Multiple Scenarios

Some people suggest that you make several sets of pro formas—most likely, best and worst case scenarios. I recommend that you carefully assemble one set of pro forma forecasts based on the most likely case. Developing pro formas is a tedious process.

In creating one set of forecasts, you will probably remain more sensitive to your assumptions and their validity regarding sales forecasts, receivable collections, bad debt allowances, and delivery schedules. Also, by creating several sets of pro formas, with each based on a different set of assumptions, you are increasing the risk of significant calculation errors. Most banks will be very happy to see one well-done set of forecasts.

However, for larger, highly leveraged businesses, banks may expect more. For example, after graduating from business school, one of my friends sought financing to buy a group of major market radio stations. The lenders told him that three scenarios were absolutely insufficient and he needed to show at least seven.

Sales Forecasts

Accurately predicting sales is one of the most important factors in making projections. However, making sales assumptions carries a high risk of inaccuracy. Use last year’s sales as your starting point for sales projections. If you are a start-up business, you may want to use your break-even sales point for sales projections.

Unless you are selling low-ticket items, last year’s total sales results should not be the only factor considered; a more detailed breakdown is required. Estimate sales product line by product line, and customer base by customer base. Estimate the impact of price increases, marketing plans, competitors, and any other major factor that could possibly have an effect on your sales potential.

Get your first sales projection from your sales manager. Remember, though, when you are reviewing his or her projections, that salespeople tend to be optimists. Conduct a second review with your other managers. If you don’t have a sales manager or other key personnel who can provide input into the sales forecast, seek the advice of someone else you can trust—your accountant, perhaps.

Break-Even Forecast

Especially when starting a new business, people tend to underestimate how long it will take to build sales. For a new business (unless it’s an established franchise) it’s very difficult for anyone to estimate sales. What I suggest is that you estimate what sales level you need to break even. Then, if you are not hitting this break-even level, you can immediately take steps to put the business back on track (such as cutting expenditures) before you get into trouble (or run out of cash).

Tools, Not Prophecies

First, think of pro formas as tools for running your business, and second as predictions of the future. The true strength of pro formas lies in your ability to make changes in them before their scenarios occur. If profitability looks too low (and it usually does in your first pass through your pro formas), then take steps to improve it. Are prices too low? Is there any expense that can be cut? Is there a product or service that is not profitable that could be eliminated?