Building Better Financials
Using Pro-Forma Financial Statements
& Their Importance to Your Enterprise
Drew Tulchin & Michael Whitehead-Bust
Social Enterprise Alliance 5th National Gathering
March 5th, 2004
Who You Are &
What Brought You Here Today
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What is your primary job title?
What is your familiarity & comfort with
financial statements?
What have you used for financial
modeling to date?
When you leave this session, you hope…
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Who We Are
Drew Tulchin
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Social Enterprise Associates:
applies business tools to achieve
financial & social ‘double bottom
line’ results.
(www.socialenterprise.net)
MBA
Winner, 2001 Global Social
Venture Competition &
Microenterprise Paper Finalist,
“Non-profits Accessing Capital
Markets”
I’m the one with the goat-tee
Michael Whitehead-Bust
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Foxhall Consulting Services:
supporting mission-driven
entrepreneurs. Services:
business planning, strategic
planning, development
(www.foxhallconsulting.com)
MBA/CFA
Winner, 2001 ICIC/National
Business School Network.
National competition for strategy
consulting to inner city
businesses
I’m the one with the goat-tee
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Session Overview
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Introductions
Value, Importance & Theoretical Framework
Key Pro-Forma Components
Building a Pro-Forma Model
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Identifying key assumptions & drivers
Expense & revenue estimates
One year income statement by month
Breakeven calculations
Five-year income, balance & cash flow statements
Handling Mission-Related Expenses & Overhead
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Session Goals…(& Limitations)
Goals
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Increase comfort with
financial statements
Impart skills / gain
confidence to use proforma analysis as a
central component of
decision-making
Explore pro-forma basics
Emphasize importance of
good research and
realistic assumptions
Limitations
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We are not accountants
(nor do we wish to be)
Financial analysis is a
tool, and but one tool,
for management
decision-making
Time allotted for this
session limits what we
can share
Our sense of humor
(sorry, no refunds)
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The Value of Pro-Formas
(Or, What’s Wrong with Just Using a Budget?)
Management – understand the past & the present
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Better understand cost/benefits of mission-driven components
Ratio analysis & benchmarking
Ability to perform (and interpret) sensitivity analysis
Strategy & Planning – prepare for the future
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Forward thinking (Year 1 by month and Years 2-5 by year)
Facilitates more rational decision-making by clarifying business opportunity
Forced articulation of assumptions and clarification of research/data
$$$ – allocate resources, explain situations & raise capital
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Balance sheet and cash flow statement can highlight risks
Used in evaluation to access new sources of capital (especially lenders,
socially responsible investors, venture philanthropists, etc.)
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Tips at the Start
Use Appropriate Resources
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Repeat, “I will not do my pro-formas in MSWord, Excel is my friend”
Invest in high-quality market research & choose meaningful benchmarks
Pay for a good accountant/finance person
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May not be the person currently handling your books
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Better a passionate business-minded person who understands your
mission, than the reverse
An Art / Language, Not a Science
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Finance people are still subjective
Make your work accessible & understandable to others
Be clear about assumptions; acknowledge what you don’t know
Prepare, But Also Be Flexible
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Things will change (little-known Harvard Study)
Allow for more time, budget for higher expenses & assume less revenue
Get comfortable with red ink (non-profits aren’t use to losses)
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Pro-Forma Process Framework
1) Where are
you now?
2) What is the
goal?
Stable, successful job
training program with
access to new $$$
a.
Spin-off business applying
job training & earns
income
b.
Benefit from brand recog.
in community
c.
Capitalize upon existing
org skills in food industry
3) What are the incremental steps
to advance?
a.
Get board buy-in
b.
Conduct feasibility study
c.
Etc.
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Philosophy / Key Concepts
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Incrementation: think in units
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Establish a compelling story
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Separate financial from mission-driven
Understand limitations / pressures on each
Earned income = Net Income
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But, be realistic, transparent & state your logic
Know your goals
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Children’s building blocks
Producing profits or just generating revenue?
Build, measure, build, measure, build
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(The carpenter’s ‘measure twice, cut once’ - measure
continuously, because what you are cutting keeps changing)
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Pro-Forma Components
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Key assumptions w/ market data
Income Statement:
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Yr 1 monthly, Yrs 2-5 annually
Balance Sheet: Yrs 1-5 annually
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Cash Flow Statement:
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Yr 1 monthly, Yrs 2-5 annually
Breakeven Analysis
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Definitions / Key Terms
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Variable/Fixed Costs
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Contribution Margin
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Revenues – variable expenses = contribution margin
Operating Leverage
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Variable costs differ based on activity level. Typically
driven by number of customers
Fixed costs remain constant, regardless of sales volume
Ratio: fixed to variable expenses
Assumptions / Drivers
Sensitivity Analysis
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Evaluation of changes in business results based on
alterations to key assumptions
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Begin the Model w/ Assumptions
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Establish the background story
Select a reasonable goal
Gather data
Determine key indicators
Establish driving unit(s) of measurement
Note:
the more specific you are with real
information for outputs and outcomes, the
easier it is to build towards them…(while being
prepared they WILL change)
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Assumptions – Expenses
Audience Participation Activity (polite applause):
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List major expenses
Classify: fixed or variable?
Identify unit(s) of measurement
Select drivers (what indicates the amounts?)
Consider growth rates / change over time
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Assumptions – Revenues
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Follow same steps from expenses
List revenues, separate by product
Establish the base unit for ‘incrementation’
Determine a defendable growth rate
Philanthropic sources excluded at this time to
focus on project revenue, but note potential
exceptions:
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if project produces incremental philanthropic stream
(i.e. grants specifically tailored for the project)
if project requires grants for social benefits that are
incremental, but inherent, project costs
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Monthly Income Statement
Steps
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Determine monthly
sales growth rate
Separate, describe
behavior and timing of
fixed / variable
expenses
Include mission-related
expenses, revenues,
and org overheads
UBIT
Outcomes
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Quick view of year one
profitability / losses
Likely not the best
evaluation of the
opportunity
Insight into capital
needs
Insight into level of risk
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2-5 Year Income Statements
Revisit original growth assumptions. Carry them
forward, with applicable changes, for years 2-5
REMEMBER:
 Additional staffing, equipment, space, other needs
 Overhead allocations
 Even conservative projections are often optimistic
– base assumptions on sound data
 Rationality wanes after Year 3 (sometimes
before). Don’t ‘bet the farm’ on Year 5 projections
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5 Year Balance Sheets
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Articulate assumptions:
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A/P
A/R
Inventory
Capital Expenses & Depreciation
Financing / Capital Structure: Debt? PRI?
Philanthropy? Parent Org investment?
Note:
Ensure consistency with I/S assumptions
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Cash Flow Statements
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Monthly (Year 1), yearly Years 2-5
Note model structure
Work with good financial professionals
Be prepared for red, but have a plan
(in advance)
Can have positive net income, but be
cash flow negative
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Breakeven Analysis
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The Formula:
Fixed Costs / (revenue per unit –
variable costs per unit) = BEP in units
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Is it attainable?
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Does market research back it up?
What is capacity?
Account for start-up costs/overhead allocations
Advanced Note: Do you know your
degree of operating leverage?
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Handling Mission-Driven Costs
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Distinguish whenever possible
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Promotes management of “business” side and
“program” side
Increases appeal to funders
Facilitates social return & SROI analysis
Initial goal statements make it easier to
attend to mission in terms of added expense
- hard questions WILL come up
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How to Handle Overhead
Allocations?
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Handle in strategic & thoughtful manner
Depends on entity’s legal status
‘Gray area’ treatment as fixed or
variable
Have an easily explained story
Have information be transparent in
assumptions
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Final Thoughts
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Do your research
Clarify goals (& costs) of missionrelated activity
Rigorously research & analyze
This is a living document
Listen to what it tells you, but utilize all
tools / data
Have fun
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Resources
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Robert Higgins. Analysis for Finance
Management
Jeffry Timmons. (Note spelling). New
Venture Creation: Entrepreneurship
for the 21st Century
The Motley Fool
What others do you recommend?
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Questions & Answers
Michael Whitehead-Bust:
mbust@comcast.net
www.foxhallconsulting.com
Drew Tulchin:
drew@socialenterprise.net
www.socialenterprise.net
(coming soon)