Experience is the Difference®

Running a business is like going on a road trip — and a detailed business plan that includes a set of pro forma financials can serve as a road map or GPS app that improves your odds of arriving on time and on budget. If your plan doesn’t cover the prospective quantitative details in pro formas, expect to hit some bumps along the road to achieving your strategic goals.

What to include

Investors and lenders may require business plans from companies that are starting up, seeking additional funding, or restructuring to avoid bankruptcy. Beyond all of the verbiage in the executive summary, business description and market analysis, comprehensive business plans include at least three years of pro forma:

  • Balance sheets (projecting assets, liabilities and equity),
  • Income statements (projecting expected revenue, expenses, gains, losses and net profits), and
  • Cash flow statements (highlighting sources and uses of cash from operating, financing and investing activities).

Pro forma financial statements are the quantitative details that back up the qualitative portions of your business plan. Pro formas tell stakeholders that management is aware of when cash flow and capacity shortages are likely to occur and how sensitive the results are to changes in the underlying assumptions.

How to crunch the numbers

Unless you’re launching a start-up, historical financial statements are the usual starting point for pro forma financials. Historical statements tell where the company is now. The next step is to ask, “Where do we want to be in three, five or 10 years?” Long-term goals fuel the assumptions that, in turn, drive the pro formas.

For example, suppose a company with $5 million in sales wants that figure to double over a three-year period. How will it get from Point A ($5 million in 2016) to Point B ($10 million in 2019)? Many roads lead to the desired destination.

Management could, for example, hire new salespeople, acquire the assets of a bankrupt competitor, build a new plant or launch a new product line. Attach a “statement of assumptions” to your pro forma financials, which shows how you plan to achieve your goals and how the changes will flow through the financial statements.

Need help?

Running a company following a business plan that doesn’t include pro forma financials is like going on a road trip with an unreliable GPS app or a bad map: Pro formas help you monitor where you are, what alternate routes or side trips exist along the way, and how close you are to the final destination. We can help you prepare pro forma financial statements, compare expected to actual results and adjust your assumptions as needed.

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Successful business people have a solid understanding of the three financial statements prepared under U.S. Generally Accepted Accounting Principles (GAAP). A complete set of financial statements helps stakeholders — including managers, investors and lenders — evaluate a company’s financial condition and results. Here’s an overview of each report.

1. Income statement

The income statement (also known as the profit and loss statement) shows sales, expenses and the income earned after expenses over a given period. A common term used when discussing income statements is “gross profit,” or the income earned after subtracting the cost of goods sold from revenue. Cost of goods sold includes the cost of labor, materials and overhead required to make a product.

Another important term is “net income.” This is the income remaining after all expenses (including taxes) have been paid.

2. Balance sheet

This report tallies the company’s assets, liabilities and net worth to create a snapshot of its financial health. Current assets (such as accounts receivable or inventory) are reasonably expected to be converted to cash within a year, while long-term assets (such as plant and equipment) have longer lives. Similarly, current liabilities (such as accounts payable) come due within a year, while long-term liabilities are payment obligations that extend beyond the current year or operating cycle.

Net worth or owners’ equity is the extent to which the book value of assets exceeds liabilities. Because the balance sheet must balance, assets must equal liabilities plus net worth. If the value of your liabilities exceeds the value of the assets, your net worth will be negative.

Public companies may provide the details of shareholders’ equity in a separate statement called the statement of retained earnings. It details sales or repurchases of stock, dividend payments and changes caused by reported profits or losses.

3. Cash flow statement

This statement shows all the cash flowing into and out of your company. For example, your company may have cash inflows from selling products or services, borrowing money and selling stock. Outflows may result from paying expenses, investing in capital equipment and repaying debt.

Although this report may seem similar to an income statement, it focuses solely on cash. It’s possible for an otherwise profitable business to suffer from cash flow shortages, especially if it’s growing quickly.

Typically, cash flows are organized in three categories: operating, investing and financing activities. The bottom of the statement shows the net change in cash during the period. To remain in business, companies must continually generate cash to pay creditors, vendors and employees. So watch your statement of cash flows closely.

Ratios and trends

Are you monitoring ratios and trends from your financial statements? Owners and managers who pay regular attention to these three key reports stand a better chance of catching potential trouble before it gets out of hand and pivoting, when needed, to maximize the company’s value.

Business man rolling up sleeves to work on budget, Delaware accountant, Wilmington CPA

As the year winds down, business owners have a lot to think about. One item that you should keep top of mind is next year’s budget. A well-conceived budget can go a long way toward keeping expenses in line and cash flow strong. The question is: Where to begin? Well, to answer this question, we don’t have just one suggestion — we have three:

1. Investigate your income statement. A good place to start on next year’s budget is with the numbers you put on paper for last year, as well as your year-to-date results. In your income statement, you’ll see information on sales, margins, operating expenses, and profits or losses.

One specific factor to consider is volume. If sales have slipped noticeably in the preceding year, your profits may be markedly down and regaining that volume should likely play a starring role in your 2017 budget.

2. Check your cash flow statement. Look at where cash is coming from in terms of daily operations, as well as external financing and investment sources. The statement will also tell you where cash is going, as you finance business activities and investments.

Even profitable companies can struggle if their cash flow is weak. Where do they go wrong? Under- or unbudgeted asset purchases can have a major negative budget impact. Another culprit is one or two departments regularly going over budget.

3. Peruse your balance sheet. Here you’ll find your company’s assets, liabilities and owner’s equity within the given period. Your balance sheet should give you a good general impression of where your company stands financially.

Take a close look at how your liabilities compare with assets. If your debts are mounting, a good objective for 2017 might be cutting discretionary expenses (such as bonuses or travel costs) or developing a sound refinancing plan.

That’s right — to get started on next year’s budget, simply pull out your most recent set of financial statements, roll up your sleeves and get to work. But you don’t have to do it alone. Our firm can help you understand where your business stands as of today and what next year’s budget should look like.

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Experience is the Difference®

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