Getting Started with Projections

Behind every success story is great execution. And behind every successful execution is a well-worn set of projections and a plan. There are multitudes of resources and templates available online from sites like the Small Business Association, but how do you get started thinking through a new product or service concept? Before you write a polished plan, pull out trusty Microsoft Excel and start creating scenarios.

First, focus on customers and revenue assumptions for the next three to five years. While establishing revenue targets are important, at this step, the purpose of the exercise is to focus on the the assumptions that will affect the business each day: pricing, customer averages, growth rate, renewal rates, market size, ability to execute, seasonality, etc. This process helps realistically determine what assumptions are required to hit the targets while identifying key metrics for measuring progress. There are three ways to to create revenue estimates (do each one!):

• Bottoms up – start with one customer and apply a *realistic* growth rate
• Worst case – what if your growth rate is 1/2 or 1/10 the expected?
• Top-down – what will it take to reach $100M (or some other pie in the sky figure); start with your pie-in-the-sky figure and work backwards in time to determine what your growth rate needs to be to hit that figure

Identify the incremental cost of each sale (Cost of Goods Sold or COGS). For example, are their credit card fees? software fees? materials cost? Etc. Knowing COGS and when they hit helps do two things: 1. understand if there is enough total and monthly margin (Revenue – COGS = Gross Profit) in the product to make it worth the effort (and provide money for profit and business investment) and 2. understand the ebb and flow of gross profit in the early days before reliable scale is achieved. This is critical because early on there is a strong likelihood a fluctuating margin will exist that could affect profitability and cash flow. For example, a software services firm…

• Sells a a software product which delivers revenue of $50k for month one and $25k per month thereafter.
• The client pays 30 days after the end of each month.
• The firm pays contractors $25k in month one to deploy (COGS) and uses full-time employees to support the customer in months 2-12 (OPEX, Not COGS).
• The firm buys $50k hardware and software to support the customer and has to pay upfront because the business is too new for credit or leasing terms; and there is a recurring $5k/month charge due upfront for maintenance & support.

Results

• In the above scenario, the *overall* deal nets the firm $325k revenue in year one with costs at $135k and therefore yielding $190k gross profit at a nice 58% margin for the year.
• However, breaking down into monthly increments revels that margin is -$30k (-60%) in month one and +$20k (+80%) in the remaining months.
• From a cash flow basis, it takes a full six months to come cash flow+ on the deal with the first two months carrying $80k of cash losses, $40k in month three, $20k in month four, breakeven in month five, and finally cash flow+ in month six <-not planning for a customer being cash flow negative for the first six months can put a company out of business fast.

Understanding cost of goods sold helps identify what operating budgets will be and the cash needed upfront to support customers. This step is critical because the worst case scenario is signing a new, game changing client or launching a new product and not being able to support them.

Estimate the fixed cost you carry each month (rent, labor, IT, etc.) or Operating Expense (OPEX). Do this last and only after you have a really good feeling about your revenue and COGS assumptions. Once revenue and COGS assumptions are established, you should have a good picture in your mind of the company resources needed to pull it off and then you can start on the OPEX.

For example, are 50,000 customers required to meet the revenue target? Then what type of Operations are needed to support that customer base – office space, phones, computers, admins, call center, etc. What if remaining money (ie. gross profit) would only realistically budget OPEX to support 50 customers? The OPEX is where, if you have not done it yet, you get honest with yourself about prioritizing resources.

Investment: Depending how revenue is collected and recognized, it may not be a problem to be unprofitable in the early going BUT it is critical to ensure you always remain comfortably cash flow positive. These monthly estimates can be used to project cash flow to determine when it will run negative. Using this estimate, you will be able to determine when and how much investment you will need to ensure you have enough cash on hand to comfortably operate your business.

If you would like additional information on this topic or a free consultation on your marketing efforts, please contact a Thrivepoint advisor.

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