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. Michael Whitehead-Bust
Who We Are
Drew Tulchin
Social Enterprise Associates: applies business tools to achieve financial & social ‘double bottom line’ results. (
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 (
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

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. Session Goals…(& Limitations)
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)

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:
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. Monthly Income Statement
Steps
Outcomes
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

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
(coming soon)
Drew Tulchin: