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Building Better Financials

Explore the value and importance of pro-forma financial statements in your enterprise. Learn to build a pro-forma model, identify key assumptions, and make strategic decisions. Enhance your financial understanding and decision-making skills.

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Building Better Financials

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  1. 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

  2. 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…

  3. Drew 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 Who We Are

  4. 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

  5. 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) Session Goals…(& Limitations)

  6. 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.)

  7. Tips at the Start Use 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)

  8. Pro-Forma Process Framework 1) Where are you now? 2) What is the goal? • Spin-off business applying job training & earns income • Benefit from brand recog. in community • Capitalize upon existing org skills in food industry Stable, successful job training program with access to new $$$ 3) What are the incremental steps to advance? • Get board buy-in • Conduct feasibility study • Etc.

  9. 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)

  10. 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

  11. 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

  12. 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)

  13. 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

  14. 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

  15. 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 Monthly Income Statement Steps Outcomes

  16. 2-5 Year Income Statements 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

  17. 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

  18. 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

  19. 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?

  20. 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

  21. 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

  22. 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

  23. 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?

  24. Questions & Answers Michael Whitehead-Bust: mbust@comcast.net www.foxhallconsulting.com(coming soon) Drew Tulchin: drew@socialenterprise.net www.socialenterprise.net

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