When preparing the proformas (financial projections) for your company, remember that they are intended to inform and guide you and your possible investors. They should project what your company’s financial performance and needs will be in the next three to five years.
A complete set of proformas will include an income statement, statement of cash position and balance sheet. Too often, the statement of cash position is not included – and this might very well be your most important projection.
There are two ways to approach financial modeling, but only one is valid — honestly state all of your assumptions pertaining to both the market and to your company’s operations, and see what the results are. Done correctly, this will state what you expect to sell at what price with a list of expected expenses and the calculations used to provide the resulting profit or loss.
The invalid approach is to adjust your assumptions to create the results that you want. And unfortunately, this second approach has become too common.
Entrepreneurs rarely start with the intent to adjust the numbers to make things look good, but the trap is easy to fall into. Typically, the valid approach is first done and the results are disappointing, so assumptions such as sales, pricing, cost of goods sold, or any number of expense items are fiddled with until the desired proforma profitability is achieved.
Because the purpose of proformas is to inform and guide, not to rationalize a failure into a success, this can be damaging to the reality of your business. That said, if your proforma numbers end in a poor result, it does not mean you must kill the proposed company, new division or product line immediately. But you must go back and determine where, along the way, you can make changes to truly affect the profit and loss outcome.
That may be increased pricing or selling more units. The goal is to be honest, know the market, your competition and the opportunities that exist. Simply tweaking the numbers in a spreadsheet doesn’t do anyone any good. Erwin Bruder ([email protected]) is president of The Gordian Organization. Reach him at (216) 292-2271.
