Creating integrated pro-forma financial statements can be a time-consuming process, but there are major benefits afforded to the entrepreneur who completes this often daunting task:
- It gives investors a degree of comfort that you understand how to build a business and execute the business model
- It shows that you have a good understanding of how the market may evolve and how to respond to changes
- It is a useful way of providing structure and discipline as operating decision points arise
The pro forma financial statement should include at least three scenarios of your financial forecast―each containing an income statement, the balance sheet, and the all-important cash flow statement. Each of these three scenarios should manipulate the various revenue and cost drivers in an attempt to determine where there is leverage in the business model to deal with what may go right and what may go wrong. All of your assumptions and estimates should be carefully documented and built into the model so that you can dynamically change them to conduct “what if” analysis in real time.
This sounds like a job for a multi-tabbed spreadsheet. However, if you are a non-financial founder this can not only be time-consuming, but incredibly frustrating as you attempt to tackle both developing a defendable set of assumptions and learning the intricacies of spreadsheets.
While there are many pre-existing models available online, using them to insert estimates without corresponding backup for every assumption can be an easy trap to fall into for the sake of simplicity. Even worse, you should resist the temptation to outsource the task to someone more familiar with accounting, but not at all familiar with your market and business model.
Anyone who has been through this process knows that the numbers are estimates that will change over time. Nevertheless, you must be able to defend every assumption, and the components must logically support one another. In the end, your pro forma financial plans must be strategically compelling and operationally achievable and they must convey both confidence and realism to investors.
So, how should a non-financial founder approach this task. In Founder Finance I advocate a process that sets aside the spreadsheet in favor of developing a set of critical assumptions based on research that you’ve conducted to develop your business model. The assumptions are used to develop sales and spending forecasts by function essentially breaking this complex task into smaller components. Only after each component passes the "sniff test" should you weave them into an integrated set a pro forma statements upon which you can perform sensitivity analysis.
The goal is to determine how much absolute cash is required to get to cash flow break-even and how this cash might be logically staged so that you can achieve a step-up in valuation at each stage.
Presenting carefully thought-out financial projections to investors is an exercise in lowering perceived risk in both you as an entrepreneur and your idea. When you are able to demonstrate that you understand the resources required to capitalize on the opportunity, and know how to allocate those resources under varying market conditions, investors will be more inclined to back you and your team.
If you're interested in learning more, check out my self-paced course. We tackle this and many other topics (such as raising and managing capital) that you might find helpful in your journey to running a successful business.