Gut Check Pro Forma

POSTED BY: burtwalker

The process of writing a business plan is often a daunting task. That is as it should be, because it’s an essential tool that requires the writer to give serious, in-depth thought to the business the owner is about to undertake. Let no one think a business plan can be written over a weekend. It is very time consuming and requires discipline, commitment, and no shortage of patience. But without a business plan, the likelihood of success will be substantially reduced. So, before one begins to invest in this process, wouldn’t it make sense to have a reasonable belief the business can succeed? Of course. That’s why I always recommend the founders prepare what I call a Gut Check Pro Forma.

A Gut Check Pro Forma is a simple worksheet that highlights the financial fundamentals of the business itself. While it is filled with assumptions and often unverified statistics, it often allows the author to understand if his business can succeed. It’s surprising how many startups dump lots of time, effort, and money into a business without ever understanding the basic economics of their business.

First, let’s understand what a pro forma is:

pro forma | prō ˈfôrmə | noun

a financial statement showing potential or expected income, costs, assets, or liabilities, esp. in relation to some planned or expected act or situation.

All business plans should include pro forma information. In most cases this involves lots of spreadsheets showing most of the financial aspects of the business. This part of a business plan is typically time consuming and involves lots of research. But the “gut check” version is really something quite different. It’s something every startup should do before writing a single word of the business plan. What is it? In most cases it is a single worksheet that shows the bare bones, what-if, kind of analysis needed to determine if the business is even worth pursuing. it’s basically, a quick and dirty break-even analysis. Here’s what I like to see in a gut check pro forma:

Product or Service Price Points. This involves showing what the owner believes are reasonable prices that the market will bear for the primary product or service. Usually, I like to include various prices in the model to allow for low-end to high-end, with some mid ranges included as well.

Costs. How much will it cost to get the product to market? This would include realistic estimates of the actual costs of production, distribution, marketing, etc. This should not be pie-in-the-sky figures. Don’t use best case scenarios. This is no time to impress your investors. Remember, this pro forma is for your consumption and nobody else’s.

Market Size and Penetration. Try to fully understand the market to which you are selling. This usually involves some research, but it’s absolutely vital that you get the best understanding of it as possible. Then, use the penetration rates that you believe are reasonable. DO NOT assume you will get 2% of the entire market because you believe that’s a low number. This is a common fallacy, and if you do it, you’ll be making a big mistake. If you believe you can get 2%, then you better have a good reason. It being a small percentage is NEVER a good reason. An alternative to percentages is actual numbers. Consider how you will achieve those numbers and once again, you must be realistic.

Working Backwards. Sometimes, its better to look at it from another angle.  Start with what you believe is the minimum you believe is an acceptable return on your investment.  Put more bluntly, what is the minimum operating profit you will need to make your investment?  Then, based on your price points and costs of production, you can see how many units you need to sell to achieve it. Then you can make a reasonable assessment of whether or not you can achieve that level of sales.

In general, a gut check pro forma will be for your eyes only, so there’s no reason to pad the figures to make it look good. Before you invest time, money, and sweat into your business, you should really believe it is possible to achieve your goals. I have reviewed several business ideas (including some of my own) that upon doing a gut check pro forma, discovered there is simply no way to make a living at it, much less get rich beyond my wildest dreams. Remember, just because you sell a million units, doesn’t mean you’ll be successful, because if the cost of production exceeds the price the market will bear, you’ll always be in a losing situation.

Below is a worksheet I put together recently when considering a business idea for building template style web sites for small businesses. Note that this model shows me how many units I need to sell to achieve my goal of an operating profit of $300,000.  Now, the question becomes, can I sell that many units and what must I do to achieve it?  If I believe I can do it, I should press on.  If not, I should abandon the project. This illustrates how a quick and dirty worksheet can give you the confidence to proceed.

Comments