By Adam Hoeksema

Every week I deal with businesses that are growing quickly, but just can’t find enough cash to finance their growth.  Certain businesses are much more capital intensive than others.  In general, physical product based businesses are far more capital intensive to start and grow than a software business or a service based business.  It can take millions of dollars to produce, sell and distribute a physical product on a national level. If you are facing this struggle, I don’t need to explain why it is so difficult to finance a capital intensive business, rather I hope to provide some advice to help you find success in this type of business. View our production forecasting excel template to get started.

1.  Find an Investor, Be Willing to Give Up Equity – There was recently a great example on Shark Tank.  A business owner had developed an interesting product, 100% recyclable shoes, but needed some cash to take it to the next level.  The business owner asked for $50,000 in order to create the mold of the product and build up some inventory, but the sharks weren’t biting.  Why?  Mark Cuban said something to the effect of, “if you are successful you will drive yourself into bankruptcy.”  Here is why.  If the company got a large order from a big box retailer like Target, it would probably take the entire $50,000 just to fulfill that order.  Then Target would pay him in 90 days.  What if the shoes were selling great, and Wal-Mart placed an order, and then Kohl’s placed an order?  He would still be waiting to get paid from the initial $50k order, so he would have to borrow even more money to fulfill the 2 new orders.  The product’s success could actually bankrupt the company because they would reach a point where they could not borrow any more money, which means they wouldn’t be able to fulfill new sales.

So here is what happened.  One of the sharks made him an offer.  He offered to fund his entire business for 80% of the company.  So he gave up 80% of his company, but in return he can have the freedom to go out and generate sales.  On his own he never would have made it in the capital intensive business of shoe manufacturing, but because he was able to find an investor, and was willing to give up significant equity, his 20% stake in this business will probably turn him into a millionaire very soon.

2.  Develop a Strategic Partnership – I have worked with one client who was able to find a private company that was willing to fund his business in exchange for a cut of the profits.  This is truly the best possible solution.  Here is why.  This particular business dealt with purchasing expensive used medical equipment, repairing it, and reselling the equipment.  The bottleneck in the business is the fact that the used equipment cost $10,000 to $15,000 per unit.  He could easily find 10 units to repair and resell in a moment, but he did not have the $125,000 it would take to purchase those units, so he purchased 1 or 2 units a time.

When he partnered with this strategic partner, he was given a large line of credit to purchase and resell as much equipment as he wanted.  The deal was contingent on giving half the profit made on the sale back to the partner.  This was a great solution for this particular startup because he was able to grow his business by 650% in a year without giving up any equity in the business.  Now he has generated enough sales that he can approach a traditional bank and secure a traditional line of credit which will be far cheaper than giving up 50% of his profits.  This strategic partnership was a great deal for both parties involved.

So in order to succeed in a capital intensive startup business you can’t rely on a 1 time loan.  It is not a sustainable solution, in fact your success may drive you right into the ground.  Instead, I encourage you to find investors or strategic partners who are willing to put unlimited cash in your hands for as long as you can provide a return on that investment.

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

Common Budgeting Mistakes & 15 Forecasting Errors to Avoid

Every startup that needs to create revenue projections will likely go through the same basic process to do so. I have outlined the process in a generic way below, and we have also created various spreadsheet templates for you to use to create your own sales projections.

1.  Stating “These are Conservative” – I wanted to start with one of the most annoying forecasting errors that nearly every entrepreneur is guilty of.  Entrepreneurs ALWAYS say, “These financial projections are very conservative.”  Here is the problem, 99% of entrepreneurs say that their financial projections are conservative, but many sources say that 50% of startups fail within the first 5 years of business.  No one would start a business if their financial projections showed that they would go bankrupt in 5 years, and yet 50% of businesses go out of business.  This means that for many of you, your financials are not conservative at all and could lead to bigger budgeting mistakes down the road.

Additionally, your banker or potential investor should be the one to analyze your financial projections and make a determination as to whether or not they are conservative.

I encourage you to make conservative projections; however, there is no need for you to tell your audience how conservative you were, it is a major turn off.

2.  No Assumptions Listed – Another instance of common budgeting mistakes is that many business owners do not include their assumptions with their projections.  When you create a set of financial projections you are making dozens of assumptions.  Some of those assumptions might not be that important because they make a small impact on your bottom line.

For example, you might assume that the price of stamps will go up 3 cents per year, but you only send out 1,000 envelopes per year, so even if your assumption is wrong, the price of stamps will have little impact on your financial forecast.

On the other hand, some of your assumptions can have a huge impact on your bottom line.  If you have a fleet of vehicles that serve your customers, then the price of gas is an important assumption.  If your fleet of vehicles requires 20,000 gallons of gas each year and the price of gas spikes $1, you are now $20,000 less profitable.  For this business the price of gas is an key financial model input.

You will make a number of assumptions as you complete your financial projections.  Your audience probably doesn’t care if you are off by a penny or two on the price of a stamp, so don’t worry about listing that assumption, but for financial assumptions that have a greater chance to impact your bottom line in a significant way, make sure to include a listing of important assumptions with your financial projections.

3.  Top Down Assumptions – One of the fatal problems in forecasting that many entrepreneurs make while creating financial projections is making top down assumptions.  Your projections should be bottom-up.  Let me give you an example of a fatal top down assumption.

“I want to start a coffee shop.  Starbucks makes $1.5 million in profit per store each year at their coffee shops.  I should be able to do at least half as good as Starbucks because my coffee and my service are better.  Therefore I will project an annual profit of $750,000 next year.”

There are a couple of problems here.

• Bankers and potential investors will look at this and immediately know that you don’t understand your industry of your business.  You can’t just assume a top line number.  In order to generate a $750,000 profit next year how many coffees will you need to sell?  At what price?  How are you going to get those customers?  Don’t say that you will have a great service, or that your coffee is better.  Your assumptions need to be based on data, when possible.  For example, “there are 100,000 people in my city, 14% of people buy coffee from a coffee shop, I will need to capture 37% of the market in my city in order to generate a $750,000 profit next year.”  Now you can outline a plan to demonstrate exactly how you intend to capture that 37% market share.
• Another major problem is that there are major costs associated with generating $750,000 in revenue.  Starbucks corporate office spends millions on marketing and branding each year.  Top down financial projections like this example simply don’t work when you try to compare yourself to a national brand.

4.  No Scenario Analysis – You should build your financial spreadsheet model in such a way that you can analyze various scenarios.  You will want to be able to easily change assumptions so that you can analyze your financials for various scenarios.  For example:

The assumption numbers in this table can be changed which will automatically populate your financial projection profit and loss, cash flow statement, and balance sheet with the new projections.  This will allow you and/or bankers/investors to forecast various financial scenarios.  Since some of your assumptions will certainly be wrong, most bankers and investors will want to see how the financial health of your company changes when they push and pull at your assumptions.

5.  Assumptions Not Based on Data – The last of our assumption based forecasting errors is that many entrepreneurs make is creating assumptions that are not based on data.  For example, you might sell flower vases online.  You might assume that the average American has at least 1 flower vase in their home, and they probably buy a new one every ten years on average.  The problem is that you have no idea how many of those potential customers will shop for a flower vase online.  Those might sound like reasonable estimates, but there is a far more accurate way to estimate your market potential for selling flower vases online, saving you from budgeting errors down the line.

Use data.

You can use the Google Adwords Keywords Tool to determine how many times keyword phrases related to “flower vase” are searched for on Google each month.

This data shows that there are 74,000 monthly searches for “Flower Vase” on Google, and many more searches for related keyword phrases.  This is a much better way to build your assumptions based on data.

6.  Misunderstanding Cost of Goods Sold – It is easy to misunderstand and miscategorize expenses in Cost of Goods Sold.  COGS are the expenses that you would only incur if you sold a product or service; whereas, an expense that you would incur whether you made a sale or not is a fixed expense or operating expense.

7.  No Written Explanation – Many times a set of financial projections includes a profit and loss statement, cash flow statement and a projected balance sheet, but there is no written narrative that explains and justifies the projections.

You should include an extensive written explanation with your assumptions and your financial statements.  If you are able to find financial information for your competitors, you should include that info, and explain why you believe your projections are different whether they are better or worse than the competition.

8.  No Bad Debt Expense – Business owners commonly exclude bad debt expense from their budget.  Bad debt expense can vary greatly depending on industry, but there are few industries where you collect every dollar of revenue earned.  Will 2% of your customers fail to pay, or will 7% fail to pay?  This is an important consideration, and failing to include this line item in your forecast can be a warning sign for potential investors.

9.  Excluding Loan Payments – One of the costliest forecasting errors you can make on your loan application is  forgetting to include your loan payment in your financial projections.  If you are applying for a loan, you should estimate the interest rate, amount, and length of loan to come up with a projected monthly payment.

Bankers want to know that you have the cash flow to make your loan payment each month.  Additionally, bankers want you to consider your loan payment as your very first expense each month.  Your loan payment should come before you pay your own salary, of before you spend a dollar on meals and entertainment.  Excluding the loan payment from your projections sets a bad tone with any banker.

10.  Excluding Taxes – Taxes can be a huge expense for a profitable company.  Depending on where you are and your corporate structure you might expect to pay 25% or more in taxes.  This might not be as important for a banker because the bank will get paid before taxes, but an investor is paid after taxes. If you forget to include these, it can lead to extreme forecasting errors. For instance, say you project a million dollar profit next year, but forget to include 25% tax rate, that is a $250,000 difference for your investors.

11.  Excluding Depreciation – Excluding depreciation is another one of our common budgeting mistakes businesses
can make. Depreciation is a non-cash expense, but it is an expense nevertheless.  Many of your assets will decrease in value each year, and will need to be replaced eventually.  Including depreciation expense in your financial projections demonstrates that you are thinking long term about the business, you expect to be around for a while.  This is a good sign for bankers and investors.

Additionally, banks will likely take some or all of your assets as collateral for a loan, so they will want to see the current value of the asset, the useful life of the asset, and the depreciation expense connected to that asset each year.  Learn more about depreciation here.

12.  No Wiggle Room – If your financial projections leave no “wiggle room” investors and bankers are going to be nervous about potential budgeting mistakes later on.  Leaving no margin for error means that if even one assumptions is wrong, you could go bankrupt.  Typically, banks don’t take those kinds of risks, so if your projections are that fragile, you may want to focus on seeking risk tolerant investors.

13.  No Contact Information – I constantly remind entrepreneurs to include their contact information on every page of their financial projections.  Your financials are probably one of the most likely sources of questions for a banker or investor, so make sure to include your name, email address, phone number and mailing address on each page of your financials. This ensures they can quickly get ahold of you if they catch forecasting errors in your projections.

14.  No Breakeven Analysis – When you create a breakeven analysis you are determining how many units you must sell in order to breakeven, in other words your revenue and expenses are equal.  A breakeven analysis can help you determine how many units you must sell each day, month, and year.

15.  Excluding Founder Salary – The last of our budgeting mistakes is excluding a founder’s salary. If you want to operate a sustainable business, then at some point you need to take home a salary as the owner.  If your projections never include a salary for yourself, your bankers and investors are going to recognize that you can’t continue to operate this way forever.  If the business can’t afford to pay you and still make a profit, then this probably is not a business that a bank or investor would be willing to put money into.  Eventually, it is doomed to fail, so make sure to include a modest salary for yourself to demonstrate truly realistic financials.

There you have it! 15 common budgeting mistakes that entrepreneurs and small business owners make. View our gym financial plan excel template, subscription excel template and home health care financial projections template to get started with your own projections. If you have any specific questions about common forecasting errors, you can
visit our FAQ page for more information or contact us!

About the Author:  Adam Hoeksema is the Co-Founder of ProjectionHub which helps entrepreneurs create financial projections without the need to have a PhD in spreadsheet modeling.