In our last article, we planned out the business chronologically; that is, what we expected to happen and when we thought it would happen. Now, we need to assign costs to the steps in that series of events and roll it up into a standard financial picture that investors, members of your board, employees, and others will understand.
Step 4: Those Darned Expenses
Now let’s cost this out. We will build on the schedule of employees created earlier (refer to www.techbriefs.com/workbook.xls for the sample Draft Workbook). Include a column to the right of the job title with the expected annual pay for this person. Now, include a column with their hire date. Make sure that each position to be filled — such as Engineer #1, Accountant #2 — has been thought through. What will this person do, specifically, that will help meet the goals/events projected on the schedule in Step One?
Total the salary costs you will face each month. Multiply this by 1.2 to capture the benefits, payroll administration, and employer tax costs.
Now, create one last worksheet; this one laying out the additional expenses you will need, function by function:
- Development — Lab or contract developers, product testing, certification, materials, equipment needed, sales travel, collaterals, numbers of prototypes, manufacturing equipment, and supplies.
- Finance/Administration — A building to hold the people; a simple gross estimate for furniture, copiers, etc.; insurance, legal, accounting, and other costs specific to your business.
These spreadsheets combine to give you a specific monthly cost, and therefore base burn-rate, as you grow.
Step 5: Getting It All Together
Now that you have your supporting information, build a single spreadsheet that collects it all in one place, and makes the higher-level thinking transparent. Start with revenue; hence “top line.” This can be summarized. There is no need to show individual salespeople, just revenue from the major product lines, or if it is more informative, from the major channels.
Next, include the expenses in summary form. Start with the costs for the products you are selling — the actual parts cost for each period. Below that, include salaries and other costs.
Across the bottom should be a total, both for the period of the column and cumulatively for the enterprise to date. If it is an ordinary business, it will start out negative, get more so for a period of time until sales begin in earnest, then soon the total for each period should go positive (called operational break-even). Once enough monthly profits have accrued, the cumulative number will cross break-even and become positive.
Most investors like to see at least operational break-even occur within 18 months. If your business does not, and especially if you do not see a profit during your three years of projections, you should review your assumptions, see where you can cut expenses, or perhaps accelerate expenses (increasing investment) to make the business profitable in the foreseeable future.
You have just created a basic Pro Forma Income Statement (pro forma referring to projecting future results). Built and used properly, this will be a tool you will rely on throughout the growth of your company. It is therefore critical that your team be included in its formation.
The Pro Forma Income Statement is also a device for communicating the underlying operating principals of your business to investors. It conveys not only how much investment you are seeking, but how you intend to deploy that capital. To make it effective, it needs to be formatted and structured in the way investors see these instruments every day. Make sure you have someone who is used to seeing Income Statements review it before you try to use it to communicate with investors.
In next month’s article, we’ll provide an operational guide to bringing your invention to market, including how to sell your idea to get the money you need to commercialize your technology.