Financial Preparation for New
Ventures - Budgeting
A budget can be no better than the
assumptions used to create it.
These assumptions should be clearly stated
in the Financial section of the feasibility
Place all assumptions in the form of footnotes in
the Input section of the Financial section.
That is where your readers will go looking for
Preparing the Financial section of a
Feasibility Plan begins by building sound
financial assumptions and a realistic budget.
This will take some thought.
Such preparation includes estimating sales,
cost of goods sold (COGS), gross margin,
expenses, and pre-tax profit.
A service firm does not have COGS. It has COS.
You will not be preparing the more
traditional financial statements that
appear in a formal business plan, such
Essentially, the Financial section of a
Feasibility plan indicates:
A. The sales level necessary to generate
positive cash flow.
B. The sales level sufficient for a quick
payout usually within 3 to 4 years.
C. The Economic Profile.
Developing the Financial section is a
way to objectively assess whether your
business idea is “doable” and has the
potential to earn an adequate profit on
In addition, the Financial section
includes estimating start-up costs
(Month 0) and sufficient cash to allow
the firm to operate for two or three
years – until breakeven.
Chart of accounts (Next slide.)
A chart of accounts lists any expenses that
will be incurred during everyday business
transactions, such as rent, salaries, utilities,
insurance, and so forth.
During your preparation, think of all the major
expenses you can. But you can always add
expenses to the chart later.
A chart of accounts does not include any
costs of producing a product or service.
Budgeting - Chart of Accounts
Advertising Office supplies
Bad debts & collection Rent
Dues & subscriptions Withholding taxes
Insurance Taxes general
Legal & accounting Telephone
To begin building a chart of accounts,
you should contact an accounting firm.
Such firms usually have examples and
free pamphlets which are available
covering the different expenses
incurred by similar businesses in your
Better than that idea, contact your
local Small Business Administration
(SBA) office for an appointment with a
SCORE representative in your
An assumption is an estimate of how
much you will spend for each cost
incurred in operating your new firm.
Your assumptions must explain to your
reader how you developed your
In other words, “Where did you get your
data?” This gives your plan additional
For example, if your venture requires renting
or leasing a location, call a local real estate
agent for the approximate costs of office or
retail space similar to the one you plan to
Footnote this by saying, “Information supplied by
Dave Talley, Foothills Reality Company by
phone interview on March 12, 2006.”
Next, contact an insurance agent for
an estimate of insurance costs that
would cover fire, liability, theft, and the
Footnote this information the same way.
Then contact your state's department
of revenue to learn about any business
licenses that may be required.
Also inquire about the applicable state
and local taxes you will need to include
in your budget.
After carefully researching every
conceivable expense, you are now
ready to write your assumption
Follow the example on the next slide:
1. Rent: $15/ sq. ft. per year + net (property
taxes and insurance)
2. Advertising: Advertising budgeted @ $400/
month for the first year, plus an additional
$600 in September for a direct-mail
3. Telephone: Average telephone cost $200,
except for October, November, December,
and January, which will be $300 per month
You will always wonder how accurate
the projected assumptions are in your
Feasibility plan and will question
whether solid business decisions can
be made from their assumptions.
They can and they must. Do not succumb
to “paralysis of analysis.”
You should collect as much data as possible
researching your business concept so you
can answer the assumption questions from
potential investors as accurately as
Then you can take action by starting the firm
or terminating the Feasibility plans because
the assumptions indicated that your
business would or would not be successful.
Determining the cost of goods sold
Finding out how much it will cost to produce
a product is usually first determined by
talking to subcontractors, suppliers, and
others producing a similar product.
They might not be able to provide a
concrete estimate of the exact cost, but they
can provide a reasonable cost estimate.
Determining costs for services (COS)
is more difficult.
You must consider any printed
materials, specialized software
programs, packaging, etc. involved in
your service as your COS.
There may be some instances when
producing a service does not involve
any additional costs other than your
This expense will be reflected under
salary expense - not as COS.
Since producing and selling events occur at
different times during the year, the retailer
uses an estimated gross margin referred to
as "'maintain markup percentage" for
determining gross margin.
The true gross margin will not be known
until a physical count of the inventory is
Entrepreneurs in the restaurant industry
encounter some of these same variables, so
they cost out their menus by projecting the
cost of each item.
Then they can use a percentage for
"shrinkage," meaning such expenses as
spoilage, giveaways, theft, and employee
meals, to arrive at their COGS.
In the service industry you probably will not
have COGS since you will not have any
inventory and all expenditures can be
considered an expense.
Therefore, you would have a 100 % gross
On the other hand, you would calculate the
cost of preparing brochures and other
promotional expenses as part of your COS.
Any item below your sales projections on
your various financial documents can be
considered to be an expense.
However, it is better to have an account of
all the expenses encountered in the COGS
so better pricing decisions can be made.
As you can see, there are no set rules on
how to calculate expenses, COS or COGS.
Each industry has its unique methods
of estimating the COS or COGS and
projecting gross margins.
In order for you to better set your
selling prices, it is important to
understand your industry practices and
to use them as guidelines in
determining your costs.
Preparing sales projections
To prepare a sales forecast, you might use
a bottom-up method.
Project all expenses for the year, including
salaries, and estimate your COGS or COS.
This will determine the sales volume and
unit or per hour sales figure needed to break
even and make a profit.
However, you may want to use the
Project their sales volume and then
estimate COS or COGS and other
expenses needed to break even and
make a profit.
What most entrepreneurs agree on is
that the type of business will determine
which method you use.
The retail business usually uses the
bottom-up method, for example.
It is easy to get good information on
what to expect for expenses and costs
from trade associations, accountants,
and the SBA.
Manufacturing firms use the top-down
method a lot because they have to
know their potential sales since this
will determine how much space and
machinery, how many employees, and
other expenses are needed in order to
make their products.
Many times service companies will use
the top-down method.
They research how many customers
they can handle in a year and what
their services will cost.
This determines their budgeted sales.
There is not a single answer as to
which method is best, so you should
talk to other people in your industry.
Then choose the method you think will
provide the best results.
Sales projections are an estimated and
In preparing sales forecasts, develop a
range for the worst-case scenario and
the best-case scenario.
Use the worst-case scenario to
determine if your business concept
could be profitable. If not, it may be
wise to rethink the business concept.
Can you (a) make changes to appeal to
more people or (b) charge more?
If you have properly researched your
industry, your actual sales volume should
fall in between the ranges you develop.
How to project sales volume is one of the
most critical skills you can learn.
Remember, your estimated sales volume
directly affects all expenses and determines
break-even and profitability for your
Start-up costs (Month 0)
One method of determining how much
money you will need to start your
businesses is to do a mental
walkthrough of what the firm will look
Consider the following questions:
Where will the business be located?
What physical size will it be (square
What types of walls and fixtures does it
What type of equipment do you need?
Carpet? Copy machine? Shelving?
How much opening inventory (value &
volume) will the business need?
How will you pay for it (COD or credit)?
What kinds of deposits will you have to
make, such as telephone, utilities, rent,
What types of signage will you need?
Are there any applicable city codes?
What types of supplies will need, such
as cleaning, office, shipping, boxes?
What type of training is necessary
before opening for business?
What types of government licenses will
Most financial institutions recommend that
you plan on having a minimum of three
months' operating capital (cash or available
credit) on hand. Ideally, they prefer six
months' operating capital in the bank.
Operating capital is defined as funds to
meet all expenses incurred that will be direct
Warning: Do not force the results of
budgeting. This is easy to do using an
Excel spread sheet.
Let the budgeting process indicate how
much money your business concept
really needs to be launched.
The purpose of the Feasibility plan is
to determine whether your business
can be successful.
If you raise enough money to start the
venture, if your business produces the
sales and controls costs and other
expenses, and if your business
supplies desired customer benefits,
the business will be successful.
Pro forma for the Feasibility plan
The following discusses what kind of
financial information should be
presented in the price and profitability
section of a feasibility plan.
It will contain enough information to make
a reasonable decision if the business
concept is feasible.
It should include a five-year monthly
cash flow statement, including start-up
Such a document will show the
accumulated cash needs and what
time of the year the need for cash
would be greatest.
Note: A cash flow statement is about 3
1) cash inflows,
2) cash outflows, &
3) timing of the first 2 events.
You will then have to raise that amount of
money to make sure that your businesses
will be profitable.
You could also increase or decrease sales
projections and adjust variable expenses
that are related to sales to determine how
these changes would affect the cash needs
of your business concept.
“What if” scenarios.
You might have a simple business
concept that does not include
inventory (a service business) and
A cash-only business will not have
Many entrepreneurs have difficulty
determining their start-up costs.
They might underestimate business start-up
costs and market-penetration costs and
forget to budget for many hidden expenses.
Budgeting for all costs outlined in this lesson
will assist you in overcoming these pitfalls.
The end of lesson 11
Financial Preparation for
New Ventures - Budgeting.