Debunking our top 5 forecasting myths

Debunking our top 5 forecasting myths

Having worked with countless founders, developers and investors on building financial forecasts, I have encountered a few themes around (what I see as) misconceptions. Forecasting is seen as a dark art and this has been down, in part, to some common myths that we have encountered when we speak to business owners and founders. Below is my top 5 myths that we hear from our customers.

Myth #1 – You need to be an accountant or have a degree in Economics and an Excel wizard 🤓

Some financial knowledge is helpful and will enable you to interpret your financial forecasts quicker but accountants do not always make good financial modellers.  Much of financial modelling is in the structuring and design of the forecasts to make them clear, consistent and able to drive decisions making.  I know great financial modellers who have no background at all in finance but have learnt from building models. So on to Excel – we love Excel, it is the incumbent software and is a very powerful tool – no doubt, having some foundation in it will assist you to build the formula needed for a dynamic model but we will show you that even the most basic o Excel skills can build a model.  There are also means outside of Excel to build you financial model, in fact this is where we can shameless plug numberslides, our forecasting platform that we have built to enable users to build bullet proof financial models with no spreadsheets whatsoever! We have created numberslides to demystify financial forecasts.

Myth #2 – You need historical data and lots of it 📚

Historic data is one way to build the foundations of you model.  If you have the data available then this is your starting point and it should form the basis of your forward looking projections but if you do not have any historic data or enough to see any trends then you can still build a robust financial model.  In this case, you work from the bottom up, looking at the core drivers and building scenarios that allow you to flex and test business cases until you land on a scenario that you are comfortable with and is deliverable.

Myth #3 – It’s all finger in the air 👆

To a certain extent this is true but the finger in the air is supported by well thought out assumptions and business logic. We do not know what will happen next year, let alone in 5 years’ time but we are showing scenarios of what may happen and providing this backed by sound logic and is achievable then this goes a long way. We see it like your old maths exams when you were given marks for showing your workings. This also brings up accuracy and how accurate your forecasts need to be…

Yes, your model has to be accurate or at least have sound basis that backs your assumptions but no, you do not need to be as accurate as possible as how can you be? We are building forecasts that your audience need to buy into – now expectations may be different between an infrastructure investor and a business angel but the forecast is another tool to sell your vision.

Myth #4 – The more complex the better 🗺

This is not true – we want your audience to be able to make a decision based on your forecasts. This means that they need to understand it and in some cases test your inputs. We see it as a balance that fits around what your audience want to see. You want you forecasts to give confidence you have a handle on your numbers not that you are an Excel wizard. So something scribbled on a paper napkin is probably not detailed enough but endless spreadsheets linking to spreadsheets with rows and rows of inputs (but in some complicated business models that may be needed) is going to delay decisions being made.

Myth #5 – Once you have your forecast, you’re done ➰

This is a big no no – like any good business plan, your forecasts need to be reviewed on a regular basis. Things change, business pivot – this could be market pricing, government policy or you lose your first mover advantage – things outside your control will mean you need to review your inputs and make sure they still reflect your situation. Also, if you are fundraising, a key aspect of this journey is investor feedback from the one’s who passed – constructive feedback may lead you to change your business model, pricing or cost base – so keeping your forecasts fresh and up to date will set you up for success.

4 Important Things to Remember When Building Your Pitch Deck

4 Important Things to Remember When Building Your Pitch Deck

Building your pitch deck can be a right pain, especially when there are a million different versions out there that you could copy. Before you dive into the mess, remember this; your pitch deck has a job to do. Don’t get in the way of it delivering the right message to your potential investors – stick to these 4 important tips when building your pitch deck.

1. Your first pitch deck is always going to be terrible

Well, perhaps not terrible, just really…mediocre in hindsight. But that’s a good thing. We always look back and groan, but nothing is ever designed to be static. What you’re currently doing right now is one step in a thousand steps to get your start-up off the ground. It shouldn’t be the finished polished best-ever pitch deck of your life. Instead, it’s got to be good enough to get the job done.

2. Don’t spend a fortune on designers

Don’t try to counteract your shoddy numbers and shortcomings by getting some clever creative to add a splash of colour and some transitions. Keep the look clean and easy to consume. Save your pennies and pounds and focus on making sure your numbers stand out above all.

3. Keep it short and sweet

Your pitch deck is not a 100-page word-dump of all your ideas. It’s your vision in a sentence and it’s the bottom line of your business; you’re here to secure funding because you’ve got an idea that’s going to work. Use your pitch deck to deliver the most important bits. Forget the frills.

4. Social proof it

The power of social proof is one that was harnessed by multiple mega corps in their early pitch decks. Show off that you’ve got an experienced CFO or product manager on your management team.

Struggling to get started? You can throw together the basics in as little as 20 minutes with Numberslides. Don’t put your pitch deck off.

How Numberslides Estimates Your Business Valuation

How Numberslides Estimates Your Business Valuation

What Are Business Valuations?

A business valuation is a method that enables someone to determine the economic power or value of a business, a limb of a business, or a group of businesses. When undergoing a valuation, we are looking for a reasonably fair value that is a baseline value of your business. This helps make better decisions and set more informed goals. You’ll need to know the value of your organisation when you’re selling your business, trying to get finance to back your business, or arranging tax payments. You’ll even need to know this information if the business owner is implicated in matters of family law, such as divorce proceedings.

How Do You Work Out a Business Valuation?

Figuring out a business’s valuation is not an exact science. There are steps you can take to make a strict, accurate, and fair valuation which you can rely on with some confidence when talking to investors, potential buyers, or a court judge. Generally, there are a few basic rules to remember, and which we apply, when helping you work out your business valuations.

Whenever the business is up for sale, the buyer will always use a method of valuation that demonstrations that your organisation has a lower value than you may think, whilst as the seller, you will likely find a valuation method that demonstrates the value of your company is higher.

Which Method Does Numberslides Use to Value Your Business?

There are all kinds of ways to value a business. You can use discounted cash flows, multiples of EBITDA, perpetual growth, or Scorecard methodology. At Numberslides, we use the perpetual growth methodology. We aim to derive a Terminal Value of your business.

How to Calculate Terminal Value with Perpetual Growth Business Valuation

To calculate Terminal Value, we must start by calculating the Free Cash Flows to the business. These Free Cash Flows (known shorthand as FCF) are the cash flows that are left over after the business has paid off all its costs, expenses, and investments. Investments describe money spent to keep the business performing at its current level of operation.

Free Cash Flows are also known as ‘Unlevered Cash Flows’ because we are talking about cash flows that do not take into account any sort of debt finance (which means we are using someone else’s cash outside of the business’s own).

The perpetuity growth model assumes that cash flows grow at a constant rate continuously and infinitely.

The Terminal Value (TV) is today’s value or the present value of all future cash flows. We work this out with the assumption of perpetual stable growth. This is the basis for your business valuation.

The formula for working out Terminal Value and Perpetual Growth is:

Terminal Value = Unlevered FCF in the terminal (exit) / (discount rate – long term Growth Rate)

The Terminal Value that we produce using this formula includes the value of all future cash flows, even when they are not considered in a particular forecast period. This enables us to capture certain values that can be difficult to predict.

Which Perpetual Growth Rate Should You Choose?

When working out your perpetual growth rate, note that this rate is almost always equivalent to the inflation rate, and less than the economy’s growth rate. In acknowledging this, we must also acknowledge that this type of business valuation does have its limitations. As it is difficult to predict an accurate growth rate, we always choose the more cautious approach.

How Can I Increase the Valuation of My Business?

So, you’re numbers have come out pretty rubbish. Perhaps you’ve been a little over cautious. There are two things you can do to shake up your predictions.

  1. Switch up the cash flow; more specifically, look at the way your company currently generates cash flow; is there any way that you can improve that ability? Can you perhaps increase revenues or reduce some of your expenses?
  2. Reduce the company’s risk; any reduction of risk lowers the business’s cost of capital and will therefore increase value.

If you make these changes and still don’t see a significant improvement in the numbers then it may not be enhancing value.

Is there a particular valuation model you’d like us to use? Contact us using the chat bot on your screen and let us know!

What Is Operating Profit?

What Is Operating Profit?

Defining Operating Profit (aka EBITDA) 💰

EBITDA stands for Earnings Before Interest Taxation Depreciation & Appreciation.

This can also be calculated by:

Revenue – (Direct + Indirect Costs) = EBITDA

In other words we are asking “what did you sell” minus “how much it cost you to supply your goods/services” plus how much it costs to run your business”.

This shows how profitable your operations are including all your core expenses. As profitability is a key determinant of long-term survival, this is an important KPI. The operating profit margin is normally the first port of call for any investor as it shows how well the business is covering your costs. If you can reduce your costs while keeping your revenue constant, the margin will increase.

Read more about direct costs here and read more about profit margins here.

What Does EBITDA Really Mean?

Operating profit is also known as EBITDA. This is where the profit and loss (P&L) makes the necessary accounting adjustments (and some “paper” i.e. not actual cash adjustments) to get to the Net Profit (the bottom of the funnel, often referred to as the bottom line).

Let’s look at each word that makes up “EBITDA” one at a time:

  • Earnings
  • Before
  • Interest: when you take a loan out, you normally pay interest at an agreed % rate
  • Taxation: if you turn a profit you will pay corporation and other taxes. The rates are dependent on where you are
  • Depreciation: when you buy a physical asset (e.g. a car), its value goes down as it gets used and the reduction in value is recorded
  • Amortisation: when you invest in a non-physical asset (e.g. patent) it will lose it’s value over time and the reduction in value is recorded

And now let’s work down to Net Profit:

From EBITDA, we take off Depreciation and Amortisation which gives us:

EBIT (Earnings Before Interest and Taxation)

Next we remove the Interest to get:

EBT (Earning before—you’ve guessed it!—Taxation)

Once we remove the taxation, we get to:

Net Profit and that’s it: the Bottom Line.

What Does This Mean In Practical Terms?

Now that you’ve seen EBITDA explained, how does it apply to your business? 

Lucky for you, Numberslides will take you through everything you need to build your revenue and cost forecast and build your very own profit and loss (P&L) statement. With this you can make all sorts of assessments of your business and by comparing P&Ls to previous ones, you can begin to set targets and spot opportunities and challenges. To determine how healthy your P&L is, you should benchmark yourself against the competitors in your market. Numberslides does this for you by comparing your P&L to thousands of companies in similar sectors. It’s important that you understand Operating Profit and EBITDA, but it’s even more important that you apply it at the right time, to truly understand your numbers.

What Is Gross Profit?

What Is Gross Profit?

Ever heard the phrase ‘gross profit’ or ‘the % gross profit margin’ used and not been too sure what it all means? Here we run through the definitions of Revenue, Direct Costs and finally Gross Profit to help explain it all.

What Is Revenue? 💵

Revenue is also known as Turnover, Income, Sales or the Top Line.

This is all the sales that you made in the defined period (could be weekly, monthly, or annually, for example). It doesn’t matter whether this revenue comes from selling products, subscriptions, or services, the sales for that defined time period are recorded as revenue.

What Are Direct Costs? 💸

Direct costs are also known as Cost of Goods Sold (COGs), variable costs, and gross costs.

The costs associated with generating the revenue in the time period. These costs are often thought of as concrete but in fact they often fluctuate with revenue. For example, costs could include:

  • the cost of making or buying in a product
  • the cost of direct labour involved in delivering a service
  • costs that will generally fluctuate with revenue, for example: payment processing

What Is Gross Profit? 📈

This is an indicator of your business’s ability (by your revenue) to cover the costs of providing your customers with your goods or services. Another way to look at this, at a unit level, is the margin between your price and direct costs.

The higher the Gross Profit Margin the more efficient the production process of the business. If a company can increase the price for goods or services without having to increase the direct costs, the gross margin will increase.

How to Work Out the Gross Profit Margin 🧮

You can work out your gross profit by using the following simple formula:

Revenue – Direct Costs = Gross Profit

So, if your revenue during 30 days is £60,000 and your costs for those same 30 days is £42,000, your gross profit will be:

£60,000 – £42,000 = £18,000

To work out the gross profit margin for that same period, you can use a financial ratio:

(Gross Profit / Revenue) x 100 = The % Gross Profit Margin

(£18,000 / £60,000) x 100 = 30%

You can find benchmark average profit margins for different sectors online and these will vary over the years and between sector. For example in 2018, women’s clothing had an average gross margin of 46.5%, whereas supermarkets and grocery stores had an average gross margin of 28.8%.

Read more

If you’d like to read more about this, check out the following articles:

 

What Makes up a Profit and Loss Account?

What Makes up a Profit and Loss Account?

As always, we share accounting knowledge in a practical way and not focussing on academic accounting theories. If you’re looking for more academic perspectives on these topics, we suggest checking out far more detailed resources on the web 🌐.

What Is a Profit and Loss Account?

The Profit and Loss account (P&L), or the Income Statement to our friends from across the pond, is one of three core financial statements that provide vital information on the health and potential of a business. The P&L indicates the profit (or loss) from business transactions over a time period.

They summarise the financial activity reading from the top-down like a funnel, we start with revenue at the top and the profit at the bottom. There are three sections of a P&L:

  1. revenues (income);
  2. expenditures (both indirect and indirect costs—more is coming on that later);
  3. and the difference between the two

The difference between revenues and expenditures gives you your company profit, and a key measure of the value that is created to the Shareholders.

Read more: