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Building Better Financials Using Pro-Forma Financial Statements & Their Importance to Your Enterprise Drew Tulchin & Michael Whitehead-Bust Social Enterprise.

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Presentation on theme: "Building Better Financials Using Pro-Forma Financial Statements & Their Importance to Your Enterprise Drew Tulchin & Michael Whitehead-Bust Social Enterprise."— Presentation transcript:

1 Building Better Financials Using Pro-Forma Financial Statements & Their Importance to Your Enterprise Drew Tulchin & Michael Whitehead-Bust Social Enterprise Alliance 5 th National Gathering March 5 th, 2004

2 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 3 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 Im 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 Im the one with the goat-tee

4 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 5 Session Goals… (& Limitations) Goals 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 6 The Value of Pro-Formas (Or, Whats 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 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 dont 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 arent use to losses)

8 8 Pro-Forma Process Framework 1) Where are you now? 3) What are the incremental steps to advance? 2) What is the goal? Stable, successful job training program with access to new $$$ a.Spin-off business applying job training & earns income b.Benefit from brand recog. in community c.Capitalize upon existing org skills in food industry a.Get board buy-in b.Conduct feasibility study c.Etc.

9 9 Philosophy / Key Concepts Incrementation: think in units Childrens 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 carpenters measure twice, cut once - measure continuously, because what you are cutting keeps changing)

10 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: Yr 1 monthly, Yrs 2-5 annually Breakeven Analysis

11 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 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 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 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 15 Monthly Income Statement 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 StepsOutcomes

16 16 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). Dont bet the farm on Year 5 projections 2-5 Year Income Statements

17 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 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 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 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 21 How to Handle Overhead Allocations? Handle in strategic & thoughtful manner Depends on entitys legal status Gray area treatment as fixed or variable Have an easily explained story Have information be transparent in assumptions

22 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 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: (coming soon) Drew Tulchin:

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