A good financial model, or “Pro Forma” is one of the essential elements needed to raise capital. It is a key communication to investors detailing how the company will scale. An entrepreneur armed with the numeric understanding of how and when his company will achieve $100 million will clearly be a stronger candidate than one who filled out an online template.
The truth is a Pro Forma has about as much chance of being accurate as a blind man hitting the bull’s-eye with a dart. So why are financial projections important? Because they communicate that you have a measurable plan, know what needs to be achieved, and can check that your company is on target. And if not, you know where to recalibrate.
A team of founders should work with a finance professional to create the initial Pro Forma at least 3-4 months ahead of an investor presentation. In the first iteration, the financial projections will be an Excel list of revenues and expenses laid out vertically, with months and quarters on the horizontal axis. It is not uncommon that the first iteration will contain estimates far from the coming reality.
However, the bedrocks of a fundable Pro Forma are well-reasoned assumptions. Hiring five engineers in the first year? Great! Costs associated with payroll had better be included. Also, if these are Silicon Valley engineers — then you better budget more than $45K a year… The point is that every line needs to be considered.
Ok, so the projections are complete. As predicted, they look great! The company is set to make loads of money from advertisements and will be profitable in a few months, which of course is justified by the exponential user growth as they just keep coming back!
Put the pro forma down. Step away slowly.
Before you spin that tale to an investor – live it. Put 3-4 months of hard work into the company and track your progress against those results. What went right? What went wrong? This known as Variance Analysis, and is a critical piece in the recipe for creating a strong set of financial projections.
The insight garnered from understanding why you hit or missed your estimates will not only help you ground your forward projections, but it will also help build a better understanding of your company. Additionally, the financial model should become increasingly accurate as you adjust your forward estimates to actual data.
Lastly, a tool is only as good as it is easy to use. A professional can add structure to your thoughts, translate ideas into numbers, and build the presentation aligning to accepted standards. Do you know how a SaaS model differs from a manufacturing model, or the interactions between financial statements? Be prepared.
Finally, if everything is buttoned up, as it should be, your Pro Forma will land you an investment that helps your company grow!
Steven Toomey & Rob McGrorty