Archives for July 2012

How to Forecast Costs to Start a Business

July 31, 2012 by Adam Hoeksema Leave a Comment

How much does it cost to start a business? This is a very common question for first time business owners, the problem is this is a complicated question with no direct answer. Since I know you are probably looking for someone to give you an exact dollar amount, I will list a few of the most common startup expenses.

Incorporation – $100 – You should be able to incorporate your business as an LLC in most states for under a hundred dollars. I suggest that you visit your state Secretary of State website to learn how to incorporate.
Logo – $50 – You should be able to get a solid logo design for $50 on free lance websites like Elance.
Website – $500 – This all depends on whether you know how build your own website, and how much functionality you need. It is certainly possible to build a simple website for $500 or less. You might consider building your own site on SquareSpace
Business Cards – $50 – As a new business owner you will probably want business cards so that you can promote your business. I have used VistaPrint a few times for business cards and have always been very satisfied.
Bookkeeping Software – $150 – I strongly encourage you to start with Quickbooks software right away. You should be able to pay for a 1 year license of Quickbooks for about $150.

ProjectionHub.com can help you project your cash flow for the first 3 years of your business.

3 Financial Ratios Your Banker Will Look at in a Loan Application

July 26, 2012 by Adam Hoeksema Leave a Comment

New entrepreneurs, or business owners who have never dealt with a lending institution before often think that securing a business loan is as easy as demonstrating that you have generated a profit in the past, and your business plan “shows” that you will increase your profits if you get a loan. Unfortunately, it is not that easy. Maybe it should be that easy, but in reality the bank is going to look at a number of other key ratios. Although ratios don’t make sense to the average entrepreneur, the bank will rely heavily on just 3 ratios to get a good picture of your business, so it is important for you to understand how to calculate them and more importantly what they mean and how you can improve. So here are the 3 important ratios that you must understand:

Leverage Ratio – Your leverage ratio is calculated by dividing your total business liabilities by total business equity. Some suggest that a leverage ratio over 4 to 1 would significantly reduce your chances of securing a traditional bank loan. The basic idea is that your lender doesn’t want you to simply borrow in order to grow the business. You need to put something in as well. So how do you improve your leverage ratio? Pay off your debts and your leverage ratio will come down, or simply increase your cash balance without borrowing.
Loan to Value Ratio – Your loan to value ratio is calculated by the total dollar amount of the loan divided by the appraised value of the collateral. Most lenders will require the appraised value of your collateral to be higher than the loan amount. The lender is looking at this ratio to see how much breathing room they have. If the business is to default on the loan and the bank ends up with the collateral, the bank wants to make sure they can sell the collateral for a value high enough to recover the entire balance of the loan. You should simply provide the bank with collateral that is appraised for more than the amount of the loan.
Debt Service Coverage Ratio – This final ratio is a bit more complex, but still incredibly important when applying for a loan. You can calculate your debt service coverage ratio by dividing your annual net income by your annual debt service. Debt service is a fancy way of saying your loan payments. Again this is simply a way for the bank to determine how much breathing room they have. This ratio tells the lender how many times you could make the loan payment with your net income. If you could make the loan payment 10 times with your net income each year, you have plenty of breathing room. If you can only make the loan payments 1.25 times per year, the bank is going to be nervous that if there is any negative downtrend with your business, you won’t be able to make your loan payment. This is simply a ratio that you should be aware of, so that you don’t request a loan that is larger than you can handle.

If you have a good handle and understanding of these three ratios, you will be able to go into the bank with confidence that your loan request is reasonable based on industry standard ratios. Once you create a set of pro forma financial statements based on your proposed loan, go through and calculate these ratios, and you will be far ahead of the average business owner. Good luck!

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Why You Should Keep Your Day Job When Starting a Business

July 14, 2012 by Adam Hoeksema Leave a Comment

If you are bootstrapping a business on the nights and weekends while you keep your day job you are probably trying to find a way out of your job.

Hold on!

Before you do that, let me explain why an alternative source of income is critically important if you want to secure a loan for your early stage business.

Banks look at your “Global Finances” which means they look at your personal + business finances. The banks wants to know that you can pay back the loan even if the business fails. Often times business owners come to the bank and say something like this, “I just quit my job to work on my business full-time, things are going well, but I could really use a loan to help secure things a bit.”

The banker translates that as, “I am in trouble, I quit my day job too soon, and now it is getting stressful because I don’t know if I can put food on the table next month.”

You are most likely to get a loan when you don’t need one. A great example of a dream loan applicant is a recent microloan applicant that I met with. He started a business 9 months ago and is working on his business at least 40 hours a week. He also has a full-time job and his wife works full-time. This proves a lot to the banker:

You are committed – you don’t “have” to start this business, you and your wife already have jobs, so you must be committed to this business.
You work hard – Putting in 80+ hours of work a week for almost a year goes to show that you aren’t afraid to work hard, and you will work hard to pay back your loan.
You have backup income – This particular business owner was not pulling a salary from his new business. This is a great situation because you don’t have to make the choice between paying yourself and making a loan payment, you don’t need the salary right now.

If this business owner had already quit his day job I would be terrified of this loan application, but instead I feel confident that the loan will be approved simply because he kept his day job until it was painful. Keep that in mind as you debate when to leave the security of your day job.

What Investors Are Looking for In Your Financial Projections

July 11, 2012 by Adam Hoeksema Leave a Comment

If you are trying to raise angel or venture capital investment you have probably been asked for a detailed set of financial projections from your potential investors. There are 3 areas that you really need to focus on as you build your forecast.

1. Market Potential Narrative – Investors want to know that you are entering a large enough market that the investor has the potential to earn a large return. If your market potential is only $10 million in annual sales, then you can’t expect to raise 5 million in investment. The market is simply too small. Here is an example of how I developed the market potential for ProjectionHub.

2. Cash Flow Projections and Analysis – If you ask for $1ook in investment, but when reviewing your cash flow projections the investor realizes your cash balance never drops below $80k. You are asking for too much. You don’t need to keep such a high cash balance. You might be able to ask for $25,000 instead, and retain significantly more equity in your business. What if sales double, how does that impact your cash? What if sales are cut in half, how is your cash flow changed? Investors will want to see that you have looked at various scenarios like this.

3. Do your Projections Seem Realistic – No one can predict the future with perfect accuracy. Investors don’t expect your projections to be correct, but they do want them to be within the realm of possibility. Your projections should be based on data, and should be built from the bottom up.

Once you have built a set of realistic, data driven assumptions, creating your pro forma financial statements is easy. There are a number of tools that will help you create the actual statements, including ProjectionHub. You can get started here.

The Difference Between a Budget and Pro Forma Financial Statement

July 10, 2012 by Adam Hoeksema Leave a Comment

You might be a little bit confused about the difference between a budget and pro forma financial statement, so I thought I would try to explain a couple of the small differences. Let’s start with the definitions:

Budget – According to Investopedia a budget is an estimation of the revenue and expenses over a specified future period of time.

Pro Forma Financial Statement – As described here, “In business, pro forma financial statements are prepared in advance of a planned transaction, such as a merger, an acquisition, a new capital investment, or a change in capital structure such as incurrence of new debt or issuance of equity.”

So there are just a couple of subtle differences here. A pro forma financial statement is essentially a budget based on a certain event occurring. Typically a budget is developed each year and might be approved by a board of directors. Many times a budget is focused more on expenses than revenue because you can control your expenses, but you can’t always control your sales.

A pro forma financial statement on the other hand is a projection based on a specific event. For example a pro forma would project your financials if:
You acquired a new company

You secured a large client
You raised a round of investment
You are approved for a loan

These situations would change your future financial results. The real difference between a budget and pro forma financial statements is negligible. The 2 terms may even be used interchangeably at times.

To learn more about budgeting for the future check out our recent blog post on the top 15 financial projection mistakes.

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ProjectionHub Picks 5 Microlenders to Help Improve Loan Application Process

July 8, 2012 by Adam Hoeksema Leave a Comment

In early June 2012 the ProjectionHub team announced an opportunity for 3 microlenders from around the country to apply and win the chance to create a custom financial projection tool for their loan applicants to create their financial projections. There was such a great response that the team felt the need to choose 5 microlending organizations. The following organizations have been selected as winners:

alt.Consulting
CDC Small Business Finance
Iowa Microloan
Southwest Initiative Foundation
Community Development Resources

These organizations have literally made billions of dollars in loans to small businesses.

Co-Founder of ProjectionHub, Adam Hoeksema, said, “It is an incredible honor to work with such prestigious organizations. He hope to learn from these experts and ultimately help their loan applicants create more accurate and realistic financial projections.”

Over the next several weeks the ProjectionHub team will work with these lenders to create a custom version of the pro forma financial tool specifically to meet the needs of each organization and their loan applicants. The tool will be a more user friendly alternative to the complicated Excel spreadsheet templates that most business users utilize to generate a set of projections.

Some have described the tool as an up and coming TurboTax for financial projections.

About ProjectionHub: ProjectionHub is a web based tool that help business owners create financial projections without a PhD in spreadsheet modeling.

Indiana Innovation Showcase Elevator Pitch

July 7, 2012 by Adam Hoeksema Leave a Comment

Today we are hard at work preparing for the 2012 Innovation Showcase on July 12th. Trying to figure out how to put together a decent exhibitor display on a shoestring budget isn’t easy!

The most difficult thing about the entire event is probably the 1 minute elevator pitch. We only get 60 seconds to pitch to a group of investors, developers, and startup VIPs. It is a real challenge to distill our message down to 60 seconds, but here is what I have so far:

“I manage an SBA microloan program, and for the last 2 years we have been requiring many of our loan applicants to produce a set of financial projections.

This spring while working on my personal taxes, I thought, why isn’t there a TurboTax for financial projections?

So my brother and I built ProjectionHub, which is a web application that helps users input sales and expense projection data, and then download a complete set of financial projections as an Excel file.

We have a working version where individual business owners can pay a 1 time fee to create and download a set of projections.

We are currently working with 5 SBA microlenders to create a custom version of the tool specifically for their organization.

This fall we plan to start selling the application directly to lenders for a monthly fee which will give their loan applicants the ability to create a set of complete and accurate financial projections that meet the lender’s standards every time.”

What do you think, is that a decent pitch? Here are some of the main points that I am trying to convey:

My background
How we came across this problem
How our solution is different than competitors
That we have a working application
We have some “traction” with our 5 beta testing organizations
Our goal is to develop a monthly, recurring revenue business model

We will just have to see how it goes!

Use Quickbooks to Create Future Financial Projections

July 6, 2012 by Adam Hoeksema Leave a Comment

If your bank has asked you to create a set of financial projections for your loan application, and you are hoping to use your Quickbooks data to help project your future financials, I have 2 things to say:

You are out of luck
You are not alone

Unfortunately Quickbooks does not have a decent solution for business owners attempting to create financial projections based on past accounting data. In the screenshot below of the Intuit Community you can see that Quickbooks users have been asking question after question to figure out how to create a set of financial projections. There are 798 results for “financial projections.”

So what are your other options right now?

Basically, the only option you have is to use the Quickbooks budget tool which is fairly limited in functionality, OR you can create your own financial projections from scratch. Typically you end up finding and using a Excel spreadsheet template that someone has published on the internet. The problem is that the average business owner doesn’t have a PhD in spreadsheet modeling, and really has no idea if their forecasts are realistic or accurate.

Doesn’t it seem like there has to be a better way? Intuit is also the maker of TurboTax which takes a complicated subject like taxes and makes it simple through software. Why isn’t there a TurboTax for financial projections?

We are working on it!

We thought that there has to be a better way, so we are building a better way.

ProjectionHub is a web application that helps entrepreneurs create financial projections without the need to have a PhD in spreadsheet modeling.

Right now the tool is fairly basic, it walks you through the process of creating up to a:

3 year Cash Flow Forecast
3 year P&L Forecast

But we have big time ambitions! We believe that data can truly change the way business owners project the future success or failure of their company, and that data can help banks better analyze the creditworthiness of a business.

So what exactly does this mean practically?

Imagine that you can connect your own Quickbooks data to ProjectionHub. ProjectionHub then looks at the past couple years of data and notices trends in both sales and expenses. ProjectionHub then automatically forecasts what your financial statements would look like if those trends were to continue.

Pretty cool, but that is only the start!

Quickbooks Aggregate Data

Now this could get really interesting when ProjectionHub pulls in aggregate data from the millions of businesses around the world that use Quickbooks. The app could look at trends by Country, State, and City. We could find trends by industry. Or let’s say you open a cafe and you have been in business for 2 years. The application would be able to look at financial data from other cafes in their second year of business, and then look what they did over the next 3 years. If the average 2 year old cafe grew 20% per year for the next 3 years, that would make a strong case for your projected growth.

On the other hand, the application might be able to see that 50% of 2 year old cafes fail within the next 3 years.

As you create your own financial projections the tool should be able to tell you when you get out of line. Let’s say that only the top .01% of businesses grow as fast as you are predicting. That should be a warning sign to you and your banker that you are being unrealistic with your financial projections.

At ProjectionHub we truly believe the possibilities are endless when it comes to utilizing data to help entrepreneurs better predict the future success or failure of their company.

What do you think? How can we improve the financial projection process to make it easier and more accurate for you and your company?

Is your Startup 98.82% Likely to Succeed? If Not, No Loan for You

July 5, 2012 by Adam Hoeksema Leave a Comment

recently reported that delinquencies for business loans are now down to 1.18%. In my opinion, this is truly incredible! Only 1% of businesses with loans from banks fail to make their loan payments on time. This means that you must convince your lender that you are 99% likely to make your loan payments.

Based on this data, it is no surprise that startups and early stage businesses have a nearly impossible time securing loans from banks. When you look at the data for small businesses, you will find that there is a significant percentage of businesses that will cease to exist in 5 years. Let’s say 25% of the small businesses with less than $1 million in annual sales will be out of business in 5 years. That means that banks are going to be incredibly unlikely to lend to these small businesses because they need to feel 99% confident that you will still be around in 5 years.

That rules out startups and early stage small businesses in technology industries like software, mobile computing, alternative energy etc because technology moves so incredibly fast that 5 years is a lifetime.

Unfortunately for small business owners banks can be selective. There are still plenty of credit-worthy, established businesses that will take loans. The banks don’t need to lend to small businesses in order to make a profit right now. In fact, the top 10 banks in the United States only approve approximately 10% of loan applications.

If you are a startup, what do you do?

I believe there are still some great options. There are 3 places I encourage you to look for a loan:

Lendio – Matches you with lenders that best fit your needs and stage of business
On Deck Capital – Unique way of lending to “Main Street” businesses. Lends even if your credit score is low
Prosper – A peer-to-peer lender where you may be able to build up to a loan capacity of $25,000.

Of course these options will have higher interest rates than your traditional bank, but if you are able to utilize other funding sources during the early stages of your business, you may be able to reach a point in time where you can actually convince your local banker that you are 98.82% likely to pay them back, and pay them on time.

Have you been successful finding other sources of funding since the banks don’t lend? If so, leave us a comment, and share with other entrepreneurs who are looking to grow and expand.

Software Development Loans – Impossible to Find?

July 3, 2012 by Adam Hoeksema Leave a Comment

Red No Circle Clip Art Banks don’t give loans for software development, it is simply too speculative. If the software has not been developed yet how do you know whether anyone will be willing to pay for your product? How do you know what a potential customer is willing to pay? How does the lender even know if you actually know how to program? There are so many hard questions to answer that most banks will simply avoid providing loans for software development altogether.

If you are determined to get a loan to develop software there are a few ways you might be able to convince a bank to lend to you.

1. Get a Signed Contract – If you have a signed contract from a customer this will answer a couple key questions. Now the lender knows that someone is willing to a buy a product, and they know how much they are willing to pay for it. There is still a major question though. How can you prove to the lender that you and your team can successfully overcome the technical challenges and fulfill the contract?

2. Demonstrate a Track Record of Success – Have you completed other software projects? Have you worked with this specific client before? If you can demonstrate that you have been doing this kind of work for 10 years and you have worked with this client on several similar projects, then you might be able to convince the lender that your past success will guarantee your future success on this project.

3. Generate Sufficient Cash Flow from Current Business – If your business is currently profitable and providing sufficient cash flow to cover your loan payments you can probably secure a loan to expand your current business. The bank will want you to use the loan to expand your current, stable business, but if you can use the loan to increase cash flow from your current business, you can then take that excess cash and invest it into your software development project.

If you can get a signed contract from a client you have worked with in the past, or you can generate sufficient cash flow from your current business, you might actually be able to secure a loan for software development. If not, then you should probably start looking for investors who have an appetite for risk.

About the Author: Adam Hoeksema is the Co-Founder of ProjectionHub. ProjectionHub is a web application that helps entrepreneurs create financial projections without the need for a PhD in spreadsheet modeling.