Financial Pro-Formas

by | October 4, 2005

In continuing with the Business Plan theme, many people find the most difficult aspect to be building the predicted financial performance of a new company (also known as pro-forma financial statements). Where do you start and how do you ‘guess-timate’ these figures? Financial statements, in general, always consist of at least three inter-related documents, the Income Statement, the Balance Sheet, and the Statement of Cash Flows. To an entrepreneur, the two most important financial documents are the Income Statement and the Cash Flow Statement. The Income Statement tells you whether your operations are profitable. The Cash Flow Statement tells you how much cash you need to start up and get to profitability — to be ‘cash flow positive’. The Balance Sheet is a third financial statement tracking assets, liabilities, and stockholder equity, and is a check and balance of the other two. If all the numbers on the first two documents are correctly linked, the Balance Sheet should, well, balance.

So where do you start? The good news about estimating expenses is that many of them are consistent within or across industries — you just have to do the research to find the numbers. Key expenses for your specific industry may be found through industry associations or similar publicly traded companies’ (comparables) financial statements. Other categories such as cost of employees may be estimated by contacting various departments within the State. Washington State has a website that outlines key salaries and other costs associated with various types of employees (https://www.workforceexplorer.com/). Another key cost element is taxes — local, state, and federal. All these can be found with some research online or through an accountant. Taxes also often drive the type of business structure you decide to set up.

On the revenue side, the analysis is more complex and a bit more subjective. The numbers are driven primarily by comparables and your market research. Look at similar industries or companies. You must determine clearly who your target market is, what the size of that market is, and what percent of the market you will penetrate. Most importantly, you need to understand what the market need you’re satisfying is, how customers are currently addressing this need, and how your product is better than the alternatives. As part of this analysis, you will identify who your competitors are — think broadly about how customers currently satisfy the need your product or service provides. You can then determine the appropriate price for your product. From all this, you will understand which customers in the target market will choose your product to satisfy their needs. Then multiply the estimated sales over the time period (month or year) by the predicted price (remember to include bulk discounts, if applicable) and you have your top line revenues.

Once you’ve performed this analysis, you’ll have the core information necessary to build your pro-formas. Samples of pro-formas are provided in most books on writing business plans and on many websites for entrepreneurs. Good luck and happy business planning!

Author: Michelle Bomberger, King County Business Lawyer