For anyone writing a business plan or trying to secure investment the financials part of the plan is the often the area that can make or break a company’s future. Many business owners and entrepreneurs find creating a 3 or 5 year future P&L extremely difficult, often these predictions are made before a single sale is made and most are finger in the air jobs.
Sales and Profit forecasts tend to go one of two ways. Either the forecasts are so conservative that they fail to interest any investor to commit to the business or go completely the opposite way and claim the business will be making £50 million within 3 years and are based on nothing but complete fiction.
A few simple techniques can help when creating financial business plans …
1> Understand where you fit in the market and its actual size – Many business owners make the mistake of mis-calculating the true size of the market in which they sit. This mistake is magnified when sales projections are then based on gaining market share. Take this (fictional) example… Company A makes software to help cardiologists make early diagnosis of heart disease in their patients. Company A’s CEO believes that 5years after launch they will achieve 1% market share – 1% is a favourite of entrepreneurs andfinancial projections, we’ll discuss the fallacy of this in the next point – The software market is worth £500 billion so In year 5 Company A will turnover £5 billion – Wrong! Company A’s market is not the entire software market, nor is it even the medical software market. The CEO needs to drill down until they find their true niche and the value of that market segment. Don’t over estimate your place in the market and over state your potential value, potential investors are very quickly turned off by un-realistic valuations.
2> Don’t use the 1% rule- It is unbelievable how many times this rule is applied by entrepreneurs and small business owners, I’m sure you’ll have heard it used. The entrepreneur tries to couple the over estimation of the market (see point 1) with what seems like a conservative (and fair) market share target (1%). The problem lies around the fact that whilst 1 % of a large market looks fantastic, when you drill down to the true market value then that 1% looks a little small. The other issue is that by quoting 1% market you look a little novice and inexperienced, (which of course you might be but you don’t want be telling everyone). Quoting 1% looks like you haven’t bothered to look at your market and don’t truelyunderstand your business.
3> Look at the competition- All companies started out at one time or another and all products were new to market at some point. You can use your competitors and their products to your advantage when forecasting your potential sales performance. What did your competition achieve in sales in their first 5 years? How did new products/services they brought to market (which are similar to yours) perform? What’s happening in your market in general? Answering these questions and adding in some reasonable assumptions of your own, should create a fair assesment of where your sales could be in 3/5 years and stand up to questioning from potential investors.
4> Don’t plan for exponential final year growth – For those of you who have watched Dragon’s Den you might recognise the following sequence…
Dragon: “Can you run through your sales and profit forecast for me?”
Entrepreneur: “Of course… 1st year sales £100,000 profit £10k, 2nd year sales £350,000 profit £50k, 3rd year sales £2.5 million, profit £1 million!”
Dragon: “OK…?”
Where did that final year projection come from? Yes we all want year on year growth, yes we all would like double digit growth but come on. I guess the lesson is be confident, be optimistic, be bullish but be realistic. Far fetched predictions will be quickly dismissed by any potential investor and it is probably at this point in your proposal or pitch that you will lose them.
However you plan your financial forecast remember to know your numbers inside out and to be able to justify them, you should find that you can stand up to even the most intense questioning from investors and your thoroughness at this stage will bode well for the future health of your business.
