Section 9: FINANCIALS

By Jack Malley, Partner, FirstJensenGroup.

See Accounting & Finance chapter for information about the author and firm.

The financials are used to document, justify, and convince. They should be prepared in harmony with the rest of the business plan, i.e., conclusions and assumptions detailed in the development, marketing, and manufacturing sections of the business plan should be reflected in the financials. Investors examine these statements to determine if management is realistic in its expectations and to determine if an acceptable rate of return on investment can be achieved.

REVENUE PROJECTIONS

Most business plans include optimistic financial projections while claiming that they are conservative. Investors will have little faith in these revenue projections but will infer from them whether the entrepreneurs are realistic in their expectations. If the so-called conservative projections are not conservative, you will find yourself defending potentially indefensible calculations. Furthermore, your reputation will suffer if you fail to meet your projections down the road. Comparables add credibility; pick several companies that are similar to yours and describe their sales growth and expenses as a means of substantiating your own projections.

STATEMENTS

The financial statement section of the business plan typically appears in two locations within the business plan: summarized data in the executive summary of the plan and in a financials section of the appendix. The summarized data displays annual data, both historical and up to five years of forecast. Line items would include revenues, cost of sales, gross margin, operating expenses, net income, capital expenditures, equity fund raising, and year-end cash balance. Additional references may include gross margin %, net income %, and year-end headcount.

A sample set of financials appropriate for a business plan appendix may be downloaded from: www.evelexa.com/resources/account_issues.cfm.

The financials section of the business plan should include a listing of assumptions used to prepare the financials, a balance sheet, an income statement, and a statement of cash flows. Historical data should be prepared as annual totals. Forecasted data should be monthly for the first year and quarterly for the second and third years. Annual totals should be provided for the fourth and fifth years.

The list of assumptions may be the most important part of the financials section. Assumptions should identify the timing of the financial event(s) and milestones the company hopes to achieve in the forecasted time period. Specific assumptions should be listed for each revenue type including the method by which revenue is to be recognized and how revenues relate to market size. Specifically, according to GAAP (Generally Accepted Accounting Principles), revenues may not track with the timing of cash receipt. For an early-stage company, the timing of revenue recognition is far less important than the timing of cash receipts. The cost of sales assumptions most often will mirror the revenue assumptions. Major categories of operating expenses, such as compensation, facilities, research and development, and preclinical and clinical expenses, should be identified. Other assumptions that should be included would relate to the company's cash flow activities. For example, the timing of customer/partner cash receipts, vendor payments, payroll, taxes and benefits, and the scope and cost of debt and equity financings would be included. Finally, the assumptions should detail when operating cash breakeven is expected.

Table 2. Sample Financials for Start-Up Business Plan

The three primary financial statements should have more line items than in the table above but not to the lowest level of detail, which is reserved for a separate operating budget spreadsheet that would not interest most investors. Line items included on the income statement should closely match the categories identified in the business plan's assumptions. The income statement should highlight EBITDA (earnings before interest, taxes, depreciation, and amortization), which is used to approximate net earnings from the ongoing operations of the company.

The balance sheet should have, at a minimum, line items for cash & cash equivalents, receivables, fixed assets net of depreciation, other assets, trade payables, bank and capital leasing debt, other liabilities, stock, and retained earnings/deficit. There should be no "plug" numbers in the balance sheet. All entries should be formula driven and derived from input data in the other two financial statements. This strategy allows for proofing of the financial statement, i.e., an out-of-balance balance sheet will indicate that a formula is not working properly.

The statement of cash flows is usually prepared in a GAAP format, i.e., one that segregates operating, investing, and financing cash activities. The operating activities include the net income of the enterprise, net of non-cash items such as depreciation, and the period-toperiod change in most balance sheet accounts. Capital expenditures comprise most of the investing activities while debt funding/payments and equity funding comprise most of the financing activities.

Since a picture is worth a thousand words, a graphical rendering of key drivers and statement elements, a socalled "dashboard report" that includes four graphs on a page, may be downloaded at: www.evelexa.com/resources/account_issues.cfm.