By Kuran Malhotra
The shelves are empty. Hand sanitizer sold out. Detergents are nowhere to be found. This was the scene of many American cities in early March 2020. Almost overnight, a global pandemic turned the status quo on its head, and individuals and businesses had to adapt to adapt and meet the challenges they were facing.
For some companies this has been a loss of pedestrian traffic or a change in consumer behavior. For others, it was a problem in the supply chain, distribution network, or development pipeline that reverberated.
In today’s environment, every company experiences its own insecurities. However, these uncertainties provide an opportunity to reflect and better understand the very essence of the business, its key drivers of profit and the ways these drivers can be used to find a way back to a new normal.
The importance of projections
As a small business owner, you’ve set out to make the products and services you love or sell to the customers you enjoy working with. Corporate financial data is intimidating, and you don’t really see the need for it right now. So they are happy to put it off for another day.
My company, a coffee company, was in a similar position. We had made some basic financial projections prior to the Covid-19 pandemic as we worked to grow our business and make decisions about where to allocate resources. Recently, however, we have identified a renewed need and meaning for them. As the pandemic raged across DC, our partners, landlords, and others viewed our planned financials not only as a measure of future success and profitability, but also a measure of our confidence in the business, our team, and the future.
Right now, as small businesses continue to face new challenges, landlords and banks want to see updated financial forecasts before examining your business for postponement, refinancing, or other relief. Often times, scholars and government initiatives view income statements as a measure of how badly the pandemic has harmed your business. The more accurate they are, the better they will serve you.
In addition, you can look at your company finances later to analyze important aspects of your company like the unit economy. For us, this meant understanding how much it costs to make a can of coffee and what that cost depended on. From there we calculated how much we were making per can and how many cans had to be sold to cover our overhead.
While coffee cans may be a niche example, this general concept of unit economy can really apply to any business: what do you do, how much, and how many do you have to sell to cover your costs?
1. Find a good starting point: create the income statement
An income statement is the best place for a small business to make forecasts. It really is the heart of the business on the smaller stage and it gives you insight into the metrics and drivers that you might want to consider later. Once you have your income statement, you can use it to create a balance sheet and, if necessary, a cash flow statement.
The best place to start when setting up your template P&L is with corporate filings from a public company. Public companies must submit their income statements, balance sheets and cash flow statements (among other things) quarterly. Finding a company or two in your industry can give you an idea of what the overall business world looks like with the key pieces of information.
Note the key line items such as the different categories of revenue, cost of goods sold / cost of services, and the breakdown of operating costs. Don’t worry too much about the more complex areas of accounting like goodwill or non-controlling interests unless you know they relate directly to your company.
2. Project revenue
Once you have a base for the line items you’re looking for, revenue is a great place to start. You already have a good understanding of how your business makes money. The key here is to split your earnings into different “streams” that make the most sense for your business and industry. Perhaps you sell items in a brick and mortar store and online. That would be two different sources of income.
Alternatively, your sources of income may be the products you sell and the service revenue that comes with the continued maintenance of those products. We have found that our industry looks at income in store versus income from sales of our wholesale coffee or grocery stores. That’s why we started there.
What drives each of these streams? For our cafes, how many people come each day and how much money they spend is a factor.
The aim is to break down the abstract number of “Café Revenue” into each of its critical parts, which are concrete and much easier to conceive and project. From there, multiply them together.
For my company it looks something like this:
Daily cafe earnings = number of cafes x number of people per day x average cups of coffee per person
These numbers are much easier to find and keep track of than doing trend analysis or just looking at historical dollar values. You can also get more nuanced with them – maybe your business has a seasonal bias, or maybe there is a weekly cadence for your business flow. As long as you can break it down into its different parts, you can realize these projections!
3. Variable expenses
Variable expenses are those that are directly related to your income. You will see them on your income statement primarily as a cost of goods / services sold, some as an operating cost.
Let’s look at a cup of coffee. In our previous example, we figured out how many cups we are going to sell in a day, and now let’s find out the variable cost: the cup and lid, the coffee itself, the water used for brewing, the syrup for flavor and milk or other additives. If we add these up and multiply by the number of cups sold per day, we get our variable cost.
Of course, your business is likely to be a little more complicated. Your products may be of different sizes and costs, or different services may cost different amounts of benefit. As long as you can point down these numbers and explain your assumptions, you are good to go!
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4. Project fixed costs
Fixed costs are much easier to project. This is the cost you will incur regardless of how much you sell. They generally fall into a few categories like salaries, rental costs, equipment costs, or other costs that you know you have to pay for, whether you are selling an item or a million.
For many of these types of costs, they are either the same year-on-year or grow at a fixed, predictable rate, like a rent that increases 2% each year. You can predict and project these, and they generally account for your operating costs, non-operating costs (like interest on loans, etc.), and possibly a small portion of your cost of goods sold.
From here, all you have to do is compile the income statement, fill in any missing lines (e.g. taxes) and off you go!
5. Structure of the balance sheet and cash flow statement
These two statements are a little more accounting. A third party may just need to look at the income statement projections and then simply ask for the actual balance sheet and cash flow statement for your last fiscal year or quarter. In this case, you may not even need projections for these two, but rather precise statements from the last operating periods.
If you choose to project your balance sheet and cash flow statement, the process is pretty similar. Take a stock corporation or other comparable annual report from your industry and fill in the lines. You should be able to work with your income statement line by line and create the cash flow statement based on the amount of cash you started with. The bottom line on the cash flow statement is the cash on hand at the end of the period that goes straight onto your balance sheet.
Before you start …
Building your corporate finances is not an easy task. It is even more difficult to project them into the future. Keep in mind that while it may not be the most exciting or interesting project, it can help you not only with your partners, but also with planning and deciphering which areas of your business are ready for success and which areas may need fine-tuning will.
Keep track of your assumptions so you can explain them and break down the intricate elements so you and your team can better predict and understand the key drivers. In the end, always remember that these are just projections. As useful as they are, they should only play a role in your decision-making process about what is best for your business.
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About the author
Contribution by: Kuran Malhotra
Kuran Malhotra is Director of Corporate Development at Compass Coffee, a DC-based coffee roaster specialist and retailer. Originally from Northern New Jersey, Kuran joined Compass as a barista while attending Georgetown University’s McDonough School of Business. He is now focused on growing the Compass Coffee Consumer Packaged Goods segment. Kuran’s favorite drink is a maple latte, and besides Compass, he is passionate about teaching finance and an avid foodie.
Company: Kompasskaffee
Website: www.kuranmalhotra.com
Connect with me on Facebook, Twitter and LinkedIn.
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