A-1: Explain the purpose of financial projections for startups.
Financial projections enable the entrepreneur to frame the opportunity from the perspective of the target market(s), understand the resources required to capitalize on the opportunity, and know how to allocate those resources under varying market conditions.
A-2: Describe financial statements as an essential part of financial projections.
The three essential financial statements are the income statement, the balance sheet, and the cash flow statement. The income statement measures performance on a monthly or annual basis. The balance sheet shows what the company owns and what it owes at a given point in time. The cash flow statement assesses the inflows and outflows of money over a period of time.
A-3: Clarify the relationship between the three financial statements.
While each financial statement provides a different view of the company, they are all needed to provide a complete picture. For example, a company’s pricing and credit policies will have a direct impact on revenue, an income statement item; and on accounts receivable, a balance sheet item.
A-4: Describe the journey of cash through the cash conversion cycle.
The cash conversion cycle is the number of days a company's cash is tied up in the production and sales process. The number of days in the cycle is calculated by adding the Days Sales Outstanding (DSO) to Days Of Inventory (DOI) then subtracting Days Payable Outstanding (DPO).
A-5: Discuss how to build a pro forma financial statement.
The pro forma financial statement should include at least three scenarios of your financial forecast, each containing all three types of financial statements. Each scenario should manipulate revenue and cost drivers to show how the business can deal with what may go right and what may go wrong. It should show a best case, a worst case, and a likely case.
A-6: Explain how to apply assumptions when building pro forma statements.
Assumptions include operating policies, which determine the speed of the cash conversion cycle, as well as taxes, interest, inflation, and the time it will take to ramp up the business. When assumptions are applied, integrated financial statements can be created and sensitivity analysis and reasonableness test applied.