FF – the Financial Forecast is a key element in the Offer Memo of which many entrepreneurs relegate this important component to the accounting team who may not have any investment or capital market experience and exposure. It is not about putting bookkeeping figures onto spreadsheets to show the investors.

The financial forecast must show clearly what are the revenue streams and where are coming from – depicted by product lines and target segments. In short, what is the ticket size per customer per purchase and how frequent are the purchases. The sum of all these give you the total revenue. The forecast needs to show the business growth in terms of the increase in the number of customers and the dollar /quantity increase in their total purchase. Investors feel more confident and happier to see the business with a small start and growing steadily over the months, quarters, years.

Investors are very sensitive to the gross margins that their investee companies make. Some firms “buy” customer-base and suffer in subsidising the customers, especially those who adopt the free-mium strategy. They are good at acquiring the customers at a loss and most times forget or could not up-sell the premiums to recover the loss and make a decent gross margin.

Of course, we have many investors who are willing to support loss-making companies with their money so as to win market-share and jack up the euphoria and share price. These investors are merely speculators that will “short” the shares and sell them at the jack-up high price which will inevitably drive down the share price. These speculators will then buy the cheap stocks to return the stocks that they sold at a high price. The issuers are always left there to clean up the mess while the speculators made a bundle. The advice is do not over-value the company and always have consistent even small growth to nudge long-term investors to let the firm grow. 

The cash balance you have and the fixed operating expenses “opex” will determine how long the firm’s runway. Let say the firm has $120,000 cash and the monthly burn rate is $10,000, then the firm is able to continue, even without earnings, for another 12 months ($120k cash/$10k opex). Investors can become panicky if a firm turns insolvent when their investments may just evaporate if the firm cannot continue as a going concern.

The cost-drivers are staff salaries, rental and marketing. Many promising firms failed because they lost control on these cost-drivers and they had to retrench and shut down offices and cut marketing and promotion expenses. Even the “Magnificent Seven” like Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla had to re-look at their opex and restructure for profitability and longer runways.

Many start-ups and even banks are deploying the outsourcing and contract for service strategy to engage staffers. These “contract workers” provide their home offices, computers, telecommunications and personal insurance and health programs thus saving the companies they work for significant costs in benefits, set-up and office rental. In addition, the contract-workers deploy their people network (through social media) to promote the products and services of the companies they work for.

For those companies that need to have properties, plants and equipment “PPE” for their business, they have to provide for depreciation, interest, amortisation and these items can take away the bulk of the profits.

For instance, the PPE for a biofuel venture can rig up capex (capital expenditure) of $100 million. With accelerated depreciation, the venture had to write down 20% of its capex and that is $20 million. Say the interest for the capex is 5%, the venture had to pay in cash each year $5 million. Assuming the maintenance and upkeep is 5% of capex, another $5 million is incurred. The total DIA (depreciation, interest, amortisation) is $30 million. Let’s assume the venture is well-managed and achieves $30 million profits and with the write down of $30 million DIA, it is now not making any money. 

With an asset-light strategy, the biofuel venture managed to “sell” the entire plant to a business-trust and then lease it back from them at 10% of the capex – $10 million a year. The profit statement now is $30m less $10m PPE lease = $20m profit. Now that the PPE is sold, the venture can recycle the capital from the sale of the PPE and use only $10m to pursue the $20m profit – a return on investment of 2x ($20m profit/$10m PPE lease). The biofuel business enjoys a price earning multiplier of 20x on the major stock exchange and this venture now is worth $400 million ($20m profit x 20 PER). Please observe the difference in the market capitalization with such tuning.

Many ventures that need large scale PPE and people to grow and expand have to consider the Indo-Pacific as the market and factory because of the region’s fastest growing economies, cost-effective production costs, tariffs and quota exemptions, tax waivers and higher productivity than most of the developed economies. Just on tax alone, the advantage is enticing for the investor. The $20m profit after a 30% corporate income tax has now been reduced to $14m for the venture and $280m market cap for the shareholders. In simple terms, your $10 share is now $7.

The financial forecast must be able to show how the firm is maximising the profits and have the cash to pay handsome dividends. If the company is fighting with the shareholders for the profit-cash because the company needs the cash for expansion or capex. If we say we split equally to cater to the needs of the company and the shareholders by allocating half of the earnings as shareholders’ dividends and the other half to fuel the company’s growth engine. This shows the plan to prosper all.   

The financial forecast must show the end-game of the market capitalization growth, profit-cash for shareholders’ dividends, how the revenue is tapped, how the margins are enhanced, how to transfer the opex and capex to others, the impact on the return on investment and how capital can be recycled.