ABC's of Projected Financial Statements
In any new business there is a long-term goal envisioned by its founders. As the business begins to take shape, that goal should be translated into a business plan, which eventually becomes the document that is used when trying to obtain financing. Whether you are looking for financing in the form of debt or equity through either a bank or a private offering, you will need a business plan that clearly demonstrates a well thought out approach to running your company.
The financial statements are equally as important as the rest of the text and material used in preparing a business plan. It is not enough to have a great idea; you need to know how to turn that idea into reality, how to market it to the public, how much of an investment will be needed and when you expect that investment to begin showing a positive return.
Every business plan should contain projected financial statements and they should be presented in industry standard format. Don't be creative in this section of the plan. Use traditional methods of reflecting financial data so it will be easier for the reader to comprehend and analyze the business. Incomplete or sloppy financial statements raise a red flag with potential investors and can mean the difference between being funded or being rejected.
There are several required components to every set of projected financial statements: balance sheet, income statement, cash flows and assumptions.
The Balance Sheet shows your assets, liabilities and equity at a particular point in time. It is basically a snapshot of your financial position. The basic accounting formula is assets equal liabilities plus owners equity. The asset section of the balance sheet should be presented in order of liquidity starting with the most liquid assets such as cash, accounts receivable and inventory. The liabilities section should be presented in order of maturity starting with liabilities that are payable over the next year such as a demand note payable and accounts payable.
The Income Statement captures profit performance, demonstrates immediate capability to service debt for banks or real potential for growth in returns for venture capital. This is often expressed in terms of sales volume, or compared to industry benchmarks.
The Statement of Cash Flows is the most critical forecast since it reflects viability rather than profitability. It can also be the most uncertain statement as projections extend into the future. Therefore, monthly cash flow is a key statement since it enables calculation of "coverage" at any given point.
Assumptions used in the preparation of the projections are probably the single most important component of a financial statement. They are the benchmarks that form the foundation for your projections and must be reconciled with the text of your plan. Your assumptions should include a section detailing the significant accounting policies used and potential risks associated with the business (regulatory requirements, copyrights, patents, production resources and strategic alliances), disclosure of various debt agreements, stock options and warrants and long-term contracts.
Another important section of the assumptions is the Use of Proceeds. This section tells a potential investor how you plan on obtaining the funds and what you intend to do with them.
When preparing the projected financial statements, there are some common pitfalls that need to be avoided:
As you can see, a projected financial statement is an important component of a business plan and the preparation of it, although complex, can be done following an approach that is as simple as ABC.
John A. Ratcliffe, CPA
Carrie J. McIndoe