Financial Planning and Projections
Innovation & New Business Planning - TUHH Institute of Innovation Marketing & Institute of Entrepreneurship, Hamburg · part of my Technology Management MBA · study notes for revision.
Everything in the module up to here has been about the market: who the customer is, what stops them adopting, what to say to them, what to charge. This session translates all of that into one artefact that an investor will actually open first, the financial plan. It is where the story stops being adjectives and starts being rows of numbers that have to add up.
The session sets out four learning goals: how to build a financial plan covering both the financial attractiveness of a venture and its financing needs, including the income statement, balance sheet and cash flow statement; the key forecast metrics of revenues, costs and cash flow; how to identify milestones that give salient information about the venture’s progress; and how to pitch a financial plan to investors. Underneath those four goals sit only two questions, and every number in the model exists to answer one of them.
The first question is how financially attractive is the venture - the financial goals, that is where you are trying to get to. The second is what financial resources does the venture need - the financial means, that is how you get there financially. The first is argued with all three statements. The second rests almost entirely on the cash flow statement, because that is the only place where the amount and the timing of the money you must raise actually appear.
1 · The two questions, and what each one is answered with
Section titled “1 · The two questions, and what each one is answered with”- Answered using all three statements together
- Income statement shows the business model and whether it can ever be profitable
- Balance sheet shows how big the asset base has to be and how it is financed
- Judged with profitability measures: gross margin, net margin, break-even, and benchmarking against competitors and other startups
- Answered mainly from the cash flow statement
- Gives current and future funding needs, both the amount and the timing
- Cash flow from operations is normally negative until maturity, and cash flow from investing is negative too
- Therefore financing is needed, and the statement tells you how much and when
2 · Forward-looking, not backward-looking
Section titled “2 · Forward-looking, not backward-looking”This distinction is the reason the whole exercise feels different from an accounting class. Financial accounting exists to report facts that have already happened, in a standardised form, to people outside the company. Managerial accounting exists to help the people running the business decide what to do next. Financial projections belong firmly in the second family. They are estimates of a future that has not occurred, built from assumptions you chose, and their value lies in the quality of those assumptions rather than in the precision of the output.
Two practical consequences follow. First, there is no auditor to appeal to: every line is only as good as the reasoning behind it, so the reasoning has to be written down next to the number. Second, being wrong is not a failure of the method, it is the expected condition, which is why the plan is a living document rather than a submission.
3 · The plan’s configuration changes with the stage of the venture
Section titled “3 · The plan’s configuration changes with the stage of the venture”The deck is explicit that a financial plan is not one fixed object. Its configuration changes as the venture matures, moving from skimpy cost structures and revenue hopes at the very beginning to increasingly precise, internally generated estimates as the company accumulates its own data. Early on you are borrowing other people’s numbers; later you are using your own.
That leads to the question the deck asks directly: do we always need a financial plan? The answer is to balance detail and analysis against realism, so that the plan is appropriate to the stage and the nature of the venture. A twenty-tab model for a company with no product is theatre, and a single annual line for a company with real customers is negligence.
- Project quarterly or monthly
- Go up to about two years forward
- Numbers come mostly from outside: market reports, comparable companies, supplier quotes
- High frequency because the thing that kills you, running out of cash, happens month by month
- Lower frequency of periods
- But reaching further out into the future
- Numbers come from own past performance, which finally exists
- Lower frequency is affordable because the near term is no longer a guess
4 · Projections as a mirror, and their limitations
Section titled “4 · Projections as a mirror, and their limitations”The most useful framing in the session is that projections can be thought of as reflections. They are not only an output for investors, they are an instrument that points back at you.
Against that, the deck is honest about what the entrepreneurial process implies. Financial projections are always inaccurate, they quickly become outdated, and they are always optimistic. All three limitations are structural rather than accidental: you are forecasting something nobody has done before, the facts move faster than the spreadsheet, and the person doing the forecasting is the person who chose to bet their life on this venture. Knowing this changes how you read someone else’s model, and how you defend your own.
5 · Where the numbers come from, and the five steps
Section titled “5 · Where the numbers come from, and the five steps”Projections reflect information about the company, the markets and the entrepreneur’s plans. The deck distinguishes four main sources of information.
| Source | What it is | When it carries weight |
|---|---|---|
| Primary data research | Evidence gathered directly from the market yourself, such as customer interviews, tests and supplier quotes | When the market is new and nobody has already published the answer |
| Secondary data research | Data that has already been filtered and prepared by somebody else, such as market reports and industry statistics | For sizing established markets quickly and credibly |
| Experience of similar companies | Learning from comparable ventures, their margins, their growth rates, their cost ratios | For sanity-checking your own ratios against what has actually been achieved |
| Own past performance | Your own historical numbers, when available | Always the strongest evidence, and the whole reason later-stage plans are more precise |
Building the projections requires discipline and an analytical approach, which the deck organises into five steps.
6 · Step 1: the timeline, and milestones
Section titled “6 · Step 1: the timeline, and milestones”Defining the timeline is three decisions rather than one. Identify the relevant business milestones, which can be laid out in a Gantt chart. Define the appropriate time horizon across those milestones, which runs from about two years for an app to twenty for something like a nuclear project, with five or six years being typical. Set the level of account detail between the milestones, monthly, quarterly or yearly, and then set the time intervals across the whole horizon.
Milestones matter far beyond the chart, because they are also used to define funding-relevant targets. The definition given is precise and worth memorising: a milestone is a salient event whose achievement reveals important information in a discontinuous way. The word discontinuous is the key. A milestone is not gradual progress; it is a moment at which everybody’s belief about the venture jumps, up or down. Milestones cover different types of business achievement, from technical to commercial to managerial, and they return later in the module in the discussion of term sheets and staged financing.
7 · Step 2: estimating revenues, top-down against bottom-up
Section titled “7 · Step 2: estimating revenues, top-down against bottom-up”Revenues are the top line, and their timing is as important as their level. The starting identity is simple, and everything else is an argument about the two terms in it.
Revenue = Price * Quantitynet price = list price * (1 - third party margin) * (1 - rate of returns)The deck breaks the estimate into three moves. Define the unit you are selling, which may be a good, a service, a customer or a contract. Estimate the price, focusing on the net average price rather than the headline, and thinking about how price is distributed over time, over units and over regions. Estimate the quantity, and this is where the two rival methods appear.
- Supported by secondary data sources
- Step 1: size of the relevant target market
- Step 2: segmentation, if any
- Step 3: market share, the captured share of the addressable market
- The speed and shape at which that share is acquired matters as much as its final level
- Works well when the target market share is well defined and can be well approximated
- Less convincing when the target market is far larger than anything the venture could reach, such as all restaurants in New York, or when the market does not exist yet because the venture is introducing something genuinely new, such as space flights
- Built on the company’s own ability to develop and deliver the product
- Supported by company data
- Necessary for very large markets, and for new markets
- Requires estimating a realistic growth rate of production capacity
- Needs realism about returns, discounts and fulfilment
- Complementary to top-down rather than an alternative to it
The two are combined by turning bottom-up capacity into an implied market share and then asking whether that share is believable.
S = C / M, where C is bottom-up capacity and M is top-down market size- Have you defined the market segment too broadly?
- Or is the bottom-up strategy simply too conservative?
- Either way the two halves are not talking about the same business
- The comfortable zone, but not an automatic pass
- The question becomes simply whether that market share is realistic
- Justify it with the competitive position, not with the arithmetic
- Can you really be the largest player in this market?
- Needs an extraordinary reason, such as a genuine monopoly on the technology
- The deck’s own wording: stop dreaming
- The market does not support the growth strategy at all
- Either the market definition or the capacity plan has to change
8 · Step 3: estimating costs
Section titled “8 · Step 3: estimating costs”The deck names three types of cost and one further group that sits outside operations.
| Cost type | What it covers | Notes from the deck |
|---|---|---|
| COGS, cost of goods sold | Costs relating directly to the production and delivery of the product | Lowest in services. Estimate bottom-up as unit costs by looking at the inputs, or top-down by learning from existing competitors |
| Operating expenses | Costs relating only indirectly to production and delivery, incurred whether or not you make a sale | Salaries and stock options are very important operating expenses for new ventures. Tangible assets loom large in manufacturing, and intangibles such as brands and R&D matter too |
| Development costs | One-off costs of creating the venture and its products | For innovative companies these are relatively recurring, by definition, because innovating is what they do |
| Capital expenses | Non-recurring costs of acquiring long-lived assets | Whether to rent or purchase depends partly on the strategic importance of the asset |
| Non-operating expenses | Recurring costs of maintaining the asset base: depreciation and amortisation, interest expenses, asset revaluations and devaluations | Important because they reflect the need to keep asset quality high enough to stay competitive |
Across all of these sits the economic interpretation: which costs are fixed and which are variable. That split is what produces operating leverage, and it decides how violently profit moves when volume moves. The line items themselves reflect the type of business, and a retailer, a manufacturer and a service company will have visibly different income statements.
The projections model handed out in class splits the cost side into four working sheets, which is a good checklist of what actually has to be estimated.
| Model sheet | What it asks you to enter |
|---|---|
| COGS | Either a top-down expected gross margin per product based on market comparables, or a bottom-up bill of materials with components, assembly, enclosure and shipping, giving total COGS per unit, plus a CAGR of unit costs |
| Payroll | For each role family, gross pay plus employer taxes, employment insurance, pension, health insurance and other benefits, giving an annual cost per person, and separately a headcount plan by quarter and by year |
| Other operating expenses | An annual cost and a growth rate for professional services, office, R&D, sales and marketing, travel, administrative and other costs, plus initial startup costs, and the corporate tax rate with the profit threshold above which tax applies |
| Capital expenses | Each item with its cost, date of purchase, ownership length in years and value at end of ownership, from which the model derives three separate effects: depreciation on the income statement, cash out on the cash flow statement, and asset value on the balance sheet |
That last row is the one students miss. A single equipment purchase touches all three statements in different amounts and at different times: the whole price leaves the bank once, but only a slice appears as depreciation each year, and the remaining book value sits on the balance sheet.
9 · Working capital, and why it consumes cash
Section titled “9 · Working capital, and why it consumes cash”Working capital is the money tied up in simply operating: goods you have made but not sold, and invoices you have issued but not been paid for, less the bills you have not yet paid yourself.
NWC = CA - CLCA = cash + inventory + accounts receivableCL = accounts payableThe model drives this from three timing assumptions, which are exactly the levers a founder can negotiate: the accounts receivable collection period in days, the inventory days outstanding, and the accounts payable days outstanding, with accrued liabilities expressed as a percentage of cost of sales. The blank model carries illustrative settings of 90 days to collect from customers, 60 days of inventory, and only 15 days before you pay your own suppliers.
Read those three numbers together and the problem is obvious. You buy and build 60 days before you sell, you pay for it after 15 days, and you get paid 90 days after the sale. Every unit of growth therefore drains cash first and returns it much later. This is why growing fast is a cash problem, not only a profit problem, and it is why the balance sheet is interpreted for working capital needs and long-term capital goods needs rather than admired as a photograph.
10 · Financing as an input to the plan
Section titled “10 · Financing as an input to the plan”The financing sheet is an input rather than a result, and this catches people out. You enter what you intend to raise and borrow, and the model then tells you whether it was enough.
- Equity fundraising: a series of rounds, each with an amount raised and a date. Money in, no repayment, but ownership given away, which is the subject of the next chapter.
- Debt: each loan with its amount, monthly payments, start date and length in years. The model then produces the change in debt and the interest payments separately, because the two hit different statements. Repaying principal is a financing cash flow, while interest is an expense on the income statement.
The logic of the whole model is therefore circular in a productive way. You forecast the business, discover the cash hole, go back to the financing sheet, insert a round of the right size at the right date, and check that the ending cash balance never goes negative. The size and date you end up entering are the answer to the second key question.
11 · Step 4: the three statements, and why profit is not cash
Section titled “11 · Step 4: the three statements, and why profit is not cash”The income statement runs down a ladder from revenue to the bottom line, and the deck gives both the accounting form and a compact set of definitions.
| Step | Line | Definition |
|---|---|---|
| 1 | Revenue | The top line |
| 2 | Less cost of goods sold | Direct production and delivery costs |
| 3 | Gross profit | gross margin = Revenue - COGS |
| 4 | Less operating expenses | Indirect costs of running the business |
| 5 | EBITDA | EBITDA = gross margin - operating expenses |
| 6 | Less depreciation and amortisation | Non-cash expenses |
| 7 | EBIT, operating profit | The core performance metric |
| 8 | Plus interest income, less interest expense | Financing effects |
| 9 | EBT, earnings before tax | |
| 10 | Less income tax expense | |
| 11 | Net income | net income = EBITDA - ITDA, the bottom line |
The balance sheet, also called the statement of financial position, depicts the venture’s position at a point in time. On the asset side: current assets of cash, accounts receivable and inventory; then fixed assets as gross fixed assets less accumulated depreciation giving net fixed assets; then intangible assets; then total assets. On the other side: current liabilities of accounts payable, wages payable and notes payable; then long-term debt, giving total liabilities; then equity as common stock plus retained earnings; and finally total liabilities and equity, which must equal total assets.
The cash flow statement reconciles net income to cash in three categories. Start from net income, add back depreciation and amortisation, then adjust for the increase or decrease in accounts receivable, in inventory and in accounts and wages payable, which gives operating cash flow. Subtract the change in gross fixed assets to get investing cash flow. Add changes in notes payable, long-term debt and common stock, less dividends paid, to get financing cash flow. Sum the three to get net cash flow, add the beginning cash, and you have the ending cash. The deck calls this statement critical for determining financing needs and valuation, and that is not an exaggeration.
The single most important consequence is stated bluntly: startups need to focus first on keeping cash balances strictly positive, and only then on becoming profitable.
CF = Net Income - change in NWC - Capex + Depreciationa positive net income does not guarantee a positive CF, or a positive cash balanceThe two subtractions are the killers. Growth increases working capital, and expansion requires capital expenditure, and both take real money out of the bank in periods where the income statement is showing a healthy profit. The deck illustrates this with the familiar pair of hockey stick curves, where the cumulative cash line dives deep below zero long before the profit line lifts off.
12 · Testing the projections, and legitimate shortcuts
Section titled “12 · Testing the projections, and legitimate shortcuts”A set of projections describes a single path for the venture, which is obviously restrictive, so both entrepreneurs and investors test the realism of the assumptions in two ways. Scenario analysis constructs alternative complete sets of assumptions, typically a base, an optimistic and a pessimistic world. Sensitivity analysis asks which individual assumptions are crucial and to what extent, by moving one at a time and watching what happens to the outcome.
The deck also permits simplifications where they make the plan more manageable, and gives three examples: build a unit model by expressing every account in product units and then varying the scale of production; limit the analysis to a key industry metric, the classic example being eyeballs; or shrink the time horizon down to the experimentation period rather than pretending to see six years ahead.
Beyond the statements the model also carries a profitability view, pulling gross profit, EBITDA, EBIT, profit before tax and profit after tax onto one sheet, and a DCF valuation sheet. That last sheet takes EBIT, subtracts taxes, adds back depreciation, subtracts capital expenditure and the change in net working capital to reach free cash flow, applies a discount factor built from a discount rate, adds a terminal value driven by a company growth rate, and sums the discounted flows into a net present value. The blank model ships with a discount rate of 15 percent and a company growth rate of 5 percent as placeholders. Valuation itself is a later chapter, but it is worth seeing that it is fed directly by this same model.
13 · Step 5: formulate the plan, and pitch it
Section titled “13 · Step 5: formulate the plan, and pitch it”The financial plan is built on the projections and addresses the two key questions the investor cares about. Attractiveness is argued using the three statements. Resource need relies largely on the cash flow statement, covering both current and future funding needs.
When pitching the financial plan, the deck lists the points that must be covered.
Case corner
Section titled “Case corner”WorkHorse, Inc., a solar energy startup. Four founders in Ann Arbor, Michigan, come together in the summer of 2019 around an idea from a university lab: a lightweight portable solar power generator with enough capacity for medium-sized electrical devices such as air conditioning units, microwave ovens and electric chainsaws. The founding team is a physics PhD who leaves her doctorate, an MBA student, a lab colleague who is the strongest scientist of the group, and an engineer who supervises production. An uncle offers 80,000 dollars to get them going. Then a wealthy alumnus who now makes angel investments asks them to send over their business plan, and the founders realise they do not actually know what he wants. That gap is the case.
The venture in outline. The market is deliberately narrowed from solar power generators in general, which is far too broad, to the consumer-oriented market for portable solar generators, split into a North American and a European geographic segment. The first product, WonderFoal, is a small generator suited to hikers, launching in North America in January 2021. The second, NokotaStar, is more powerful and aimed at campers, launching in January 2022, which is also when both products enter Europe. Competition is condensed into a two-by-two of current against future and established players against startups, giving Honda now, Black & Decker as a possible entrant, YouSolar as a current startup rival, and Chinese competitors as the future flood. Manufacturing is in China; hikers can be reached through word of mouth, specialty magazines and online forums, but campers buy on brand, so a co-branding partner is needed and will cost margin.
The financial-planning question. How attractive is WorkHorse, and how much money does it need, when? The founders answer it exactly along the five steps of this chapter.
Step 1, the timeline. A Gantt chart lays out milestones for the next two years. From it comes a financing timeline: a seed round in January 2020 to finish the WonderFoal, and a Series A in January 2021 to develop the NokotaStar. Note how the milestones and the rounds are the same events seen from two sides. For the projections they choose a six-year horizon, quarterly for the first two years and annual thereafter, which is precisely the early-stage guidance from section 3.
Step 2, revenues, done both ways. Top-down starts from a North American consumer solar generator market of 1 billion dollars in 2020, of which the portable segment is about 10 percent, giving a 100 million dollar target market growing at 30 percent to 371 million by 2025. Europe is assumed to be half the size, 50 million, but growing faster at 35 percent to 224 million. The total target market therefore grows from 150 million in 2020 to about 595 million in 2025. Because those figures are at retail prices, third-party margins have to come out, and a shortcut average margin of 40 percent for 2021 and 50 percent from 2022 is used. Market shares are 5 percent in North America in 2021 with one product, 10 percent in 2022 with two, then growing 5 percent per year in relative terms, so 10.5, 11.0 and 11.6 percent. Europe starts at 5 percent in 2022 growing 15 percent relative, reaching 7.6 percent.
130 * (1 - 0.40) * 5% = 3.9 million dollars169 * (1 - 0.50) * 10% = 8.5 million dollarsNorth American revenues run from 3.9 million in 2021 to 21.5 million in 2025, Europe from 2.3 million in 2022 to 8.5 million, total 30.0 million by 2025.
Bottom-up starts from the price. The WonderFoal has a suggested retail price of 580 dollars net of tax and the NokotaStar 780 dollars. Retailers take a 40 percent margin, the co-branding partner takes a further 20 percent on the NokotaStar, and about 5 percent of merchandise comes back as returns.
580 * 60% * 95% = 330.60 dollars780 * 40% * 95% = 296.40 dollarsThe cheaper product earns more per unit than the expensive one, which is the single most instructive number in the case and would be invisible from a top-down forecast. Unit sales are 7,000 WonderFoal in 2021 rising to 35,000 by 2025, and 10,000 NokotaStar in 2022 rising to 80,000, giving revenues of 2.3 million rising to 11.6 million, and 3.0 million rising to 23.7 million, so 35.3 million total by 2025.
| Year | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 |
|---|---|---|---|---|---|---|
| Top-down, million dollars | 0 | 3.9 | 10.7 | 15.1 | 21.2 | 30.0 |
| Bottom-up, million dollars | 0 | 2.3 | 7.6 | 12.9 | 21.1 | 35.3 |
| Bottom-up as share of top-down | - | 59% | 71% | 85% | 100% | 118% |
The two estimates are reasonably close, which is the reassurance the exercise was designed to give. Top-down is higher in the early years because it implicitly assumes fast adoption of both products in both markets at once, while bottom-up assumes a gradual ramp; by 2025 bottom-up overtakes it. The founders prefer the bottom-up numbers, on the grounds that they are slightly more realistic and easier to justify. Apply the implied-share test from section 7 and it holds up: 35,000 units at 580 plus 80,000 at 780 is about 82.7 million dollars of retail value against a 595 million dollar target market, roughly 14 percent, which sits inside the normal 5 to 25 percent band, though near its upper half.
Step 3, costs. The bill of materials is fully bottom-up. For the WonderFoal: solar panels 45, battery 35, circuitry and hardware 15, assembly 20, enclosure 8 and shipping 4, a total of 127 dollars per unit. For the NokotaStar the panels are 55, battery 45 and circuitry 25, with the same assembly, enclosure and shipping, a total of 157 dollars. Unit costs grow at 4 percent per year and prices are deliberately not raised, because the market is expected to be competitive, so gross margins fall over time: WonderFoal from 60.1 to 53.3 percent and NokotaStar from 42.7 to 35.6 percent, with the blended figure sliding from 60 to 41 percent. The founders note that this is unusually conservative, since most entrepreneurs project rising margins.
They then cross-check top-down. The industry rule of thumb is that COGS is about 25 percent of the sales price, which would give 145 dollars for the WonderFoal and 195 for the NokotaStar, both higher than their own bill of materials. They conclude the rule of thumb comes from companies charging lower prices for less efficient products, that it compares solar generators with diesel generators, and they keep the bottom-up figures. This is a model answer for how to handle a disagreement between the two methods: understand where the benchmark came from before you accept or reject it.
On payroll, engineers and sales and marketing are hired at about 80,000 dollars gross, administrative staff at 50,000 and finance experts at 110,000. On top of gross pay come 15 percent employer taxes, 5 percent employment insurance, 2 percent pension, 7 percent health insurance and 10 percent further costs such as hiring and benefits, a loading of 39 percent.
80,000 * (1 + 0.15 + 0.05 + 0.02 + 0.07 + 0.10) = 111,200 dollarsThe founders pay themselves a minimal 25,000 dollars in the first year rising to 85,000 in 2021, and the case notes drily that they naively assume investors will simply go along with this. Payroll rises from 210,000 dollars in 2020 to 4.6 million by 2025, driven almost entirely by headcount rather than salary increases, with employees growing from 2 at the end of 2020 to 39 by the end of 2025. Other operating expenses are 197,000 in 2020 growing to 2.42 million by 2025: professional services 20,000 growing at 15 percent, office 25,000 at 10 percent, R&D 90,000 at 80 percent, sales and marketing 30,000 at 80 percent, travel 20,000 at 20 percent, administrative 5,000 at 10 percent and other costs 7,000 at 10 percent. The two 80 percent growth rates are a deliberate strategic statement: the plan depends on innovation, so R&D is not allowed to be underestimated the way it is in many tech companies.
Capital expenditure is kept deliberately lean, and each item carries a cost, a purchase date, an ownership period and a residual value: lab tools of 6,000 in September 2020 over 7 years, a product testing unit of 20,000 in November 2020 over 6 years with a 5,000 residual, office furniture of 3,000, then a company vehicle of 35,000 in June 2021 over 5 years with a 5,000 residual, a high-capacity testing unit of 55,000 in July 2021 over 6 years with a 13,000 residual, more office furniture of 8,000, storage racks of 3,000 in April 2022, new lab tools of 15,000 in April 2023 and a second company vehicle of 45,000 in September 2025 with a 7,000 residual.
What the plan then says. Attractiveness is genuine: a product with a 60 percent initial gross margin in a market growing at 30 to 35 percent a year, reaching over 35 million dollars of revenue in six years. But the resource question is the sharper one. Revenue is zero in 2020 while payroll and other operating expenses already consume around 400,000 dollars, capital items are being bought from September 2020, and unit production in China has to be paid for well before retailers pay WorkHorse. That is exactly the shape the seed round in January 2020 and the Series A in January 2021 are sized to fill, and it is why the milestones and the financing timeline are the same list read twice.
The transferable lesson. Do both forecasts, compare them, and then justify which one you trust. Take the channel and returns out of the price before you call anything revenue. Cross-check every top-down benchmark against your own inputs, and when they disagree, find out why before you pick. And remember that the interesting number in this case, that the 580 dollar product yields more per unit than the 780 dollar one, only became visible because somebody built the model bottom-up.
Worked example
Section titled “Worked example”A small venture sells a desktop air-quality monitor to small offices, through resellers. Six-year models are for later; here are the first three years, forecast twice.
Top-down. The overall national market for indoor air-quality devices is 400 million euro in year 1, of which the small-office segment is 25 percent, giving a target market of 100 million growing at 20 percent per year. Resellers take a 40 percent margin, so only 60 percent of retail value ever reaches us. Planned market share is 0.5 percent, then 1.2, then 2.0 percent.
100,000,000 * 60% * 0.5% = 300,000 euro120,000,000 * 60% * 1.2% = 864,000 euro144,000,000 * 60% * 2.0% = 1,728,000 euroBottom-up. The list price is 300 euro net of tax, resellers take 40 percent, and about 4 percent of units come back. Production and sales capacity supports 1,500 units in year 1, 4,500 in year 2 and 10,000 in year 3.
300 * 60% * 96% = 172.80 euro1,500 * 172.80 = 259,200 | 4,500 * 172.80 = 777,600 | 10,000 * 172.80 = 1,728,000| Method | Year 1 | Year 2 | Year 3 |
|---|---|---|---|
| Top-down, euro | 300,000 | 864,000 | 1,728,000 |
| Bottom-up, euro | 259,200 | 777,600 | 1,728,000 |
| Bottom-up as share of top-down | 86% | 90% | 100% |
The same shape as the case: bottom-up is more cautious early because capacity ramps gradually, and the two converge. The implied-share check gives 10,000 units at 300 euro retail, that is 3.0 million against a 144 million target market, about 2.1 percent, which falls in case 1, under 5 percent. So either the segment is drawn too broadly, or the capacity plan is too conservative. Both are worth arguing about before the model is finished.
Now the cash. Take year 1 only, monthly. Revenue is invoiced evenly at 21,600 euro a month. COGS is 40 percent of revenue, 8,640 a month, paid in the month. Payroll and other operating expenses are 11,000 a month. Customers pay after 90 days, so the first cash actually arrives in month 4. The company starts with 60,000 euro and buys 12,000 euro of test equipment in month 1. Ignore depreciation for clarity.
21,600 - 8,640 - 11,000 = +1,960 euro every month, from month 18,640 + 11,000 = 19,640 euro, from month 1| Month | Cash in | Cash out | Net | Closing balance |
|---|---|---|---|---|
| 1 | 0 | 31,640 | -31,640 | 28,360 |
| 2 | 0 | 19,640 | -19,640 | 8,720 |
| 3 | 0 | 19,640 | -19,640 | -10,920 |
| 4 | 21,600 | 19,640 | +1,960 | -8,960 |
| 5 | 21,600 | 19,640 | +1,960 | -7,000 |
| 6 to 8 | 21,600 each | 19,640 each | +1,960 each | -1,120 by month 8 |
| 9 | 21,600 | 19,640 | +1,960 | +840 |
| 12 | 21,600 | 19,640 | +1,960 | +6,720 |
The venture is profitable from month 1 and out of money in month 3. It never makes a loss, and it still dies, unless roughly 11,000 euro plus a sensible buffer arrives before the end of the first quarter. The reconciliation is exactly the formula from section 11.
net income 23,520 - increase in NWC 64,800 - capex 12,000 = -53,280 euro of cash60,000 - 53,280 = 6,720 euro at the end of year 1The 64,800 is simply three months of invoices sitting unpaid, that is 3 times 21,600. Nothing went wrong. The business is just financing its own customers.
Apply it to your project
Section titled “Apply it to your project”-
Fill in the Intro sheet first. Company name, start date, currency and units. The model’s colour key tells you where to type: orange cells are required numerical inputs, yellow cells are optional numbers or text, and unfilled cells are calculated for you, so never type into them.
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Define the timeline before any number. List your milestones as salient events that reveal information discontinuously, put them on a Gantt chart, pick a horizon appropriate to your industry, and choose quarterly detail for the first two years with annual detail thereafter.
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Do the Top-Down sheet. Size the overall market for the year you are sizing it, apply your target segment share, apply a growth rate, take out third-party margins so you are counting money that reaches you, then set a market penetration path period by period rather than a single number.
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Do the Bottom-Up sheet independently. Enter the list price net of tax, the third-party margin and the rate of returns to get a net price per unit, then a unit sales plan that reflects what you can actually build and ship.
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Compare the two on the Revenues sheet and choose a method. Compute the implied share and place yourself in one of the four cases. If you are under 5 percent, your segment is probably too broad or your plan too timid; if you are over 100 percent, start again.
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COGS next. Build a bill of materials bottom-up with components, assembly, enclosure and shipping, add a cost growth rate, and separately estimate a top-down gross margin from comparables so you have something to argue against.
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Payroll. Enter gross pay plus employer taxes, insurance, pension, health and other benefits for each role family so you have a fully loaded annual cost per person, then a headcount plan by quarter. Decide founder salaries deliberately, and be ready to defend them.
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Other operating expenses and capital expenses. Give every line an annual cost and a growth rate, and be honest about R&D if your strategy depends on it. For each capital item, record cost, purchase date, ownership length and residual value, and remember it hits all three statements differently.
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Working capital. Set your receivable days, inventory days and payable days. These three numbers, more than almost anything else, decide how much money you must raise.
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Financing. Enter the equity rounds with amounts and dates and any loans with their terms, then look at the ending cash balance line and check that it never goes below zero. If it does, change the amount or the date and try again.
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Read the statements. Income statement for profitability and break-even, balance sheet for working capital and long-term capital needs, cash flow for the amount and timing of funding. Benchmark your margins against competitors and comparable startups.
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Test it, then pitch it. Run scenarios and a sensitivity analysis to find which assumptions really matter. Then present in the deck’s order: assumptions first, then revenues by level, growth and timing, then costs by nature, level and growth, then profitability drivers and timing, and finally funding needs and cash flow analysis.
Key terms
Section titled “Key terms”| Term | What it means in plain words |
|---|---|
| Financial projections | Forward-looking estimates of revenues, costs and cash for a venture, built as a managerial tool rather than a report of past facts |
| Financial goals | The answer to how attractive the venture is: where you are trying to get to |
| Financial means | The answer to what resources the venture needs: how you get there financially |
| Milestone | A salient event whose achievement reveals important information in a discontinuous way, technical, commercial or managerial, and used to set funding-relevant targets |
| Top-down forecast | Demand-side revenue estimate: market size, then segmentation, then market share, built on secondary data |
| Bottom-up forecast | Supply-side revenue estimate: what the company can realistically develop, produce and deliver, built on company data |
| Implied market share | Bottom-up capacity divided by top-down market size, used to sanity-check whether the two halves of the forecast agree |
| Net price | List price after the third-party channel margin and expected returns have been taken out, that is the money that actually reaches you |
| COGS | Cost of goods sold, the costs directly tied to producing and delivering the product, lowest in services |
| Operating expenses | Indirect costs of running the business, incurred whether or not you sell anything, with salaries usually the largest for a new venture |
| Capital expenditure | Non-recurring spending on long-lived assets, which leaves the bank at once but reaches the income statement only as depreciation |
| Non-operating expenses | Recurring costs of maintaining the asset base: depreciation and amortisation, interest, and asset revaluations |
| Net working capital | Current assets less current liabilities, that is cash plus inventory plus receivables less payables, the cash tied up in simply operating |
| Operating leverage | The effect of the fixed against variable cost split, which decides how sharply profit moves when volume moves |
| Gross margin | Revenue less COGS, the first profitability measure and the one investors benchmark first |
| EBITDA | Gross margin less operating expenses, before depreciation, amortisation, interest and tax |
| Scenario analysis | Building alternative complete sets of assumptions, such as base, optimistic and pessimistic |
| Sensitivity analysis | Moving one assumption at a time to see which ones the outcome really depends on |
Test yourself
Section titled “Test yourself”- State the two key questions a financial plan answers, and say which statement or statements answer each one.
- Why are financial projections described as managerial rather than financial accounting tools, and what three limitations does the deck attach to them?
- Explain top-down and bottom-up revenue forecasting, and give one situation in which top-down is not convincing.
- A product has a list price of 400 euro net of tax. Distributors take a 35 percent margin, a co-branding partner takes a further 10 percent, and 6 percent of units are returned. What is the net revenue per unit, and if you can build 8,000 units in a year, what is the bottom-up revenue? If the target market is 90 million euro at retail, what is the implied share and which of the four cases is it?
- A venture shows a profit every single month yet runs out of cash in month 3. Give the formula that reconciles net income to cash flow and name the two items most likely to be responsible.
- What must a pitch of the financial plan cover, in order?
Revision summary
Section titled “Revision summary”Next: Ownership, Dilution & Returns → - who ends up owning what, and what the investor makes.