I am writing a daily blog series on how to start a business. If you’d like to review previous posts on this series, you can find them here:
So You Want to Start a Business
Revenues, Direct Costs and Expenses… Oh My!
How Can You Earn More Revenue without Spending More Time
Direct Costs and Gross Margin
Keep Expenses LOW!
Profit is NOT an Ugly Word
The past six posts have covered elements of your financial forecast. I want to talk about how you put all of these elements together into a 10-Year financial forecast. If you are interested in adding your name to our email list, you can also receive the Acuity Financial Forecasting Tool that is references in this post, so that you can plug in your own numbers for your own company’s financial forecast. For this post we will do a financial forecast for a daycare business that starts out in a home and grows to 36 kids over a period of 10-years.
Revenue – The Top Line
We talked about hourly rates and non-labor revenue in two previous posts. That is where you start your financial forecast. You have to estimate how many customers you will have and how much they will pay you. For now, don’t worry about where you will get these customers. We will cover this base in a future post.
For the daycare scenario, I have assumed that I will get two infants, two toddlers and two young children in the first year of operation. Based on recommended daycare providers to children and other daycare prices, I want to charge $1,700 per month for infants, $1,500 per month for toddlers, and $1,300 per month for young children.
I have estimated the direct hours required for each day-care worker based on recommended day-care guidelines for each type of child. Based on child-care guidelines, I have estimated that you will need: 57.2 hours per month for an infant; 43.3 hours per month for a toddler; and 34.7 hours per month for a kid. This amounts to 3 infants per worker, 4 toddlers per worker and 5 kids per worker. The example for the infant input for the Acuity Financial Forecast Tool is shown below.
Desired Owner Work Hours
On our way to estimating direct costs, it is important to establish how many hours you want to work in your new business versus how many hours you want your employees to work. This is one of the most overlooked aspects of owning a new business. A new business owner feels like they can make more profit by working all of the hours themselves and then find themselves bound to their new business, overworked and a pain to be around at home. Therefore, in the Acuity Financial Forecast Tool, I have allowed for the business owner to input how many hours they would like to work so that they can determine how many employees they need to hire in order to maintain their sanity. In our example, I have assumed that the owner will work a traditional 40-hour work week; and have four weeks of vacation per year.
Direct Cost Staff Work Efficiency
In our daycare example, I have used a work efficiency rate of 100%. This means that 100% of all hours worked will directly be spent earning income for the daycare business. Many other types of businesses this may need different efficiency rates. Especially, for professionals that have billable hours to clients. However, in the case of the daycare, workers will spend an entire day caring for children. There are no breaks or other activities happening.
Staff Positions and Salary
The next item that you will need to know is what type of staff you will need to run your business and how much you will pay each staff position. You can use hourly, daily, weekly, monthly or yearly compensation rates with the Acuity Financial Forecast Tool. In the case of our daycare example, I have estimated that a Daycare Worker will make $14/hour and the administrator will be paid $11/hour. This amount must include any employer-paid payroll taxes and any benefits provided to your staff. Do not consider the business owner’s salary in this financial forecast.
After you have included each staff position and compensation rate, you then assign each resource to fill positions in either direct cost categories or indirect cost categories. An excerpt from the Acuity Financial Forecast Tool is shown below.
We discussed expenses in a previous post as fixed costs. These costs often do not increase with your client work load, but they can.
I have estimated the annual expenses I predict for the day care center. In our daycare example, I want to start out as a home daycare provider and then lease a building once my daycare service grows above 10-children. So, although, I have included the building lease as an expense, I only apply this expense once the daycare service expands. You can also see in our example that I have included $15,000 in expenses that will have to be spent before I start my daycare business. One of these expenses is professional development to educate myself on the daycare business; and the other is to advertise my business and gain my first clients. It is important to try to be as thorough as possible when estimating expenses for your company. I would suggest asking other business leaders what their expenses were in certain categories. Some business leaders may be protective of this information because, after all, you are their competition. However, if you ask people in a different geographic area that will never compete with you, you will find they are often quite forthcoming with this information.
We are now reading to look at the 10-year picture of your business. If you are using the Acuity Financial Forecast Tool, this is located on the Hours & Staffing tab.
When I first start the daycare business, I am operating out of my home and choose to employ a few daycare workers for only part of the year. Based on my desired work load, it appears that I can meet my desired goal of working 5-days per week and taking 20-days of vacation. The Acuity Financial Forecast tool shows you the non work hours you will have throughout the year (Under Hours in Green) on your desired work hours that you input. You will notice that as the company grows, I have added staff to our 10-year forecast model. By the time you get to year 10, you will have 7 daycare workers, a daycare manager, and an administrator. You may also note that in year 10, you have 2,911 hours available. In other words, you are not working in the business at all because you have trained a manager to run the entire daycare operation.
Now that we have completed all of the tasks above, we can now look at our financial forecast.
Revenue & Direct Costs
The Acuity Financial Forecast Tool shows the revenue and direct cost for each type of product for each year of your financial forecast. You will be able to see the profitability of each product and adjust your pricing if you feel like you are either making too much gross margin or not enough gross margin.
One of the first things you will need to look at in your financial forecast is the Gross Margin. This is the amount of money that you are charging your client above your direct costs. Each industry has a traditional gross margin. Some are higher, and some lower. As a new business owner, the gross margin percentage should be close to 50%. Especially, since you are not considering your own salary as a direct cost. If the Gross Margin rate is too low, you can either increase your revenue per client; or you can reduce the salary of your direct-cost staff.
After you pay your expenses, you will have a Net Profit in your annual cash flow tab. It is normal to show negative profit prior to having clients (Year 0). However, you ought to show a profit in every year in your financial forecast. As the business owner, this net profit is your personal income. If you make more income than you need or want, you can reinvest this income back into your company, give discounts to your clients, or do whatever you want with it. If your income is negative, you will need to make adjustments to other inputs until you show a profit. The profit should be at least what you feel you could earn as an employee to start; and it should be quite robust at the end of 10-years. After all, it is risky to start a business; and you need this cash flow to cover your risks.
I’d love to tell you that you get to keep every penny of your profit, but it doesn’t work that way. The first commitment of your profit will be to purchase needed assets for your company. In the case of the daycare business, I have assumed that you will purchase a few computers each year and buy additional furniture for your daycare children as you grow your business.
So, the good news and bad news. The Good News? Even after you purchase assets, you will most likely have cash left over. If you don’t, you need to either increase your prices or reduce your expenses. The Bad News? It is every civic-minded American’s duty to give money back to our government. And so, you will need to give some of your cash to the government in the form of taxes each year. Since most small companies can fully depreciate small asset purchases in a single year, the Acuity Financial Forecasting Tool assumes that asset purchases are the same as expenses for cash flow and tax purposes.
After taxes have been paid, you can see that after growing your business for 10-years, you have an amazing source of recurring revenue of over $160,00 per year; and have made $750,00 dollars in this same period. What is best is that you don’t need to show up to work any longer, now that you have created your cash-cow.
If you’d like to complete a financial forecast for your own company, I’d encourage you to sign up to get updates from Acuity.Consulting; and get your free Acuity Financial Forecasting Tool. You will see the email subscription link on our home page.
On the next blog post, we will review the financial forecast and explain why we spent so much time talking about numbers as you started on your path to becoming an entrepreneur.