Startup company business plans.
Once the strategic, technical and organizational elements of your business plan are in place,
it’s a good idea to include estimated financials in your business plan.
Which key numbers should you forecast?
How do the key metrics in a business plan relate to each other?
Get started with this short video on business plan financials, going from revenue to profit
to free cash flow.
Let’s take a look at Nick’s business plan.
He has a startup company idea that will take a few years to fully mature once he puts his
idea into action.
Year 1 will be the year of heavy investment and the start of operations.
Year 2 scaling up.
Year 3 rapid growth and expansion.
Year 4 stabilization and fine-tuning.
Year 5 fully maturing with operational excellence.
Nick has done some pro-forma financial projections, based on market data, technical data and financial
data that he has gathered so far.
In year 3 after starting his business, Nick is aiming for half a million dollars in revenue.
Revenue is the sum of the value of the goods and services delivered and invoiced to customers
during the year.
From this revenue number, he deducts variable costs of $300,000.
Variable costs are the type of costs that increase when you sell more units.
Examples of variable costs are raw material, production labor, and the electricity that
is needed to run the production equipment.
If Nick takes revenue and deducts variable costs, he gets to Contribution Margin of $200,000.
This is a profitability “subtotal”: what he sells his products and services for minus
the amount he makes them for.
Next, he deducts fixed costs of $150,000.
Fixed costs are the costs that do not increase when you sell more units.
Examples are depreciation on the production equipment, marketing expenses, and the salary
of the managing director (Nick himself).
Nick takes Contribution Margin and deducts fixed costs,
to get to Operating Margin of $50,000.
This is another profitability “subtotal” that represents the margin generated from operations.
Next, he deducts interest, the cost of debt financing, and corporate income taxes.
These total $20,000.
That gets him to the “bottom line” of the projected income statement for his startup
company: net income, also known as net profit or net earnings.
What’s left if you deduct all expenses from revenue.
In his case $30,000 in year 3.
Time to catch our breath.
Projecting your startup company income statement can be a lot of work, as there is a lot of
data to be gathered, and there are a lot of assumptions to be made.
What else do you need to do to get a bigger picture of the financial attractiveness of
your startup business idea?
The answer to that is: gather cash flow related information!
First of all, some good news.
Not all of the costs that Nick incurs are paid in cash in the same year.
An example of this is depreciation, which is the accounting process of allocating the
upfront investment in production equipment over the years that he uses the equipment.
The cash outflow occurred when Nick bought the equipment, depreciation is just spreading
that investment amount over the years,
accounting for the use of the production equipment as an expense.
In Nick’s example, the fixed costs that we deducted in order to calculate the estimated
profit included $70,000 of depreciation.
For Nick to get to the cash flow picture, he needs to add back the deprecation that
was deducted earlier.
Next step to get from profit to cash flow
is to look at the working capital needs in year 3.
As the company is expected to grow rapidly, Nick projects an increase in working capital,
which means from the cash flow perspective that there is a cash outflow.
Here’s how that works.
Working Capital is the sum of Accounts Receivable (invoices that you sent to customers that
have not been paid yet), plus Inventory (goods that you hold to sell), minus Accounts Payable
(invoices received from your supplier that you have not paid yet).
If Working Capital goes up, then cash goes down.
The opposite would also be true: if Working Capital goes down, then cash goes up, but
this is unlikely to happen in a fast-growing startup company.
Once Nick adds up the last three lines, Net Income plus Depreciation minus the cash outflow
from the increase in working capital, he gets a cash flow subtotal
called Cash From Operating Activities.
This is the amount of cash generated from the business operations.
As you see, this is projected to be zero for year 3.
This brings us to an important learning point for any startup company.
Profit does not equal Cash Flow.
Let’s look at the final element in this example.
Nick expects to expand the production capacity of his startup company in year 3 to capture
a bigger piece of the value chain, in other words make a more valuable product.
To do that, he needs an additional investment in equipment,
also called capital expenditures, of $200,000.
This brings his Free Cash Flow to minus $200,000, in other words he needs to bring more capital
into the business (through an equity injection from shareholders or a loan from the bank)
to take his year 3 plans forward.
Free Cash Flow is that part of the total cash flow
that is not required for operations or reinvestment.
If Free Cash Flow is positive, then you can take cash out of the business.
If Free Cash Flow is negative, then additional cash needs to be invested into the business.
Hopefully, Nick can achieve a positive Free Cash Flow in years 4, 5 and onward, in order
for his startup idea to generate value.
How? More revenue, lower costs, managing working capital,
and planning the capital expenditures carefully!
Want to learn more about business and finance?
Then subscribe to the Finance Storyteller YouTube channel!
Thank you.