fbpx

ProjectionHub

“Measure” Your Lean Startup Early and Often with Financial Projections

by Leave a Comment

Build. Measure. Learn.  These are the principles that the Lean Startup lives by.  In this blog post I am going to outline in detail how I believe a lean startup should integrate financial projections between each step of the process.  I believe that financial projections can help you measure your potential for success from the very beginning and then as you continue to build, measure and learn you will hone in on developing a more accurate set of projections.

The reason I strongly believe in developing financial projections right from the get go is not because I think they will be accurate, it is because I think they might be able to uncover a fatal flaw in your business model sooner rather than later.  Each time you learn and gather more data, you will be able to tweak your assumptions in your financial projections and determine whether or not there is still potential for profit.  

Lean Startup Financial Projection Example

So now I want to go through an example of how an entrepreneur following the lean startup process might use financial projections to their benefit.  

Imagine a Business Model or Two

So you come up with a solution to a problem and you want to build a business around this solution.  In my humble opinion the first thing you should do is some simple back of a napkin type math and imagine what a business model might look like for this solution.  I am not suggesting a 30 tab spreadsheet financial model for the next 5 years of the business.  What I am suggesting is that you do 10 minutes of research and get a rough idea for the following data points:

  • How many customers might you be able to sell to?

  • How much might these customers be willing to pay?

  • How much will it cost you to produce this product or service?

The purpose of this exercise is to determine whether or not moving forward is worth your time.  If you conclude that your total market for this product or service might be $50,000 annually, then maybe you should spend your valuable time elsewhere.  Or maybe you realize that the technology just is not there yet, and it will cost you so much to produce the product that you would have to charge your customers an arm and a leg for the end product.  Maybe this is what happened with the Apple Newton.  The Apple Newton was a great idea, ahead of its time.  How do we know this?  Because of the success of the iPod, iPhone, and iPad, but the technology just wasn’t ready yet, and it cost too much for the limited functionality that it had.  

Build an MVP

Once you have passed the first test, and it looks like there is a business model that could be profitable, now build your minimum viable product.  Once you have a product or service for sale you can learn a number of details that will help you iterate on your financial projections.  

For example, let’s say you built a software application that you are selling.  Let’s also assume that it is NOT a recurring monthly or annual fee for the software.  The user purchased a license once and it is theirs forever.  

So you start out by selling it for $25 per license.  It is already built, so there aren’t really any cost of goods sold expenses.  In other words, you could sell 100 units or 1,000 units and your cost of goods sold would be the same.  With that in mind, then it is really all about customer acquisition costs.

You might start out selling your product primarily through advertising with Google Adwords.  You can test over a period of time and determine how much you pay in advertising for each unit you sell.  Let’s say you are paying $32 worth of advertising for each $25 sale.  It doesn’t take a rocket scientist to quickly determine that something must change.  So you can either work to optimize your advertising to lower your cost to acquire a customer, or you can increase your pricing.  

Adding New Features

As you add new features I think it is worth your time to create a quick financial projection for each feature.  For example, you might want to add live chat support to your software.  This is a slightly more complex projection, but a good example.  

The question is how do you know whether or not it might be worth adding the new feature before you spend the development time.

Let’s say you are going to use an out of the box live chat system like Olark.  You are also going to customize the integration a bit and you expect about 20 hours of development to be spent on implementation which will cost you about $1,000, along with $200 a month for the premium version of Olark.  The other thing to take into consideration is that you will need to hire live chat support.  Let’s say you pay $15 an hour and will have someone available 24 hours a day.  That is an additional $10,800 a month.

So in total we are looking at a $1,000 up front investment and $11,000 monthly expense.

Now the question is how will the addition of a live chat feature impact your sales?

If you think it could drastically increase sales, it might be worth moving forward, BUT before you hire a few people to man your live chat desk 24 hours a day, you need to Build, Measure, and Learn to determine whether the finances make sense.

So you could implement the most basic version of Olark’s live chat feature and test to see if your sales conversion rate increases.  Test it for a week.  With the addition of live chat do you convert 20% more website visitors into customers?  Now you can iterate on the financial projections again.  Is the 20% sales increase enough to justify the additional expense?

You could run this same experiment with each 8 hour shift.  Maybe it is profitable to have a live chat from 8 am to midnight, but not from midnight to 8 am.

With each cycle in the lean startup process I recommend a mini financial projection that can help you stay on the path toward a profitable business.

Let me know if you have any questions, I would love to chat.  Shoot me an email at adam@projectionhub.com

Why a Growing Business Always Needs More Cash

by Leave a Comment

Over the last 24 hours I have talked to two fast growing businesses who are in need of cash.  Both business owners described their frustration  that they feel like the need for cash is never ending.  One business owner asked, “does it ever end?”  Does the need for cash ever end for a growing business.  Unfortunately in almost any circumstance the answer is no…  As long as you are growing your business you will need more investment, more loans, more financing of receivables etc.  There are always going to be upfront costs to acquire new customers, and you won’t see a return on your upfront investment for weeks, months, or even years depending on the business.

In case you thought after you get that loan or that round of investment you have reached the promised land, let me provide a an example that illustrates why you will likely require additional funding with each step of growth.

Growing Business – Growing Pains

I want to start with a fast growing VOIP phone service company that I have worked with.  Their business model is highly profitable over the life of a customer, but it is laden with up front costs each time they acquire a new customer.  Think about the costs that go into each new phone line they sell.

  1. Travel – In order to get the sale in the first place you will need to spend cash traveling to visit the client, develop and present a proposal.
  2. Sales Commission – Right off the top the sales guy is going to want to get paid for bringing in the sale
  3. Phone Installation – The phone service company may or may not provide installation for new clients
  4. Support – Initially the client is going to need additional support during the first few weeks or months as they get used to the new phone system

The problem, as you can see, is that each time the company adds a new phone line they may have $100 worth of up front expenses, and they may only profit $15 a month per phone line.  If that is the case it will take them 7 months to breakeven.  Once they have reached that breakeven point the business model is wonderfully profitable, but they have a real need for cash up front.

As long as this business is accelerating growth it will always need more cash.  Take a look at your situation.  If you feel like you are growing and should be profitable, but you always need another cash infusion, this may describe your situation.  There is no magic bullet to solve your financing needs.  That is why they call entrepreneurship FUN!

Please Don’t Start a Business Until…

by Leave a Comment

Every week I meet with hopeful entrepreneurs who have an idea to start a business, and come to me seeking funding through the SBA Microloan Program that I manage.  Lately I have been noticing some trends with many of our potential borrowers.  They are not ready to start a business because they have not taken care of 3 important things yet.

1.  Personal Finances are a Mess – If you are in debt up to your eyeballs, barely keeping up with minimum payments, and your credit score is in the dumps, then you are not ready to start a business yet.  Your personal finances will determine your ability to secure a loan for your business in the future.  If you anticipate needing a loan for the business at some point, but your personal finances are already a mess, get that taken care of first, otherwise you won’t be able to secure financing, and may lose your business altogether.   You don’t need a perfect credit score or a net worth in the millions, but if you are barely holding on now, how are you going to make it through the first few years of startup a business?

2.  No Market Potential Research – Does anyone actually want your product or service?  I pound this into my clients time and time again.  Before you start a business, take 5 minutes and use the Google Adwords Keyword Tool to determine how many people are searching for keyword phrases related to your product or service each month.  For example, maybe you are going to build a web app where a user answers a number of questions and then the tool automatically tells them the kind of dog that is most compatible for their family.  Before you hire software engineers, and web designers, you should find out how many times people search on Google for keywords like:

  • Good dogs for people with allergies
  • Cheap hypo allergenic dogs
  • Dogs that don’t shed

You will probably find that these keyword phrases get hundreds of thousands of searches each month.  That is great, but is there competition?  Sometimes it might be better to compete in a market with no competition and 1,000 monthly searches versus a highly competitive niche with 100,000 monthly searches.  Either way you need to do the research.

3.  No Cash Flow Projections – Finally, you need to create some financial projections for your proposed startup.  Many business owners just get started and then realize that they are going to need $50,000 to fulfill orders.  The only problem is that they are only a couple months into the business at that point and no bank is going to lend them 50 grand so early in the business.  If you would have worked through some cash flow projections and different scenarios before you started the business you could have worked to line of financing from friends and family in the event that you need some additional cash.  It is not a good idea to go to friends and family for money last minute.  You should warm them up to the idea, let them watch the business grow and succeed, and then ask for them to partner with you.

Until you take care of these 3 things, you really have no business starting a business.  You are setting yourself up for failure, a failure that could be avoided if only you took the time to get these 3 important aspects of your business taken care of first.

How to Project When Your Startup Will Run Out of Cash

by Leave a Comment

Cash flow is probably the most important financial metric for any startup, and the ability to predict when your company will run out of cash, even if it is 12 months into the future, is incredibly important, especially for startups that are looking to raise capital from investors or lenders.  There are a handful of factors that will impact your cash flow, and putting them altogether in a financial model is necessary for any business to determine the timing and amount of capital that is needed.  The primary factors that impact your cash flow include:

  1. Accounts Payable Terms – How many days can you wait to pay your bills?
  2. Accounts Receivable Terms – How long does it take you to collect payment for your sales?
  3. Bad Debt Expense – What percentage of your customers just won’t pay?
  4. Seasonality of the Business – Some businesses (lawn care or snow removal) make 90% of their revenue in a 3 month period of time
  5. Annual Expenses – There are certain annual expenses that can surprise you if you don’t plan well (property tax, insurance, payroll taxes)

Now the challenge is to put all these factors together to predict the exact month you will need an infusion of cash for the business.  I am going to use our ProjectionHub forecasting tool to demonstrate how this process should work:

1.  Project Sales

You will start by projecting your sales.  This isn’t simple, but you can either project sales based on your past performance, or based on competitor data.
For now I am just going to input some data into our tool for each of the first 12 months.  We will start by creating a new product and entering in some basic assumptions including the price of the produce and the Accounts Receivable Terms – this is how long it takes us to get paid.  In this example we are assuming it will take 45 days to get paid after we make the sale. data.
Now I enter in the number of units I expect to sell of “New Product #1” for each of the first 12 months as seen below:
2. Expense Projections
Next we get started with projecting our expenses.  We start by setting your Accounts Payable Terms which is how many days you take to pay your bills.

So as you can  see here we are projecting that you typically take 25 days to pay your bills, and from above we know that your customers take 45 days to pay you, so you will have some inherent cash flow challenges.

3. One Time Expenses

Now we look at those pesky one time annual expenses that tend to creep up on you.  You think you are doing well because you made a profit the first 4 months of the year, but you forgot that in month 5 you have to pay $5,000 in property taxes that will eat away all of your profits to date.  So with ProjectionHub you can enter in those one time expenses ahead of time to help you predict when you will run out of cash.

4.  Bad Debt Expenses

It is a fact of life that some customers just won’t pay.  You should come up with some percentage of sales that you don’t expect to receive payment for.  Maybe that amount is 5%.  I entered a percentage for miscellaneous expenses which includes bad debt expense and other unexpected expenses.

Now that we have entered in all of our basic sales and expense data into ProjectionHub, lets look at the resulting Excel file that the tool produces, and check our cash flow statement to see if we run out of cash.

Awesome Startup Runs Out of Cash in Month 2

So without a capital infusion our startup is already in the red in month 2, and it only gets worse from there as you can see below:

Now we need to think of plan B.  What if we could get a small loan to start the business to help with cash flow.  Let’s enter a small $15,000 business loan at 6% for 24 months starting in month 1.

Now with this infusion of cash let’s go back and check how our cash balance is doing on the spreadsheet that ProjectionHub produces for us.

You can see that we stay cash flow positive through month 7 now that we have this loan, but maybe you would like to expand your vision for the company a bit.  You are going to need to quit your day job to work on this full time, and you are going to need a salary to pay your personal expenses.  Let’s start you out with a meager $3,000 monthly salary starting in month 6.

Now there is a small problem because if you look at month 7 above you have a cash balance of $5,896, but we just added $6,000 worth of salary expenses for month 6 and 7, so you are going to end up in the red again in month 7 if you don’t raise more capital.  This time let’s think about finding an investor.  Let’s assume you are planning ahead in month 3 and see that you are going to run out of cash if you start taking a salary, so you call your rich uncle and convince him to invest $15,000 in month 5.

Finally, let’s look how this investment sets you up going forward.

Congratulations!  Look at the influx of cash between month 5 and month 6.  You are going to survive, and  your startup won’t run out of cash.  Now why don’t you take some time to play around with ProjectionHub and run various scenarios to determine if and when your startup will run out of cash.

How to Calculate Whether or Not a Loan is Worth It

by Leave a Comment

By Adam Hoeksema

In order to determine whether or not you should apply for a loan and how much you should ask for, you need to run some numbers.  The best way to test is by creating a cash flow projection.  There are a number of tools and spreadsheet templates you can use to create financial projections including:

  • ProjectionHub – Web based tool that helps you create financial projections
  • LivePlan – Business plan software that includes financial projections tool
  • EZnumbers – Extensive spreadsheet tool to create financial projections

Once you have a baseline set of cash flow projections you can start playing with some what-if scenarios.

So let’s look at 2 scenarios to determine whether a loan is worth it:

1.  Buy Larger Quantities of Inventory – This is a fairly straightforward calculation.  Let’s say that right now you are buying inventory in shipments of $1,000 at a time.  Each time you have to pay $100 for shipping.

If you were to secure a $25,000 loan to purchase inventory maybe you would purchase one large $25K order.  You might get a quantity discount from your supplier of 10%, so you immediately save $2,500.  You might also only pay $500 to ship the entire order together which is another $2,000 savings.  You are saving $4,500 by ordering in larger quantities, but you will have to pay interest on the loan.  Let’s say the loan is at 10% interest for a 12 month term because your small business is relatively risky.  For the life of the loan you would pay $2,500 in interest, but the cost savings makes this a no brainer.  Ultimately, you end up saving $2,000 which makes this loan worth it!

2.  Advertising for the First Time – Now let’s say you want to take out a 12 month $25,000 loan at 10% in order to advertise your product through Google Adwords.  This is the first time you have ever used Google Adwords to advertise your product which makes this situation very risky.  Let’s assume you make $50 of gross profit on each item sold.  Since this is your first time advertising you can’t know the average cost of customer acquisition.  Let’s say Google charges you $1 a click and you only convert 3% of visitors into customers.

So for $25,000 you would get 25,000 website clicks and you would convert 750 into customers.  You would make $37,500 in profit ( $50 x 750 ).  But you paid $25,000 + $2,500 in interest for the life of the loan.  Again, in this situation it would be worth it to take out a loan, but if your conversion rate went down to 1.5%, you would only make $18,750 which would make advertising a terrible use for the loan funds.

When you are looking to secure a loan for your small business, make sure to run through various scenarios.  If you aren’t sure whether you will be able to make a profit from the loan, then you should do more testing and analysis until you are certain the loan is worth the 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 to have a PhD in spreadsheet modeling.

Why You Need to Include a Narrative With Your Cash Flow Projections

by Leave a Comment

It is incredibly important to include a narrative explanation with your cash flow projections.  Typically, your cash flow projections are provided to your banker or potential investor as part of your funding application.  When a banker or potential investor looks at your projections they want to clearly understand how and where you came up with your numbers.  You made a number of assumptions in order to create your projections, you must clearly explain those assumptions through a written narrative.  Let me give you an example of how I would write a narrative section to go along with my actual projections.

Let’s start by assuming you are applying for a $50,000 loan for your software business in order to advertise and market your product.  You may want to attach a narrative section similar to the following:

Sales Projection Narrative

We assume that the $50,000 loan will allow us to drive 50,000 targeted visitors to our website over a 3 month period.

We assume a $1 cost per click based on the cost per click estimates provided to us from the Google Adwords Keyword Tool.

We assume that we will achieve a 3% conversion rate.  To date, approximately 2.75% of our website visitors have converted into paying customers.  With A/B testing we believe we can increase our conversion rate to 3%.

We assume that the average customer will pay $49 per month for our product based on our performance over the last 12 months.

We assume we will lose 7% of customers each month.

Sales Projection Table

Based on those assumptions our sales projections for the next 12 months are as follows:

Including a narrative will help your audience understand how and why you came up with the numbers that you did, and should help to instill confidence in the future prospects of your business.

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

How to Create a Cash Flow Projection with ProjectionHub

by Leave a Comment

For many startups and small businesses cash flow, or the lack of cash flow, is the most important factor when it comes to business survival.  Entrepreneurs must be on top of their cash flow, and be able to create cash flow projections for the future.  The purpose of this guide is to walk you through the process of creating a 12 month cash flow projection for your business using ProjectionHub.

ProjectionHub is a web-based tool that helps business owners create financial projections without the need to be a PhD in spreadsheet modeling.

Much of this guide is identical to the guide on How to Create an Income Statement Projection with a few additions and subtractions specifically related to cash flow.

Here is how it works:

  1. Enter Financial Projection Info
  2. ProjectionHub Automatically Creates Your Spreadsheets
  3. Spreadsheet Projections Are Emailed to You
  4. Download Your Spreadsheets

Let’s get started.

1.  Contact Information – First we are going to ask you for your contact information.  This accomplishes 2 things:

  • Creates a ProjectionHub Account – By providing your email address and a password we are able to create an account for you.  Now you will be able to quit in the middle of your projections and all your data will be saved and ready for you to jump back into at any time simply by logging in.
  • Includes Contact Info on Spreadsheets – One of the most common mistakes made by entrepreneurs is neglecting to include their contact information with their financial projections.  Simply enter your contact info once and we will include it on every page of your projections.

2.  Start Creating a 12 Month Cash Flow Projection

Simply click to start creating your 12 month cash flow statement projection.  Depending on the size of your business, your familiarity with creating financial projections and how much you prepared before getting started, you should budget between 10 minutes and an hour to complete your projections for this 12 Cash Flow Statement.
3. How Will You Project Sales?

The next step is to determine how you will project your sales numbers.  ProjectionHub gives you three options:

  • Project sales for each individual product or service (Choose this option if you only have a few products and/or services)
  • Project sales for product lines or groups of services
  • Project sales in total – (If you have hundreds of products and services, you may want to choose this option)

4.  Enter Sales Projections

Creating accurate and logical sales projections can be incredibly difficult.  Anyone can throw some numbers into ProjectionHub and come up with a set of projections, but your projections need to be based on data.  They need to be bottom’s up.  They need to include logical assumptions.  I have created a short instructional video on how to create sales projections:

Once you know what you are going to forecast for sales, you can enter each individual product or service into a table.
You will notice that we ask for the product name, the sales price per unit, and how many days it will take you to get paid.  The days to get paid is not important for your income statement, but it can become incredibly important information for your cash flow projections.

Next you will enter in the number of units you intend to sell for each product for the next 12 months.

Finally, you can add additional products or services to your sales projections quickly and easily.

5.  Project Your Cost of Goods Sold

Now you need to start projecting your expenses, starting with, Cost of Goods Sold.  In this video I explain what cost of goods sold is and what it is not.

Now you simply need to enter the direct labor, material costs, and variable expenses for each product or service:
6.  Enter General, Administrative and Selling Expenses

Now we need to project all of your General, Administrative, and Selling expenses in the tables below:

The first question we ask is “How many days does it take you to pay your bills?”  Again this question will impact your statement of cash flows, not your income statement.

Next you will need to input your corporate income tax rate if you anticipate paying corporate taxes.

Lastly, you will need to enter projected expenses for the first 12 months for various categories like:

  • Accounting
  • Advertising
  • Rent
  • Utilities, etc.

7.  Cash on Hand

Next you simply need to include how much cash you have on hand currently.  That will help us create your cash flow projection.

8.  Download Financial Projections

You are done!  Now you can download your financial projections as an Excel document.

Simply click the “Download Income Statement”

9. View and Edit Your Financial Statement

There are 2 ways you can edit your financial projections.

  1. Edit the Excel Spreadsheet – The first tab of your Excel Spreadsheet file will be a data entry sheet.  You can change the data directly in the Excel file to change your projections.  If you are not comfortable with Excel, then I suggest logging back into ProjectionHub and editing your financials.
  2. Login and Edit in ProjectionHub – Simply go to http://www.projectionhub.com and login at the top right corner.  Use your email address and password to login, and edit the data in your projections.

There you have it, a detailed guide on how to create an income statement projection using ProjectionHub.  Get started now!