2006 Summer/Fall Volume 6 No. 2
Keeping Score with Financial Projections
By John Camphouse
It’s half time, the game is on the line … do you know the score? You would if you and/or your accountant made careful financial projections and kept them updated quarterly.
Having detailed projections gives you a way to compare current results to what you predicted. It is like a status report for the moment, and it is particularly helpful during the busy season.
While you may be accustomed to traditional financial statements that are "historical" in nature and show where you have been, it is equally important to know where you are now compared to what you expected to accomplish when you made your predictions.
Wall Street investors always get excited when a company beats projections. These are the results of all the business assumptions that were predicted in the previous quarter. While projections can make or break stock prices on publicly traded companies, they are also important for small companies like yours. After all, even the smallest portable restroom company has investors—these include the owners, the owner’s family, the bankers or credit specialists who lend money to the company, and even key employees who may not invest money, but do invest their life’s work in the company’s future.
Investors of all kinds need an idea of how a company is doing and how it is expected to do in the future. But it is especially important for management because it can help make fundamental questions easier to answer, such as:
• Can I afford to make a large purchase, like a new truck?
• Can I afford to hire a new employee?
• Can I afford to bid on a large contract, knowing that if the bid is won, large purchases will have to be made?
• Should I lease or buy equipment?
• Should I purchase a building or continue to lease my business property?
• Am I doing better now than last year at this time?
• Will I have enough cash to operate, if a major customer pays late?
• How will my projected growth rate in revenues affect my variable and fixed costs?
• At what level of revenues does my breakeven point occur?
• What affect will inflation or higher interest rates have on my business?
Projections may also be required if you are applying for a business loan, selling your business, seeking a business partner, or planning a major expansion.
There are 7 items in any financial pro-jection for a portable restroom service company—
2. Cost of Service
3. Cost of Selling
4. Fixed Costs
5. Variable Costs
6. Gross Profit
7. Operating Income
Your accountant may break these categories down differently; but however you slice it, you’ll need the same key information.
To make solid projections, you need to make rational, educated guesses about where each of these financial measures will be in the future based on what you assume will happen going forward. For this assumption to be valid, it must be based on past experience as well as known future events such as signed contracts for service not yet performed.
Sales: The most effective sales projec-tions are based on previous years’ sales. If for example, over the last five years you had 12%, 4%, 8%, 13%, and 9% growth figures, your projections would take last year’s sales and add a predicted growth rate based on your average growth. Adding average growth to last year’s revenue would predict 9.2% growth (12 + 4 + 8 + 13 + 9) ÷ 5 = 9.2.
An average may also be used for businesses in retraction. For example, your numbers may read +6%, -3%, -8%, +2%, +1%. Your forecast with these numbers would predict a -.4% loss from last year at this time.
It is also appropriate to look for trends in the numbers. For, example: -7%, -5%., -2%, + 3%, +5%. In a case like this, averaging the numbers would wrongly assume that the business would be predicted to retract by –6%. However, the growth curve clearly would predict continued growth at 5% or better.
Also, don’t use averages alone when other known factors are relevant. For example, if you just won a major new customer, (or lost one) you may be able to predict what the effect will be on your sales in the coming months or year and how it will affect your sales average. You should also take into consideration whether the local economy is in a boom or bust phase. Recognize whether competitors are grow-ing stronger or weaker.
Cost of Service: In the portable restroom industry, this figure would include all the usual costs of renting restrooms including: cost of supplies (soaps, deodorants, and paper), cost of dumping, as well as gas and maintenance for service trucks. Also see Variable Costs
Selling Costs: These include adver-tising costs, promotions, yellow page ads, web sites and sales staff expenses such as gasoline, automobile leases, entertainment and telephone usage.
Fixed Costs: These are defined as all the costs a business accrues simply by opening their doors for business, such as the monthly cost of equipment (leases, depreciation, and interest payments on trucks and restroom equipment), the monthly cost of real estate (lease, mortgage and/or property taxes), utility bills, insurance, and permanent employee salaries and benefits.
Variable Costs: Variable costs are those that change rapidly as business increases, or decreases. Therefore this projection should be tied to projected sales. Unexpected jumps in this figure can happen if the price of gasoline goes up significantly as it has recently, if suppliers raise prices, or if a costly unanticipated break-down occurs such as a blown engine on a truck with low miles. While permanent employees would not be in this category, the cost of temporary employees and overtime payments that can be applied to specific service jobs could be included here.
Gross Profits: This equals the total sales minus the direct cost of service.
Operating Income: This is essentially the bottom line, or gross sales receipts minus cost of service, selling costs, and fixed costs.
A complete financial forecast includes pro-jected cash flow statements and balance sheets as well. And while these are every bit as important to the financial forecast, these statements logically flow from the operating income statement.
As long as your projections are reconciled to historic financial statements, or “make sense based on past experience,” then you have a good basis on which to plan the next move. A comprehensive projection is like a score book. It shows you where you are now, it shows you how different parts of your team are doing, and it gives you a clearer vision of how to execute the game plan going forward. your business.
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