It is easy to imagine that in the work of a venture capital manager, one of the most common routines is to analyze financial projections for startups of companies that are candidates for investment. However, what is not so obvious is the most common mistake we find in these projections: the investment needs calculation.
Any investor of any category and investment thesis analyzes the company as a whole, not part of it.
Below I describe a simple step-by-step, so you don’t make mistakes when doing this calculation.
Step 1: Make a complete financial projection
Don’t forget to include everything, really everything, in your projection: revenue, taxes, direct and indirect costs, fixed and variable operating expenses, financial expenses, fees related to various bureaucracies, general expenses, investments, salesperson and partner commissions, fees means of payment, provisions for payment of bonuses, etc.
Analyze the business model as a whole and get input from multiple people. Then, do the exercise for five years. I know this is futurology, but it is part of our assessment to understand where the entrepreneur thinks the business can go.
One last tip: try to balance aggression and reality, that is, think big, but don’t take steps bigger than your legs. To err too high or too low, in these two aspects, is very bad.
Step 2: Check the size of the usable market
No company can be bigger than the market it is entering. But, at the same time, no investor will be interested in investing in a company that, after five years, intends to have a very irrelevant share of the market. That’s why it’s always good to compare the number of customers you project with the number of companies or people in your target market.
Step 3: Analyze the maturity level of your team
Yes, that’s right. The perceived maturity of the team counts a lot when an investor believes in the execution capacity of the people involved in projecting happen. Who do you think can raise more funds in the same condition: two 23-year-old recent graduates or two executives with extensive experience in the industry they are undertaking?
Two things can help increase the team’s perception of maturity: previous professional experiences and business model validations. These two factors help when attracting an investor, so make sure you have that mapped out before you start raising investment. This will ensure that you capture as many resources as possible for your entrepreneur profile.
Step 4: Calculate the company’s cash flow
Once you’ve made the complete financial projection, checked the consistency of the numbers according to your target market, and ensured that the execution is plausible considering your team, it’s time to calculate the cash flow. Again, there’s not much mystery. You add all the inputs (income) and subtract the outputs (costs, expenses, taxes, and investments). In the end, the profile of this indicator should behave more or less like the graph below, at the beginning negative, that is, you spend more than you earn, and then positive.
Step 5: Calculate the accumulated cash flow
Then simply sum the monthly cash flows to get the accumulated cash flow, which should behave like the curve below. The graph line goes down until the company starts to receive more than it spends, the well-known break-even point, then it goes up until it crosses the zero line, where what we call payback occurs, that is, the company has recovered all the loss up to that point time.
For more information you should visit business plan consultants.
Step 6: Add the working capital requirement
Perhaps the second most common mistake in our projections forgets working capital. Some business models are more working capital intensive than others – when the time for receiving customers is much longer than the time for paying suppliers. But in the simplest case of software-as-a-service companies, we generally recommend adding at least a month’s worth of expenses. In addition to the difference between inputs and outputs, the company needs a cash reserve for emergencies and projection errors. The new curve would look like this:
Step 7: Identify the most negative point of this curve
The last step is to identify the most negative value of the accumulated cash flow, considering working capital. Then, in the same period that the break-even point occurs, the investment need will correspond to the worst situation in the graph.
The amount of your investment round must match this amount. Not too high, not too low. It is worth mentioning that, like any projection, this value must also be compatible with the maturity of the team and the company. Always look for consistency.