building better financials using pro-forma financial statements & their importance to your...
TRANSCRIPT
Building Better Financials
Using Pro-Forma Financial Statements
& Their Importance to Your Enterprise
Drew Tulchin & Michael Whitehead-Bust
Social Enterprise Alliance 5th National Gathering
March 5th, 2004
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Who You Are & What Brought You Here Today
What is your primary job title? What is your familiarity & comfort with
financial statements? What have you used for financial
modeling to date? When you leave this session, you hope…
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Who We AreDrew Tulchin
Social Enterprise Associates: applies business tools to achieve financial & social ‘double bottom line’ results. (www.socialenterprise.net)
MBA Winner, 2001 Global Social
Venture Competition & Microenterprise Paper Finalist, “Non-profits Accessing Capital Markets”
I’m the one with the goat-tee
Michael Whitehead-Bust Foxhall Consulting Services:
supporting mission-driven entrepreneurs. Services: business planning, strategic planning, development (www.foxhallconsulting.com)
MBA/CFA Winner, 2001 ICIC/National
Business School Network. National competition for strategy consulting to inner city businesses
I’m the one with the goat-tee
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Session Overview
Introductions Value, Importance & Theoretical Framework Key Pro-Forma Components Building a Pro-Forma Model
Identifying key assumptions & drivers Expense & revenue estimates One year income statement by month Breakeven calculations Five-year income, balance & cash flow statements
Handling Mission-Related Expenses & Overhead
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Session Goals…(& Limitations)
Goals Increase comfort with
financial statements Impart skills / gain
confidence to use pro-forma analysis as a central component of decision-making
Explore pro-forma basics Emphasize importance of
good research and realistic assumptions
Limitations We are not accountants (nor do we wish to be) Financial analysis is a
tool, and but one tool, for management decision-making
Time allotted for this session limits what we can share
Our sense of humor (sorry, no refunds)
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The Value of Pro-Formas (Or, What’s Wrong with Just Using a Budget?)
Management – understand the past & the present Better understand cost/benefits of mission-driven components Ratio analysis & benchmarking Ability to perform (and interpret) sensitivity analysis
Strategy & Planning – prepare for the future Forward thinking (Year 1 by month and Years 2-5 by year) Facilitates more rational decision-making by clarifying business opportunity Forced articulation of assumptions and clarification of research/data
$$$ – allocate resources, explain situations & raise capital Balance sheet and cash flow statement can highlight risks Used in evaluation to access new sources of capital (especially lenders,
socially responsible investors, venture philanthropists, etc.)
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Tips at the StartUse Appropriate Resources Repeat, “I will not do my pro-formas in MSWord, Excel is my friend” Invest in high-quality market research & choose meaningful benchmarks Pay for a good accountant/finance person
May not be the person currently handling your books Better a passionate business-minded person who understands your mission, than
the reverse
An Art / Language, Not a Science Finance people are still subjective Make your work accessible & understandable to others Be clear about assumptions; acknowledge what you don’t know
Prepare, But Also Be Flexible Things will change (little-known Harvard Study) Allow for more time, budget for higher expenses & assume less revenue Get comfortable with red ink (non-profits aren’t use to losses)
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Pro-Forma Process Framework
1) Where are you now?
3) What are the incremental steps to advance?
2) What is the goal?
Stable, successful job training program with access to new $$$
a. Spin-off business applying job training & earns income
b. Benefit from brand recog. in community
c. Capitalize upon existing org skills in food industry
a. Get board buy-in
b. Conduct feasibility study
c. Etc.
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Philosophy / Key Concepts
Incrementation: think in units Children’s building blocks
Establish a compelling story But, be realistic, transparent & state your logic
Know your goals Separate financial from mission-driven Understand limitations / pressures on each
Earned income = Net Income Producing profits or just generating revenue?
Build, measure, build, measure, build (The carpenter’s ‘measure twice, cut once’ - measure continuously, because what you are cutting keeps changing)
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Pro-Forma Components
Key assumptions w/ market data Income Statement:
Yr 1 monthly, Yrs 2-5 annually Balance Sheet: Yrs 1-5 annually Cash Flow Statement:
Yr 1 monthly, Yrs 2-5 annually Breakeven Analysis
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Definitions / Key Terms
Variable/Fixed Costs Variable costs differ based on activity level. Typically
driven by number of customers Fixed costs remain constant, regardless of sales volume
Contribution Margin Revenues – variable expenses = contribution margin
Operating Leverage Ratio: fixed to variable expenses
Assumptions / Drivers Sensitivity Analysis
Evaluation of changes in business results based on alterations to key assumptions
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Begin the Model w/ Assumptions
Establish the background story Select a reasonable goal Gather data Determine key indicators Establish driving unit(s) of measurement
Note: the more specific you are with real information for outputs and outcomes, the easier it is to build towards them…(while being prepared they WILL change)
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Assumptions – Expenses
Audience Participation Activity (polite applause):
List major expenses Classify: fixed or variable? Identify unit(s) of measurement Select drivers (what indicates the amounts?) Consider growth rates / change over time
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Assumptions – Revenues
Follow same steps from expenses List revenues, separate by product Establish the base unit for ‘incrementation’ Determine a defendable growth rate Philanthropic sources excluded at this time to
focus on project revenue, but note potential exceptions: if project produces incremental philanthropic stream
(i.e. grants specifically tailored for the project) if project requires grants for social benefits that are
incremental, but inherent, project costs
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Monthly Income Statement
Determine monthly sales growth rate
Separate, describe behavior and timing of fixed / variable expenses
Include mission-related expenses, revenues, and org overheads
UBIT
Quick view of year one profitability / losses
Likely not the best evaluation of the opportunity
Insight into capital needs
Insight into level of risk
Steps Outcomes
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Revisit original growth assumptions. Carry them forward, with applicable changes, for years 2-5
REMEMBER: Additional staffing, equipment, space, other needs Overhead allocations Even conservative projections are often optimistic
– base assumptions on sound data Rationality wanes after Year 3 (sometimes
before). Don’t ‘bet the farm’ on Year 5 projections
2-5 Year Income Statements
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5 Year Balance Sheets
Articulate assumptions: A/P A/R Inventory Capital Expenses & Depreciation Financing / Capital Structure: Debt? PRI?
Philanthropy? Parent Org investment?
Note: Ensure consistency with I/S assumptions
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Cash Flow Statements
Monthly (Year 1), yearly Years 2-5 Note model structure Work with good financial professionals Be prepared for red, but have a plan
(in advance) Can have positive net income, but be
cash flow negative
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Breakeven Analysis
The Formula:
Fixed Costs / (revenue per unit –
variable costs per unit) = BEP in units Is it attainable?
Does market research back it up? What is capacity?
Account for start-up costs/overhead allocations
Advanced Note: Do you know your degree of operating leverage?
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Handling Mission-Driven Costs
Distinguish whenever possible Promotes management of “business” side and
“program” side Increases appeal to funders Facilitates social return & SROI analysis
Initial goal statements make it easier to attend to mission in terms of added expense - hard questions WILL come up
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How to Handle Overhead Allocations?
Handle in strategic & thoughtful manner Depends on entity’s legal status ‘Gray area’ treatment as fixed or
variable Have an easily explained story Have information be transparent in
assumptions
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Final Thoughts
Do your research Clarify goals (& costs) of mission-
related activity Rigorously research & analyze This is a living document Listen to what it tells you, but utilize all
tools / data Have fun
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Resources
Robert Higgins. Analysis for Finance Management
Jeffry Timmons. (Note spelling). New Venture Creation: Entrepreneurship for the 21st Century
The Motley Fool What others do you recommend?
Questions & Answers
Michael Whitehead-Bust: [email protected] (coming soon)
Drew Tulchin: [email protected]