A business plan is among the crucial building blocks of any successful venture. Among its key ingredients should always be detailed financial projections for at least the first two years after purchase. These projections are estimates of your net inflows and outflows, income and balance sheet, and operating and expense. All investors should closely examine these, as well as your business strategy and tactics for achieving success. In addition, this report goes over some of the pitfalls of relying on a business plan for acquisition funding.
There are several reasons why an investor should doubt the validity of financial projections, particularly the first. First, most business plans assume that growth will continue apace, with little change. Financial projections assume that operating margins will remain relatively constant, with expenditure growing at a rate faster than productivity. While this may result in higher profits for the first few years, the effects of inflation and cost of living reduce profit margins over time. Consequently, investors will typically deem the investment more risky than it really is.
The second reason for concern is that financial statements do not accurately reflect outside funding sources. Outside funding sources consist of angel investors, venture capitalists, and other individuals who may invest in your business as long as you follow the procedures required by the law. However, as with all financing, there are risks involved, including possible losses and delayed payments. To address this problem, a good business plan should include a separate financial section that specifically identifies outside funding sources. This section should include loan amount, interest rates, term of repayment, and other relevant information.
Of course, the long-term results of financial projections are heavily dependent on future business plans. So, a key requirement of a great business plan is an effective forecast of earnings for at least the first year of operations. The first year is considered the “washboard” year, since a company must first obtain a clean financial picture to create its forecasts. In short, if financial projections appear unrealistic, the projections will likely be off base.
One way to create financial projections is to create an assumption or series of assumptions. For example, if you anticipate an income tax refund of 15% on capital gains, you must estimate how much of your salary will be subject to tax. By using a profit and loss statement, you can more effectively project the tax consequence of several different scenarios. However, it is important to remember that profit and loss statements only provide the most accurate estimate of taxes due; they do not eliminate other common assumptions associated with your business plan.
When investors read the business plan, they are looking not only for factual information, but for their own objectives. Therefore, it is important to address these objectives directly, particularly those that will have direct impact on investors. Do you expect to increase the amount of revenue? Or, does the plan call for increased capital expenditures? The information that you provide must address these objectives in order to demonstrate to potential investors that the plan will be successful.