size every year. That rate of growth would
turn a $500,000 company into a nearly $16-million business
in only five years. And although that can happen,
it is definitely not the norm. Also, entrepreneurs often
try to convince lenders that as their company grows it will
achieve economies of scale, and gross and operating profit
margins will improve. In fact, as the business grows and
increases its fixed costs, its operating profit margins
are likely to suffer in the short run. If you insist that
the economies can be achieved quickly, you will need to
explain your position.
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