This post involves financial management.  Start-ups and many other small businesses need to frequently raise capital.  The CFO is crucial to the success of this endeavor because the firm’s business plan must include meaningful projections.  The CFO can provide and refine these projections through developing logical financial assumptions.  The assumptions help improve a growth strategy by keeping information simple and emphasizing key metrics such as market size, market share, growth, operating efficiency, and profitability.

               Both revenue and costs must be developed in building the projections.  Critical inputs for revenue estimates enable the development of robust revenue projections.  One input is market levers which are the various opportunities available to earn revenue.   Another is revenue drivers, which are activities that influence that influence levers and produce sales.  A third input is driver activity assumptions that indicate how revenue drivers will act.  This exercise will involve working with the CEO as well as marketing and sales executives.  Finally, a pricing policy is necessary to calculate total revenues.  Integrating these inputs will allow robust revenue assumptions to be development.

               It is important to use a range of activity assumptions to determine a best case scenario, a worst case scenario, and a most likely scenario.  In addition, the CFO must make sure that each revenue assumption is backed up by robust calculations.

               The remainder of the projections include, cost of sales, selling, general, and administrative expenses (SG&A) expenses, and capital investments.  These lead to determination of cash flow which will be of great importance to lenders and investors.

               Cost of Sales are the costs directly related to the product or service and the resultant revenue produced.  It is important to compare the resulting margins to industry benchmarks and similar companies.  In early stage companies, the cost of sales relative to sales may be higher than industry norms, but operational efficiencies should help reduce this ratio over time.

               SG&A expenses include salaries and benefits, marketing expenses; IT related costs, and other costs (such as rent, office supplies credit card fees, etc.).  In the case of the latter it is safe to produce high level assumptions based on revenue, location, industry, etc.  It is important that management stay familiar with technological terminology and cost structures to avoid surprises.  It is also necessary to ensure the marketing and staffing plans align with revenue expectations.  One mistake to avoid is understating legal and accounting fees during inception and early growth spurts.

               Estimate capital investment dollars needed per year and category such as computer hardware, software, machinery, receivables, and inventory.  These estimates should correspond with revenue growth.  It is important that capital providers are shown a capital investment purchasing plan for the business and how the funds will be allocated.

               The preceding inputs are then utilized to calculate cash flow, often expressed as EBITDA in early stage companies and free cash flow in more mature firms.  In either case, capital investments must be highlighted.

               We believe the presentations to capital providers should include a condensed profit and loss statement, cash flow, capital investments, and bullet points on key revenue and expense assumptions.  We also suggest that metrics and graphs be part of the presentation.  These metrics and graphs should address matters such as breakeven point, payback period or IRR, revenue growth, key expenses, major capital investments, and a picture of the full market potential and the firm’s target market share by year.

               We urge that the presentation be comprehensive, yet simple.  Numbers can be rounded to the thousands and key assumptions highlighted.  In addition, we suggest that no decimals be used in the financial projections.  Furthermore, do not confuse the overall story by providing too many details.

               Start-ups and many other small businesses need to frequently raise capital.  The CFO is crucial to the success of this endeavor because the firm’s business plan must include meaningful projections.  The CFO can provide and refine these projections through developing logical financial assumptions.  The assumptions help improve a growth strategy by keeping information simple and emphasizing key metrics such as market size, market share, growth, operating efficiency, and profitability.

               Capitol CFO Solutions serves clients in Washington, D.C., Maryland, and Virginia.  Please contact us for a free consultation.