Pro formas and forecasting

2010

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Topics

1. Sensitivity testing

2. The one-year financial model

3. The cap (“capitalization”) table

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Section 1 -- Sensitivity testing

1. Operating scenario• Software company

• Revenues $2m last year, and $3.6m projected this year

• Profitable -- $230k

• Headcount to increase from 14 to 26 this year

2. Financial position• Cash at end of year projected at $88k

• Receivables at end of year = $745k

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Question – which assumptions are the most significant?For one quarter? For the year?

PLAN

Sales performance vs. quota 91%

Annual maintenance fees 15%

Commission rates 8%

Annual travel expenses $30,000

Spending on marketing programs $350,000

How fast customers pay us 50 days

How fast we pay creditors 35 days

Spending on new computers for each hire $3,000

% of equipment purchases financed 60%

Interest rates paid 18%

Executive compensation $100,000

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These are the most significant assumptionsOne quarter Annual

PLAN$ effect of a (10%)

difRank

$ effect of a (10%)

difRank

Sales performance vs. quota 91% -2 -127 1

Annual maintenance fees 15% -3 -26 3

Commission rates 8% +2 -10

Annual travel expenses $30,000 -1 -6

Spending on marketing programs $350,000 -5 -18

How fast customers pay 50 days -55 1 -75 2

How fast we pay creditors 35 days -16 2 -14

Spending on new computers for each hire

$3,000 -- -2

% of equipment purchases financed 60% -1 -3

Interest rates paid 18% -- -1

Executive compensation $100,000 -2 -7

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1. Organize the model (Excel workbook)2. Forecast billings (and, revenues)3. Forecast expenses4. Plan the financing and investing strategies5. Create the balance sheet6. Review for reasonableness7. Make the Plan work8. Summarize

Section 2 – The one year financial model

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1. Summary• Graphs / Text / Sensitivity analysis

2. Top level financial statements• Same format as the monthly financial statements• Income statement• Balance sheet• Cash flow statement (optional) -- Checkbook format

3. Projection details• By natural expense• By functional area

4. Assumptions5. Populate actual results year-to-date

Step 1 -- Organize the model

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1. Productivity of sales force• By individual sales person• Provide time for new hires to become productive

2. Productivity of sales partners / distributors• Based on prior experience

3. Current backlog• Funnel size• Funnel phases, and time to convert• Historic conversion ratios• Weighted average calculation (amount by probability factor)

4. Effectiveness of marketing programs5. Project revenues by customer

Step 2 -- Forecast billings (and, revenues)

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6. Reconcile to GAAP accounting• Billings do not = revenues

• Software

• Service companies

• Construction

7. Different revenue types have different bases• Software company – licenses, training, maintenance,

consulting

Step 2 -- Forecast billings (and, revenues) (ctd)

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1. Materials (cost of goods sold)• Know the “learning curve”

2. Compensation• Salaries – show salary for each employee• Bonuses – may be iterative• Commissions, including draws – very difficult area• Benefits – taxes, health insurance, education

3. Travel 4. Facilities

• Use market rates• Provide for utilities and other tenant costs

Step 3 -- Forecast expenses

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5. Marketing programs

6. Professional services (legal / accounting)

7. Consultants

8. Interest

9. Income tax provision• NOL carry forwards

• Effect of change in control

Step 3 -- Forecast expenses (ctd)

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1. Financing• Equity

• Debt1. Equipment

2. Bank• Receivable-based line of credit

• Factoring accounts receivable

3. Bridge

2. Investing• Capital equipment purchases

Step 4 – Plan the financing and investing strategies

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1. Equity• Invested equity from financing plans (FFF, angel, VC)• Earned equity from the income statement

2. Debt • Borrowings (bank, equipment lessors) based on financing strategy• Trade payables – based on payment strategy• Deferred / unbilled revenues – when billed in one month, earned

in another month

3. Assets• Fixed assets -- from cap spending • Inventory – based on manufacturing efficiency (“turns”)• Accounts receivable – based on collection history (“dso”) Cash balance – balance

Step 5 -- Create the balance sheet

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Step 6 -- Test for reasonableness

1. Questions asked by a potential investor• Likelihood of a specific deal closing?

• Ability to staff up to meet Plan?

• Revenue recognition issues – samples given out?

• Revenue recognition issues – sell through by distributors?

• Level of confidence in board design? (inventory write offs)

• Who buys the inventory and when do you pay for it?

• Availability of hardware components needed to manufacture products?

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Step 6 -- Test for reasonableness (ctd)

1. Questions asked by a potential investor (ctd)• Capital spending plan?

• Salaries – reasonable?

• Commission structure – market?

• Map engineering expense to specific product development plans!

• What are the trigger events for hiring groups of people?

• Want to see a breakdown of revenue by customer!

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Step 7 -- Make the Plan work

1. Get buy in. Use cash bonuses based on Plan #’s

2. Get next month’s sales forecast right

3. Eliminate low return development projects

4. Compare your spending to others in the industry

5. Plan for profits

6. Rank the marketing programs by cost, leads received and perceived benefit

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Step 7 -- Make the Plan work (ctd)

7. Run a sensitivity test – know the EOY cash balance

8. Build in a cushion

9. Keep a waterfall chart

10. Relate the hiring plan to the capitalization table

11. Update frequently

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Step 8 -- Summarize

1. Graphs

2. Significant numbers

3. Assumptions

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Section 3 – The cap (“capitalization”) table

1. Reflects changes in ownership, by owner2. Includes common shares outstanding +

• Shares issuable upon stock option exercises• Shares reserved for future option grants• Shares issuable upon conversion of preferred stock

and debt

3. Calculates• Ownership percentages of all stockholders

• founders / employees / investors

• Price per share at various times / events• Value multiples

4. Must be consistent with financial plans