Financial projections, or financial modeling, should tell a story about the future of your business. Building a credible ‘story’ is an essential tool for selling or seeking investment funds, and also helps you make quantifiable decisions about your business—such as what your sales goals should be based on your sales closing rate, how many employees you should have, when you should hire them and more.
Investors and buyers want to read a story that shows how much sales revenue you expect to bring in and how much money is left over once all expenses are paid. A good story will give them a solid understanding of your business’s cash flow, validate that your service or product is profitable, allow them to calculate the potential return on their investment and otherwise help them determine if your business model is a compelling investment.
How do you tell your business’s story?
Start by making assumptions about the future performance of your business through the extrapolation of previous data.
Your financial projection story should focus on cash flow drivers and keep the data simple and transparent, clearly showing all assumptions and avoiding overly complicated formulas. On average, reviewing and analyzing 36 months of data is a good indication of how your business performs.
The various ‘chapters’ of your story should answer these questions:
- What are the units that drive revenue and costs?
- How do you market your product/service and what does that cost? (Typically, the service or product unit that drives revenue also drives cost.)
- Have you considered all relevant support and infrastructure expenses?
- What kind of return should an investor reasonably expect?
To thicken the ‘plot’ of your story, be sure to include:
- Income Statements. Clearly explain how, at any given point, you will have the funds or cash to finance the ongoing needs of your business. An income statement should include an analysis of revenue, cost of goods sold (COGS), and selling, general and administrative expenses (SG&A).
- Balance sheets. Clearly review assets and liabilities to show:
- Accounts Receivable (A/R): How long, on average, does it take your customers to pay?
- Inventory: How much is appropriate to keep on hand? 60 days, 90 days, etc.?
- Property, Plant & Equipment (PP&E): What is the cost of the infrastructure needed to sustain your business?
- Accounts Payable (A/P): How quickly do you pay your vendors.
Overall, investors and buyers want to read a sensible story that explains how they’re getting back what they’ve put in, along with an attractive return. And like any good page-turner, the plot needs to be both exciting – in terms of ROI – and easy to follow, and the key characters in your drama – such as your clients, vendors and employees – must be well described. The right story can mean the difference between a best seller and a bomb.
This article originally appeared in Edge Magazine's November 2013 issue.