Financial Model Mistakes

Only cash is cash  

Suppose you sell something this month for $100, and it cost you $60 to make it. But you have to pay your suppliers within 30 days. But the buyer probably won’t pay you for at least 60 days.

In this case, your revenue for the month was $100, your profit for the month was $40, and your cash flow for the month is zero. Next month your cash flow will be -$600 when you pay your suppliers.

Although this example may seem trivial, very slight changes in the timing difference between cash receipt and disbursement of just a couple of weeks can bankrupt your business.

When you build your financial model, make sure that your assumptions are realistic.  

Lack of detail

Your finances should be constructed from the bottom up and then validated from the top down. The bottom of the model starts with details such as when you expect to make specific sales or hire more employees.

Top-down validation means that you examine your overall market potential and compare that to the bottom of revenue projections.

Round numbers like 1 million in R&D expenses in your two, and 2 million in your three, are you sure sign that you do not have a bottom-up more. 

Unrealistic financials

Only a small handful of companies achieve 100 million or more in sales only five years after founding. Projecting much more than that will not be credible and will get your business plan canned faster than almost anything else. On the other hand, a business with only 25 million in revenues after five years will be too small to interest serious investors. Financial forecast or a litmus test of your understanding of how venture capitalists think.

If you have a realistic basis for projecting 50 to 100,000,000 in five years, you probably a good candidate for venture financing; otherwise, you should probably look elsewhere.

Insufficient financial projections

Basic financial projections consist of three fundamental elements: income statements, balance sheets, and cash flow statements. All of these must conform to generally excepted accounting principles or GAAP.

Investors generally expect to see five years of projections. Of course, nobody can see five years into the future. Investors primarily want to see the thought process you employ to create long-term projections.

A good financial model will also include sensitivity analysis, showing how your projected results will change if your assumptions turn out to be incorrect. This allows both you and the investor to identify the assumptions that can have a material effect on your future performance to focus your energies and validate those assumptions.

It should also include benchmark comparisons to other companies in your industry, things like revenues per employee, gross margin per employee, gross margin as a percent of revenues, and various expense ratios (general and administrative, sales and marketing, research and development, and operations as a percent of total operating expenses.

Conservative assumptions

Nobody ever believes that assumptions are conservative, even if they truly are. Develop realistic assumptions that you can support, refrain from using words “conservative “or aggressive “in your plan, and leave it at that.

Offering a valuation

Mini business plans here, stating that their company is worth a certain amount. How do you know? The value of a company is determined by the market, by what others are willing to pay. Unless you are in the business of buying, selling, or investing in companies, you probably don’t have an accurate sense of what the market will bear.

If you name a price, one of two things will happen to tell you that your price is too high, and investors will toss your plan, or thar5 your price is too low, and investors will take advantage of you. Both are bad. The purpose of the business plan is to tell your story in the most compelling manner possible so that investors will want to go to the next step. You can always negotiate the price later.

Stylistic mistakes

Poor spelling and grammar

If you make silly mistakes in your business plan, what does that say about how you run your business? Use your spelling and grammar checkers, get other people to edit the plan, do whatever it takes to purge embarrassing errors.

Too repetitive

All too often, a plan covers the same points over and over. A well-written plan should cover key points only twice, once briefly and then the executive summary, and again in greater detail, in the plan’s body.

Appearance matters

At any point in time, an investor has dozens, if not hundreds of plants waiting to be read. Get to the top of the pile and making sure that the cover is attractive, the binding is professional, the pages are well laid out, and the fonts are large enough to be easily read.

Execution mistakes

Waiting until too late. The capital formation process takes a long time. In general, count on six months to a year from when you start writing the plan until the money is in the bank. Don’t put off your management team should be prepared to invest about 500 hours into the plan. If you are too busy building your product, company, or customers (which is probably a better use of your time. Consider outsourcing the development of the business plan.

Failing to seek outside review

Make sure that you have at least a few people review your plan before you send it out. Preferably people who understand your market, sales, and distribution strategies, the DC market, etc.

Your plan may look perfect to you and your team, but that’s because you’ve been staring in for months. Good objective reviews from outsiders with fresh perspectives can save you from myopia.

Over tweaking

You could spend countless hours tweaking your plan in the pursuit of perfection. A lot of this time would be better spent working on your product, company, and customers. At some point, you need to pull the trigger and get the plan out in front of a few investors. If the reaction is positive, and they want to move forward, great.

If the reaction is adverse, assuming that the investor was a good fit to begin with, and you may have been heading down the wrong path. Get feedback from a couple of investors, and if a consensus emerges, go back and refine your plan.

Conclusion

It’s a tough investment climate, but good ideas backed by good teams and good business plans are still getting funded.  Give yourself the best chance by avoiding these simple mistakes.