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Archives for February 2013

4 Reasons Why Your Balance Sheet Does Not Balance

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ScreamingThe balance sheet can be the single most frustrating thing for a business owner.  If you are having trouble with your balance sheet my first suggestion is to hire an accountant.  My second suggestion is to use Quickbooks which automatically generates your balance sheet so that you don’t have to worry about it.  But there are many early stage companies and a little bit less sophisticated small businesses that aren’t using Quickbooks yet, and can’t afford a CPA.  So if you are just using an Excel spreadsheet, or a piece of paper and pencil to do your accounting and someone asks you for a balance sheet, do not fret, you can create your own balance sheet.  Here is a detailed blog post on how to create a projected balance sheet that will get you started.

But you will undoubtedly run into problems.  Your balance sheet won’t balance.  So now I just wanted to give you 4 things to look for if your balance sheet is not balancing.  

1.  Paid in Capital – Before I jump in to Paid in Capital mistakes, I just wanted to make sure that you understand the basics of a balance sheet.  At the end of the day, in order for your balance sheet to balance, you need your Assets to equal your Liabilities plus your Owner’s Equity.  Paid in capital is an owner’s equity account.  The definition of paid in capital is “the capital contributed to a corporation by investors through purchase of stock from the corporation.”  For most small businesses Paid in Capital is the amount of cash you personally invested in the business to get it started.  You may have had other investors as well when you started, their investment plus your investment should be the total of Paid in Capital.

2.  Loan Amortization Mistakes – Another common mistake for companies that have loans is to screw up the breakdown between principal and interest amounts for loan payments.  A common mistake is to reduce your loan balance on the balance sheet by your monthly payment amount.  Don’t forget that only a portion of each loan payment will go toward the principal on the loan!  The rest will go to interest.  Your interest will only show up on your income statement and cash flow statement, not the balance sheet.

3.  Change in Inventory – Another common mistake that impacts the balance sheet is a change in inventory.  You would think that it should be pretty simple.  It is easy to determine how much inventory you have right now because you can just go make a physical count, but if you are working on a set of financial projections you will need to project future inventory amounts, and this will impact your balance sheet each month.  The trick is that a change in inventory also impacts your cash flow statement, you actually have to take last month’s inventory and subtract this month’s inventory and then reduce your cash balance by that amount.  Yes, it really is tricky that is why a good CPA is worth their wages.

4.  Retained Earnings – Retained earnings is kind of a catch all.  Retained earnings is supposed to be the sum of all your net income or net loss from the day you started your business.  So if you were doing things right from the beginning you should be able to calculate retained earnings, but what I often see with small businesses is that they don’t have all the data needed to calculate retained earnings, so they just use Retained Earnings as a plug number.  They make retained earnings whatever it needs to be in order for the balance sheet to balance.  I am not suggesting that you do this, but just know that it is not an uncommon practice.

My suggestion, don’t waste another minute trying to figure out how to balance your balance sheet if it is not working.  Hire an accountant, learn to use Quickbooks, or use ProjectionHub if that can meet  your current needs. I have wasted many, many hours wrestling with a balance sheet, and I have a background in accounting.  I hope this post either cleared some things up for you, or helped you make the decision to stop wasting your time and to call in a professional.  Good luck!

3 Realistic Ways to Finance a Software as a Service Startup

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Graph line: up and down 1Software as a service startups are popping up everywhere these days, and for good reason.  The monthly recurring revenue business model is certainly desirable because it is predictable and profitable.  The problem with a successful software as a service company becomes financing growth.  Generally with software as a service there is no upfront, one time cost to get started.  Instead, many times a company will offer the first few months for free as an incentive to get a customer to try the service.  The problem is that in general most of the costs for the company are incurred when they sign up a new customer.  For example, it may cost you $100 to acquire a customer who then pays $20 a month for your service.  This is a great business if you can keep the average customer for longer than 5 months, but it causes some real cash flow issues.  Each time you sign up a new customer, you need to come up with $80 initially to fund the difference between the acquisition costs and the first month’s revenue.  So how do you finance a business like this?  At some point you will be able to raise investment, but probably not right away.  You need to show growth and sales first.  So here are 3 realistic ways to fund this type of startup:

1.  Microloans – Traditional banks are scared of software, they are scared of this type of recurring revenue business model in the early days of the business because every time you grow you need more cash.  That scares the traditional bank, but there is another option.  The SBA has a program called the Microloan Program.  There are SBA microlenders all around the country who work to fill a lending gap.  They lend where traditional banks do not.  You won’t be able to run forever on a microloan, but it may help you get closer to securing that large investment or line of credit from the bank.  Microloans are typically between $1,000 and $50,000.  Here is a listing of all the SBA Microlenders in the United States.

2.  Credit Cards – In a software as a service business you will always need additional funding if you want to grow.  There is no magic bullet.  Even if you raise some angel investment you will need to come back for more time and time again if you want to grow.  A majority of your costs are up front.  Over the long term each new customer will be profitable, but that breakeven point might not be for 6 months or longer. Sometimes this problem may drive you to fund your growth with credit cards.  This is not ideal, but it can work.  Just like a microloan, a credit card won’t solve all of your financing problems, but it can help you kick the can down the road.  The problem is, if you go to an investor and you have very little in sales, you are going to have to give up a huge percentage of ownership.  You need to find ways to increase your sales so that you can demand a higher valuation when it comes time to meet with investors.  Yes it is risky to get yourself too deep in debt growing the business and then find out you can’t secure an investor, but generally you will be able to find investment for a growing software as a service business, the only question is the valuation.  How much of the business will you give away.

3.  Alternative Financing – Lastly, there are some interesting new ways to finance businesses that charge their customers via PayPal or credit cards.  New alternative lenders are actually taking your PayPal data or your credit card/bank account data to determine how much they are willing to lend to you.  There are two examples of this type of financing.  Kabbage.com uses your PayPal data, social network data, and Amazon or eBay seller data to determine your credit-worthiness and how much you are able to borrow.  Similarly, OnDeck Capital uses your cash flow data from your bank account to determine if they are willing to lend and how much they are willing to lend.  Then they actually pull small payments back from you on a daily basis.  They realized that it could be hard to come up with a 1 time monthly payment for your loan, so they pull on a more regular basis.  This reduces their risk and a lender.  Now both Kabbage and OnDeck come at a price.  This is certainly not the cheapest way to fund your business, but it can help you grow without giving away the entire company to an investor.

All 3 options here are a bit more realistic than walking into your local bank and asking for a $100,000 line of credit to help grow the business.  That is very rare for a software company and even more rare for a startup.  So consider these financing options as stepping stones until you get to that $500,000 in annual recurring sales.  At that point you will be able to secure an investor without giving away all of your equity.  Good luck!

Creating Financial Projections for a New Restaurant

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There are probably more restaurants started and more restaurants that fail each year than any other type of business.  There are several reasons that so many restaurants fail:

  1. Just because you can cook does not mean you can start and run a profitable restaurant
  2. Owners underestimate how much it will cost to open, and have no working capital left once they open
  3. They don’t create realistic financial projections BEFORE they start the business

So now I am going to help you by creating an example set of financial projections for your restaurant.  I am going to walk through the process that you need to think through as you are creating your projections, and I am going to use ProjectionHub to actually complete a 12 month set of projections.

Restaurant Sales Projections

The first thing you need to do is build a set of sales projections.  Let’s assume you are going to open up a cafe that offers breakfast, lunch, and dinner, with a focus on the business professional lunch crowd.  In order to develop sales projections you will need a set of assumptions to build off of.

Sales Assumptions

  1. There are 100 seats in the cafe
  2. Average order is $10
  3. At full capacity the restaurant will serve 50 people for breakfast, 100 for lunch, and 50 for dinner
  4. There will be 3 months of expenses, renovation, training etc before the store opens
  5. We will assume that the first 2 months of sales will be below your ultimate capacity by 25%

So each month we will project the number of meals sold.  At capacity it would be 200 meals per day x 30 days = 6,000 meals, but during the first couple months we will estimate 4,500 meals as sales ramp up.

Expense Projections for a Restaurant

There are 3 different types of expenses that we will need to forecast, your cost of goods sold, general expenses, and startup costs.  Here are some basic assumptions that you will need to develop for your own situation.

Cost of Goods Sold Assumptions

  1. I am assuming that my labor costs will be 30% of sales
  2. I am assuming that food costs will by 20% of sales

General Operating Expenses

 

These are all of your normal operating expenses like rent, salaries, wages, taxes, advertising, maintenance, cleaning, accounting, legal, etc.  You can see the monthly and one time expenses I entered for the restaurant below.  I did not assume that the owner will take a monthly draw each month, so the owner is actually working for free initially in order to help stabilize cash flow during the first year.  

Restaurant Startup Costs

Now we need to determine the startup costs that we will incur before we even open the restaurant.

  • Furniture = $10,000
  • Kitchen Equipment = $30,000
  • Building Renovation = $5,000

Once we enter these startup costs we will also enter two loans that the business has incurred in order to cover initial costs.  A $10k loan from family and a $15k loan from a local bank.

That is it.  Now we need to check and see how the final financial projections turned out for the first 12 months of the business.  I have included a link to the Excel file that ProjectionHub produced based on our inputs and assumptions.  It looks like you will make money in the first year based on these assumptions.

How to Start a Coffee Shop and NOT Go Bankrupt

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At one time or another almost every aspiring business owner I know thinks they would like to open a coffee shop someday.  Usually someone is able to talk them out of it, but sometimes you find a person that is so committed to entering this highly competitive market that there is no stopping them.  The reason that most independent coffee shops fail is because the business owner loves coffee not accounting.  They love fair trade beans, not sales.  In the end coffee is their hobby, not their business.  If that describes you, then please keep reading.  Here are 4 key steps to starting a coffee shop that is sustainable and profitable.

1.  Don’t Start With a Shop –  The first step is NOT to start your coffee business by opening a coffee shop.  Depending on how much renovation the space needs, you should expect to spend between $50,000 and $250,000 to open a coffee shop.  This is all before you make your first sale.  What if you ended up picking a bad location?  What if you took out a loan to purchase the equipment and make the renovations, and now it is taking you a bit longer than expected to ramp up your sales, and now you can’t make your loan payment?  What if you find out that people are not willing to leave their current coffee shop to come to yours?  All of your potential customers are coffee drinkers right?  They probably drink coffee every day right?  Which means they are currently getting coffee somewhere else, and  they may not care that there is a new coffee shop down the street.  There are many, many reasons not to start by opening a coffee shop right off the bat.  Instead, you should start to generate sales.

2.  Build Recurring Sales – Before you even think about investing a couple hundred thousand dollars to open a new coffee shop, start by finding customers.  That is right, you can actually build a base of repeat customers before even open a store front.  Find a small space, purchase or lease a coffee bean roaster, and start roasting your own small batches of fresh coffee beans.  Then sell your coffee to other coffee shops, local office buildings, churches, and individuals.  You need to build a base of recurring customers, customers that you can count on every day, week, or month.  Once you have that recurring income, you can start looking into financing.  You probably wouldn’t be able to get a loan anyway without sales, but even if you could it is a much better position to be in if your current customers are producing enough positive cash flow for you to be able to make the monthly loan payments.

3.  Purchase an Existing Coffee Shop – Next, I strongly recommend that you consider purchasing an existing coffee shop before you open your first shop on your own.  Why?  Because you can review the financial statements of the existing shop and see that it is profitable and sustainable based on the current customer base.  When you own your first coffee shop, you are going to make mistakes, you can afford to make a few more mistakes when you have an established and profitable business rather than trying to start something from scratch.  So you can use the wholesale and coffee by the pound business that you generated in step 2 to help you secure the financing to purchase an existing shop.  So many questions are already proven when you purchase an existing shop.  You know the location is good enough, the customer demand is there, the pricing is right, the environment in the shop is working.  You know all of these things because the business is already profitable, if you were to start from scratch, you could make mistakes in any of these areas.  I encourage you to purchase an existing shop instead of starting your own for your first experience as a coffee shop owner.

4.  Become a Pro Forma Financial Statement Expert – Now it is time to become a pro forma financial statement expert.  You have some stability with your wholesale and coffee by the pound customers, along with your established shop, now you need to start looking at various options for growth.  A pro forma is essentially a financial projection based on some given scenario.  So you might create 4 pro forma financial statements for the next 12 months based on the following scenarios:

  1. Keep everything the same as it is now
  2. Expand your wholesale side of the business by hiring a salesperson to pick up new wholesale accounts
  3. Take what you have learned from owning the first coffee shop and look to open a second location from scratch
  4. Purchase another existing coffee shop

You can develop financial projections with ProjectionHub for all 4 scenarios and determine which option you believe will be the most profitable, and put you in the best position for continued growth.

So if you are thinking of draining your retirement account and starting your own coffee shop, Don’t!  Consider how you can build the business the right way, the smart way, and the financially sound way.  Good luck!

 

SBDC and SCORE Utilizing New Financial Projection Tool to Simplify Projections for Clients

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score sbdcIn the Spring of 2012 Adam Hoeksema, Co-Founder of ProjectionHub, was working on his personal taxes using TurboTax when it hit him, “If TurboTax could take a highly complex process like preparing a tax return, and make it simple enough for someone other than a tax professional to complete, there must be a way to make the process of creating financial projections much easier as well.”

Adam manages a small business loan program at a non profit business incubator in the Indianapolis area, and often requires his loan applicants to create financial projections for their business.  He noticed that the typical Excel template that most people use to generate financial projections is too complicated and intimidating for most small business owners.  Adam said, “The light bulb really went off when I was working on my own taxes, and I thought that we could create a TurboTax-like tool for financial projections.  I called my brother who is a web developer, and we got started building ProjectionHub right away.”

Free Demo Version for SBDC and SCORE

The second version of ProjectionHub was released in early 2013, and is starting to gain some traction, particularly with business advisors at many Small Business Development Centers and SCORE offices.  The company recently released a Demo Version that is available to all SBDC and SCORE business advisors.  To access the demo version simply:

  1. Visit http://projectionhub.com/coupon.php 
  2. Enter Coupon Code “score” or “sbdc”

Many business advisors are asking their clients to complete a set of financial projections using ProjectionHub before meeting face to face to walk through any questions they might have.  This drastically cuts down on the time it takes for the advisor to help the client create projections.  Give the tool a try today and see how it can help your clients improve the financial projection process.

How Quickbooks Online Will Change The World

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I believe that Quickbooks Online is the final piece of the puzzle for Intuit to control the financial world for you at home, at work, and in the eyes of the government.  You may not realize this but Intuit owns the 3 top finance web applications in the world:

  • Mint.com – Personal Finance
  • TurboTax – Tax Finance
  • Quickbooks – Business Finance

As all three services make the transition from driving to Best Buy, picking up the latest version of TurboTax or Quickbooks, and installing on your computer via CD, to a cloud based solution, Intuit is unlocking an absolute gold mine of data.  Intuit can now take that data from their over 65 million accounts, and make it available to developers like ProjectionHub who will cut and slice the data in order to provide incredibly valuable information to a wide range of customers.  As my day job, I manage a small business loan program, I can think of several ways that we could use Intuit data to make our job of lending money easier.  These are just a few of the ways that I believe Quickbooks Online, and it’s partner programs Mint and TurboTax will change the world for lenders, investors and small businesses everywhere:

  1. Predict Business Failures – As a lender and business consultant I would love to be able to take the Quickbooks data of a small business and compare it to aggregate industry data.  For example, an application could easily be developed to compare your restaurant’s sales, margins, cost of goods sold, labor costs, etc to the aggregate of all other restaurants that use Quickbooks Online.  This would tell me what areas the business needs to improve on.  The data can go way beyond that though.  A couple of clever statisticians could find trends that might show that a business with certain sales levels, certain margins, etc fails 40% of the time within 5 years.  You could find commonalities with the businesses that succeeded, and focus on those areas for your business.  No longer do we need a thousand management consultants to tell us their idea for how to improve our business, the data will speak for itself, and the numbers don’t lie.    
  2. Benchmark Against Industry in “Real Time” – I already mentioned the idea of benchmarking and comparing your business to other businesses in your industry, but you could take this a step further and compare your business in real time.  Many Quickbooks users are entering in data on a daily basis for their business.  You could watch your daily sales at your coffee shop compared to daily sales of all other coffee shops around the country.  Maybe you run a promotion and business picks up by 10%, and you assume it is because of the promo you are running, but if you noticed that other coffee shops in your region also saw a spike in sales, you might realize that it was not your ad, it was the fact that it was exceptionally cold this week and more people wanted a warm beverage.
  3. Simplify Loan and Investment Approval – Finally, I believe that when Quickbooks Online is connected in a coherent way with Mint.com and TurboTax, Intuit could vastly improve the loan and investment approval process.  Lenders typically want to look at both personal and business financial information.  Mint can provide the personal, Quickbooks can provide the business financial info.  Since you can put anything you want into your Mint and Quickbooks account, a tax return is typically used to validate that you are telling the truth.  TurboTax can provide that information quickly and easily for both the personal and business finances.  I could imagine a day when the bank clicks one button that brings all this data together and gives the person a score immediately that will describe their creditworthiness.  This level of information would put the credit score to shame.  Credit score information would still be important, but it would be only a small piece of the overall puzzle, instead of the primary number that most banks look at.

I truly believe I am only scratching the surface with all of the really crazy and cool things that we will be able to do with Intuit data someday.  I would like to develop an app here at ProjectionHub that utilizes this data that is now becoming available, I just need to focus in on one core problem that this data can help solve, and then build it.  Any ideas?

3 Deadly Pro Forma Balance Sheet Mistakes Entrepreneurs Make

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Entrepreneurs are often asked to create a set of pro forma financial statements for their business during the process of securing capital through a loan or investor, or when they are about to experience a big change like a merger or acquisition, or a large new customer.  Future financial projections can be tricky all the way around, but the balance sheet is particularly difficult for non-accountants.  Before we get into 3 common mistakes that small business owners make when developing a pro forma financial statement, you must first understand the difference between simple financial projections, and a pro forma financial statement. Here are 3 of the most common and damaging mistakes that you can make when working on your balance sheet forecast:

1.  Incorrect Accounting for a Loan – There are a few ways to really screw up your balance sheet if you don’t understand how a loan impacts the balance sheet.  So let’s say you are applying for a loan, and you are creating a pro forma assuming you got a $100,000 loan.  After you get the loan, obviously cash should increase by $100k, you should have a loan account on the liabilities side of the balance sheet for $100k, but what happens in the subsequent months?  Let’s say you have a $1,000 monthly loan payment, so cash will decrease by $1,000, but your loan balance will not decrease by $1,000.  A portion of the loan payment will go toward interest expense which will not decrease the loan balance, instead it would decrease net income which ultimately decreases your retained earnings line on the balance sheet.

2.  Failing to Account for Depreciation – Let’s assume that you use the $100,000 loan to purchase a building.  So again your liabilities will increase by $100,000, but your assets will also increase by $100k initially.  Then you need to determine how long the building will last.  Typically you can assume 30 years for a new building, and then calculate depreciation for each month of the 30 years.  This means that each month the value of the building will decrease due to depreciation.  In our example we can assume the building will be worthless after 30 years, so we will depreciate the building to 0 over 30 years.  So to calculate monthly depreciation you will just take $100,000 divided by 30 years divided by 12 months which equals $277 per month.  Each month the value of your building asset should go down by $277 and your retained earnings should also decrease by $277 per month.

3.  Assets Do Not Equal Liabilities + Owner’s Equity – The worst mistake that you can make when creating your balance sheet pro forma is when your balnce sheet does not BALANCE!  In order to keep your balance sheet balanced, you must utilize the equation Assets = Liabilities + Owner’s Equity.  This equation must always work, it must always balance.  If you change the value of an asset, you must change the value of either a liability or owner’s equity account.  You really need to understand accounting to make sure you are getting this right, otherwise you are going to end up with an unbalanced balance sheet which could be pretty embarrassing when you bring your financials to a potential lender or investor.

Next time you are creating a pro forma financial statement make sure to keep this common issues in mind.  If you feel uncomfortable with your own projections, but don’t want to spend $250 an hour for your CPA firm to review what you have created, feel free to shoot me an email at adam@projectionhub.com and I would be happy to review your pro forma financials for you.