<< Start-up Sales Projections Part 1 – Start-up Sales Projections Part 3 >>

Well the summer break is officially over and school is back in session.  Welcome back!

In Part 1 we discussed developing “a reasonable range of sales” using the breakdown method which takes a market and estimates the sales based on market capture.  For some types of businesses where the potential market is too large (Nationwide/Worldwide) or is not granular enough we can use the “Buildup Method.”  The Buildup method takes your variable costs (merchandise/inventory/cost of sales), your fixed costs (rent, utilities, payroll, etc) and your average selling price per unit and figures the break even point. Once you know your break even point then it is just a matter of setting sales goals to achieve profitability.

Let’s use the same hypothetical maternity clothing store in Fargo, ND as an example.  Again the numbers in this example are not 100% real but they are pretty close and should give you a good idea of how to use this method.

The Buildup Method

The basic formula for break even point in terms of units sold is:

BEP = Fixed Costs / (Selling Price Per Unit – Cost of Goods Sold Per Unit)

Where:

Fixed Costs = Total Operating Expenses Per Month or Year

Selling Price = Average Selling Price Per Unit

Cost of Goods = Average Cost of Goods Per Unit

*Don’t forget Order of Operations – Solve the ( ) first then divide!

So, in the example above if the average price of maternity shirts, underwear and pants is $22.50 and the average COGS is $12.50 that means that the contribution margin is $10.00 per item sold.  The annual operating expenses (not including inventory of course) is $75,000 so $75,000/$10 = 7500 units or articles of clothing sold.

That means that this clothing store will have to sell 625 items a month or 144 items a week or about 20 items a day.  Alternatively we can multiply those numbers by $22.50 to determine the annual, monthly or daily sales goal to achieve break even point.  Past the point of break even every dollar of sales contributes  $0.44 to the bottom line of this business.

Because the annual break even point of this company is $170,000 the entrepreneur starting this company will have to analyze the break even point against the potential market for this type of business (determined in part 1 as $380,000 a year) is large enough to take on the risk of starting this business.  If they believe that their reasonable range of sales of $380,000 plus or minus 10%, 20% or 30% is correct then they would probably proceed with starting the business.  However if the data for the market showed a total market of only $200,000 and Break Even is $170,000 this would probably not be a good opportunity at all.

Remember, projecting sales for a start-up is not about being right…it’s about what happens if you are wrong.  Every aspiring entrepreneur should complete a scenario analysis raising and lowering sales and expenses to create a best, worst and expected scenario.  Your success in the long run and ability to stay in business is dependent on it!

Guest post by Bill Grodnik CEO of Davinci Virtual Office Spaces and Solutions.

Dare to be different– Starting out, it’s vital to choose to operate a business where you already know something about the industry, or you have experience having worked in the field. Nobody wants to invest in a business where you’re reinventing the wheel, so use the knowledge to innovate something different in your field before you forge ahead.

Bootstrap like there’s no tomorrow- With no debt and no investors, you’re free to take your company in whatever direction you see fit. Rule #1 for the small business owner should be to self-fund for as long as is humanly possible – then look to external sources for funding. With the emergence of Internet business, you can cut down on costs and operate your business from the Internet.

Be more attractive– The #1 most attractive trait? It’s not being a blond or driving a Maserati – it is being profitable! If you’re not there yet, have a clear, well-thought-out plan in place that shows your company’s path to profitability. This will enable you to at least negotiate some of the terms of third party investments.

Show your growth– For most businesses, funding in the early stages of a company’s launch is incredibly difficult. As the business owner, your #1 priority should be growing your business, in terms of customers and infrastructure. The best way to do this is to focus all of your energies on your core function and outsource what you can – the cloud offers ample opportunity to save time, effort and money. Even early stage companies that show solid growth will be attractive to investors.

The impetus behind increments– The first step is to decide how much money you need. And no, “a lot” doesn’t count! When you’re talking to potential to investors, they’re going to ask you the size of the increments you’ll be offering. (i.e. $1 million raised in $100,000 increments.) Pick the largest increment size you think you can get investors to match. You can always split and quarter your increments, but some investors will take “one” no matter the size, and the fewer investors you have, the more control you’ll have over your own business.

VCs can be costly– My best advice is to avoid VC funding in your company’s early stages. When there is little you can offer them in terms of value, many VCs will “offer” to take a controlling stake in your business in exchange for the funds you seek. If you take them up on their offer, you will likely end up with a group of “bosses” that tell you what to do with your business to ensure a quick return on their investment. Once you’ve built a team and an infrastructure, and you’re profitable – that is the right time to go after VC funding.

Consider other options- Many times there are alternatives to VC funding including local angel groups, private investors and – surprise! – friends and family. In fact, the easiest money to raise is from friends and family – friends will follow other friends and, if you’re willing to let your family invest in your business, most will consider the investment sound. Try to evaluate what your venture realistically needs to succeed and first look for funding and strategic support close around you – you may be surprised at the interest and advise you’ll find!

Learn more about Davinci Virtual by visiting http://www.davincivirtual.com/

<< Building Quality Financial Projections – Start-up Sales Projections Part 2 >>

When projecting sales for a startup business there are generally two ways come up with what we have called “a reasonable range of sales.”  The first is the Breakdown method where you take a large potential market and break it down into a smaller target market and finally determine a percent of market capture.  The second is a Buildup method where you calculate breakeven point for your company and then determine the buildup of sales over time to achieve profitability.

Let’s use a hypothetical maternity clothing store in Fargo, ND as an example.  The numbers in this example are not 100% real but they are pretty close and should give you a good idea of how to use this method.

The Breakdown Method

The more local and the more specific the target market the more reliable the Breakdown method becomes.  The example of a maternity clothing store is perfect because it is a niche market but also statistics are readily available for the demographic set.  When you research data is that already available from another source we call that “Secondary Market Research”.   When you conduct your own survey or gather your own data we call that “Primary Market Research”.

To figure the Total Market and Target Market for maternity clothing we use secondary market research data.  The total market for maternity clothing is of course women, which account for about half of the 150,000 people in the Fargo / Moorhead MSA.  But specifically, pregnant women is the target market, therefore if we look at the number of babies born in Fargo at the two major hospitals in the area we can find that each year approximately 9,500 babies are born.

But this alone is not enough information to do a sales projection.  The second step is to make an assumption about “Market Capture” and finally conduct primary market research on the average dollars spent on maternity clothing during pregnancy.  To determine market capture you have to weigh the 4 P’s (product, place, pricing, people) against the competition to come up with an estimated market capture.  For example if we are a high end maternity clothing store in a community with lots competition we can expect to have  a lower percent of market capture but we also have a higher price per item of clothing.  On the other hand if we are going to start a second hand clothing store in a community with limited competition we can expect a higher market capture but lower margins.  At this point we have only one part of the equation solved – Target Market X Market Capture = # of Customers.

The final part of the puzzle is to determine the average annual spending on maternity clothing.  One way to determine this is to survey friends and family who have recently had a baby and ask how much they spent on average.  I had a student of one of my Entrepreneurship classes conduct this very survey and found that the average spent on the first pregnancy for clothing was $500 and about $300 on the second child.  Now again, we can’t expect to capture all of these dollars because some of it will go to the competition therefore you have to make another assumption about how many of these dollars your company will capture.  For the purposes of this example we assumed $200 of the total budget.  Therefore the second half of the equation is  – # of Customers X Capture of Annual Purchases = Sales Projection.

So to lay out the example:

Target Market X Market Capture = # of Customers
9,500       X             20%           =        1,900

# of Customers X Capture of Annual Purchases = Sales Projection
1,900                X                          $200                     =          $380,000

Let’s be clear… NOBODY should believe that this business will do exactly $380,000 in sales.  That is not the purpose of this exercise.  Nor should you believe that within the first year that it is a reasonable sales projection.  This number, $380,000, represents a basis for determining a Reasonable Range of Sales for this startup company.  It is a target to be achieved once the business has met its full potential for the current business model in its current market.

With this information we need to determine what will happen to the business is we only achieve 90% of the projection, or 85% or 50%.  We also need to estimate approximately how long it will take to get to that sales goal.  Will your company still be in business if it takes 18 months instead of 12 or 24 months instead of 18 months.

The number one reason why half or more of all startup businesses fail is because they RUN OUT OF MONEY!  But I believe the reason why they run out of money is because they think they are going to get to break even before they actually do…they over estimate their sales and the speed at which they will achieve them.

Take the graphic above for example.  Given the breakeven point and the sale projection this entrepreneur is expecting to burn the amount of cash where the sales are below break even.  Say that length of time is 12 months.  But what happens if the length of time to get to break even is even 50% longer (18 months instead of 12) as in the graphic below.

The amount of cash burned is almost twice as much because in the beginning months you burn more cash until you get to break even.  The “VOLUME” of the area below breakeven must be considered…the relationship is NOT one to one.  This is the single biggest reason why sales projections are so important.  You have to project different scenarios (best case, expected case, worst cast, super awful case) and prepare for the worst.  It’s the only way your startup business will survive.  And guess what…?  The assumptions for your projections come from your business plan so you can’t achieve quality sales projections without  a quality business plan.  If you put garbage in, you will get garbage out.

Part two will focus on the Buildup method for projecting sales which works best when you have a national market or a non-niche product.

<< Business Plan Templates - Startup Sales Projection Part 1 >>

Probably one of the most uncomfortable things a first time entrepreneur has to attempt is their first set of financial projections.  Frequently I hear the following:

• “Well…I don’t know how many people will buy from me!”
• “I just took a WAG (wild ass guess).”
• “This is so stupid…why am I doing this!”
• “How the hell am I suppose to know?!?”

To all of them my answer is “YOU are the expert in the business you are starting and You have to set some expectations for the banks and/or investors.”

As you may have heard, “Financial projections are part art and part science”.

So what does that mean?

It means that you won’t know really how to do them until you have done them.  Sure there are some things you can estimate based on your knowledge and experience with a particular type of business, but the rest has to come from research. And, that research, is part of the overall business plan.  In other words, the “part art” is the educated guess or the assumptions you base your projections on, which inturn is based on your expectations.  Your expectations are based on the research you completed in the written section of your business plan, that is the “part science”.

Regarding the comments above, the last one: “How am I suppose to know?!?” is peticularaly troubling. As mentioned before, you are suppose to be the expert.  But also, you should have done the research to set your expectations based on a reasonable set of (documented) assumptions.  Banks and investors will expect you to know your stuff upside down and backwards.  If you bring in a boiler plate business plan with canned financial projections, or ones written primarily by another person with numbers that you can’t explain, you won’t be getting any money any time soon.

After all that I hear:  “Well, all of that’s nice, but I still don’t know technically how to complete my financial projections.”  So here is the process:

1. Make sure you have a solid financial projection program to begin with. It can be a standalone program or excel templates but make sure the three statements (Income Statement, Balance Sheets, and Cash Flows) are interconnected.
   
2. A well researched and written business plan is a must. Every section of the business plan holds key data related to the financial statements.
   
3. Build a Beginning Balance Sheet or Sources and Use of Funds. Your Operations Plan should have laid out the assets you need to purchase to get started (Building / Equipment / Furniture & Fixtures / Inventory).  Get firm quotes from several sources on each.  Then document your funding based on sound business banking criteria including proper equity injection.  Finally, your balance sheet should “balance” – i.e. sources of funds=uses of funds (otherwise they wouldn’t call it a balance sheet!).
   
4. Build your sales / revenue projections. The data in the Market Potential section of your business plan or independent Marketing Plan will help you bracket your expectations for sales but in general, Sales projections are determined two ways: Driven from market data:  Target market size is determined in units or dollar volume and you estimate the amount of that market you can capture…bracketed by competitive factors (number, advantages, price) and industry factors (growth, decline, obsolescence). Driven from budgets:  When pursuing a broad market strategy it is better to determine break even point then estimate a sales goal to reach break even and eventually profitability.
   
5. Build your expense projection. Again, the information you compiled in your operations plan and other parts of your business plan will help you determine appropriate business overhead expenses. For example your location/building will determine your lease, utility, maintenance, insurance and property taxes.  Your inventory section will help you determine cost of goods sold and cash flow terms such as accounts payable.  The marketing section will help you budget your advertising and promotion expense.  And, your personnel section will help you forecast your salaries and wages, payroll taxes and benefits.

There is no great mystery to building financial projections.  With the right forecasting software, it can be fairly simple to do.  And now that we have demystified the “art and science” of it, you have the tools you need to get started and confidently plan the launch of your new business idea.

On a final note, you don’t have to go it alone.  There are business consultants located at Small Business Development Centers all across the country.  These counselors are usually well versed in business planning and helping your produce solid financial projections for your business.  So look them up and get started today! 

<< How To Write a Business Plan – Building Quality Financial Projections >>

Just because you need a business plan doesn’t mean you need to write a 100 page tome.  Depending on the type of business you are starting and the purpose for writing the plan there are four different types of business plans you could write.  Click on the picture below to view templates for each of the different types.

1. The One Page Plan – Popularized by Jim Horan’s book of the same name, this business planning model is intended mainly as a strategic planning tool the one page plan gives entrepreneurs a 10,000 foot view of their opportunity.  It focuses mainly on the mission, vision and objectives of the company at the expense of the marketing and operations plan.  If you aren’t looking for capital then this just might be the ticket for you.
   
2. The Three Sheet Strategy – Also based on a book but this one is by Mike Michalowicz call The Toilet Paper Entrepreneur.  The three sheet strategy takes the one page plan and adds two more components (and therefore pages…smart huh?), the SMART goals page and a paper version of a financial dash board.  This model is also designed for strategy but uses a 10,000 foot view, a 90 day goaling window and a historical look back at the metrics.
   
3. Summary Business Plan – A summary business plan is a comprehensive business plan with the operations plan ripped out.  This plan usually has a business description, market analysis and full financial projections but is designed for businesses that are don’t have overly complex operations.  A couple examples are e-commerce companies, consulting companies and service companies.   Another version of this is the Company Acquisition Proposal.  Since companies being purchased are usually in operation the operations planning can be minimized.
   
4. The Comprehensive Business Plan – And then there is the grand daddy of them all.  There are literally hundreds of different comprehensive business plan templates but they all pretty much boil down to the following six sections: Executive Summary, Business Description, Market Opportunity, Marketing Plan, Operations Plan and Management Plan.  Tack on 3 or 5 year financial projections and you’ve got yourself a business plan.  Software such as Business Plan Pro and Ultimate Business Planner reign supreme in this area but if you want to try it out without a financial commitment you can always try out Capital Business Plan’s free online business planning software (shameless plug…I know).