Sunday, September 10, 2000
Financial projections: Let's get started
By Rhonda Abrams
Gannett News Service
When I work with entrepreneurs filling out financial forms for a new business especially if they've never done financial projections before numbers seem daunting.
Once you have an established company, you have a pretty good sense of how much things cost, the size staff you'll need, and the sales you're likely to make. But when you're just starting out, numbers appear a complete mystery.
They're not at least not entirely. Just remember Rhonda's Rule: Numbers are the reflection of decisions you make.
Start at the bottom
Every decision you make when planning your business has a number attached: If you choose to exhibit at a trade show there's a cost; if you choose to locate your business in one town rather than another, there's a cost with that.
The key is to create your financial projections after or at the same time you plan your business. The problem arises when you complete your financials before you've made critical business decisions, or when you do projections from the top down rather than the bottom up.
Top down numbers are enticing to work with, because they always come out looking good.
Here's how they work: You look at the big picture the total market size, growth rate, average sales price, average profit margins, etc. These numbers are typically found through demographic, industry, and research data.
You assume achieving a 10 percent market penetration, improving margins by 2 percent, etc. Then you fill in each line of your financial statements to make the totals come out to the big numbers projected.
Let's say you've invented a new, improved golf club. Here's an example of top down numbers:
Total annual sales of golf clubs is $2 billion. We'll achieve at least 1 percent market penetration for our superior club within 3 years: amounting to $20 million in annual sales. With a profit margin of 15 percent, we will have a net profit of $3 million.
Back to reality
Sounds good, doesn't it? Top down projections result in some very positive numbers the kind that make you and perhaps some potential investors excited. They just don't happen to have much relation to reality. And they're undefensible when investors start asking tough questions.
Instead, the best financials are developed from the bottom up. You start doing the real business-building legwork: examine different distribution channels, source manufacturers and suppliers, develop a staffing chart, etc.
So let's say you're that same golf club manufacturer, building your financials from the bottom up:
You first compare different distribution channels direct online sales, manufacturing for other name brand companies, sales through general sporting goods shops, sales through specialty golf retailers, etc.
Choosing one let's say selling through specialty golf retailers and golf country clubs has associated costs and impact on income.
You'll need a sales force to sell to those shops, you must exhibit at the four annual golf sporting good trade shows, advertise in Golf Retailer magazine, etc, and you will receive only 40-45 percent of the final sales price of the club, since the retailer takes half and the salesperson receives a commission.
Now, you're starting to get real numbers to plug in to each of the lines of your financial forms. You've got numbers for advertising, numbers for staffing, numbers for income.
The best place to start is by speaking with others in your industry, attending trade shows, contacting your industry association. Another excellent source is the RMA Annual Statement Studies, which look at actual financial statements of companies in individual industries. You can find these at: http://www.rmahq.org/Online_Prods/asstOL.html#single.
By the time you're done, numbers won't seem so mysterious.
Rhonda Abrams is the author of The Successful Business Plan: Secrets and Strategies. To receive free business tips, register at www.RhondaOnline.com or write her at 555 Bryant St., number 180, Palo Alto, CA 94301.
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