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Easy Pro Forma Income Statement Tutorial: New vs. Existing Businesses - YouTube
Channel: get Poindexter
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If you're looking to learn about
pro forma income statements,
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then you've come to the right place.
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We're about to cover exactly what
a pro forma income statement is,
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and how to calculate one
for your own situation,
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which I know is extremely exciting.
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My name is Brandon.
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I'm the CEO of Poindexter,
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which is a software that
has helped thousands of
businesses create their own pro
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forma's.
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So we have a little bit of
experience in this space,
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but,
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today we're going to focus more so on
the distinction between creating a pro
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forma for existing businesses
versus new businesses,
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because the approach for
each is much different,
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and I don't see a lot of videos or
tutorials talking about those differences.
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So,
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we're going to cover them here today.
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We'll start by talking about
exactly what a pro forma is.
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So a pro forma income statement is
simply a future version of an income
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statement.
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And just as a refresher,
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so,
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our income statement is just a summary
of our financial performance over some
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period of time.
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And so a future version of that is how
we want our business to perform in the
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future.
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So,
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it kind of represents our financial goals,
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if you will,
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or what we want our business to look
like at some point in the future.
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And when that point in the future is can
be determined by you or your particular
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needs.
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So there's not really a hard and fast
rule on that it's just simply the fact
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that it is a future version
of the income statement.
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And how we calculate the income statement
is going to depend upon two different
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situations,
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or two different considerations.
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And as we already mentioned,
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it's going to matter whether you're
doing this for an established business
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versus a new business and most videos
focused on established businesses.
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So we'll cover those first,
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and then we'll move on to how
it works for new ventures,
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which is slightly different.
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So the benefit of existing businesses
is that you already have financial
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performance,
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financial data being
generated by the company.
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And so you should already
have an income statement.
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And if you don't have an income statement,
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that is a huge problem.
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I would stop this video and go get
one of those together first because,
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it's going to be,
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that's going to be a bigger
problem than creating a pro forma.
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So,
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with that benefit of already
having the data in hand,
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all we have to really do is decide
when in the future are we looking to
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establish a goal or an outcome for this
particular forecast or this particular
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pro forma.
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So for now we'll just choose six
months from where we are today.
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And then typically the way this works for
existing businesses is pretty straight
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forward.
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So you focused on revenue and what we do
is we establish some benchmark or some
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goal that we'd like to
achieve with revenue.
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So an increase of 20% let's say,
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and all we'd have to do is say
that within that six months,
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we want to achieve a 20% increase.
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And so that 20% increase times,
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our current revenue would
equal $1,200 in this scenario.
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So $1,000 plus 20% is $1,200.
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So,
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pretty straight forward.
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That's generally how we reach our
revenue forecast for the pro forma.
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But the thing is about this is that it
doesn't really tell us what the hell this
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means,
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right?
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So we have an increase of 20% and
we want to achieve it in six months.
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Great.
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That's,
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good that we have a timeline and a goal,
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but you know,
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what does that tell us about what we
need to do today or each day to achieve
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this goal?
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And so I like to actually convert the,
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revenue forecast into something
that is tangible or more tangible.
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And so,
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if we say for instance,
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that we're selling each product here
in this fictitious scenario for $10.
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And so that would equate to 120 sales.
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And so 120 sales is actually a lot
easier to get our heads around as far as,
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okay,
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you know,
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how many customers need
to come through the door,
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you know,
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and then we can start backing into how
many new leads do we need to generate
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from our marketing channels?
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So it gives us a lot more
actionable insight into what
we need to do to actually
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realize that increase of 20%,
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which is simply just 20 more customers
over the course of that six months.
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Now we can start to focus on the costs.
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And,
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typically the way this works for most
tutorials are just going to tell you to
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do,
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one thing which is creating a,
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what is called a common size format.
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So converting the costs into
percentages based on revenue.
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So if we look at revenue itself,
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right,
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this top line revenue,
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that is 100% of the common
size income statement.
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So when we look at costs,
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it is simply a factor of dividing the
costs by revenue to arrive at some
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percentage.
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So we can convert costs of goods sold
into a percentage based on revenue.
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And then that way everything is
translated into terms of revenue.
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And typically what you would want to do
if you have an existing business is look
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at this,
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common size format over a certain number
of months or certain number of periods
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to get an average,
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if you will.
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And then what you can do is you can take
this average and you can multiply the
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new revenue here by this common size
amount and you would arrive at some number
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based on the growth in sales.
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So it's treating,
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it's almost treating all of these costs
as if they grow in line with sales when
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you do it this way,
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which I don't really like that much.
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And I'm not sure why it's recommended
very often that you do that,
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because typically what you want to do
is you'd want to consider which of these
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costs are going to be fixed and
which are going to be variable.
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And fixed costs tend to stay pretty flat
over certain periods of time or within
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certain windows of time.
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So things like,
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you know,
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your rent or your employee salaries,
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like things that take a while to actually
increase because you have to move to a
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new building or you have
to onboard a new employee,
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which takes time.
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So the fixed costs are
going to stay pretty flat,
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but variable costs are really the
ones that are going to grow along with
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revenue.
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So as you sell each new unit of product,
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you're going to need,
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you know,
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maybe some material costs that go
into that or you're going to need some
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shipping that takes place because
you ship each unit to a customer.
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You know,
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things that literally are directly related
to the delivering and production of
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the goods or services that
you're providing to customers.
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And a lot of the times those variable
costs sit very heavily up in the cost of
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good sold section,
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but they're all are also some variable
costs that take place in the SG&A or,
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or sales,
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general and administrative
section as well.
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So it's really,
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if you want to get a detailed perspective
on what these costs are going to be in
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the future,
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I would actually go out and identify
which individual line items are fixed
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versus variable and
forecast them appropriately.
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So keep the fixed cost the same.
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If you don't expect to do things like
move into a new building or hire new
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employees,
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keep those costs fixed,
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but change the variable costs and that
will give you a better sense of how
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things are going to react within
at least a short timeframe.
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If we're looking at a few years out,
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that might be a different
story because generally,
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you know,
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we can't go from $1,200 in
sales to $100,000 in sales
without almost all of our
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costs growing.
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So just consider the difference
between fixed and variable.
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And I think that you're going to get
a much more detailed sense of how your
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income statement is going
to react in the future.
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So from there we can calculate all
of our profit margins and then we,
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that's all we have.
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So that's the pro forma income statement
for an existing business and the
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general approach that you should take.
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If you wanted to do this
on a month by month basis,
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you would simply just approach
it the same exact way.
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So,
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you know,
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from six months here we could forecast
out another 20% for the next six months
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and arrive at another,
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forecast for 12 months out from now.
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So just keep that same process going and
that's essentially how you approach it.
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So now we're going to talk about
creating a pro forma for a new business,
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which is slightly different because
there are a lot more unknowns with new
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businesses.
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We don't have that historical data that
we can use to forecast our pro forma
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income statement,
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which is a problem,
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because where do we start?
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Right?
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We don't have the information,
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the same exact process that we use for
existing businesses we cannot use here.
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So what I recommend we do is approach
things from a bottoms up perspective.
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This is what most investors
are going to want to see,
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right?
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What are the actual activities that
you're going to be doing that are driving
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revenue directly but not focusing on a
revenue number and then breaking down how
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many units we need to sell or customers
we need to get as a result of revenue.
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But instead using the revenue
driver to forecast for us,
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or give us some insight into what revenue
will look like at some point in the
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future,
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because we have a lot more control over
what the revenue drivers are than we do
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what the actual dollar
amount of revenue is.
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And so once we get an idea of whether
we want to forecast revenue based on,
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you know,
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our marketing activities or
maybe cold calling for instance,
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we can start to look at what the
transaction actually looks like.
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So we have our revenue drivers,
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which we have much more control over
than the dollar amount of revenue.
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And then we have the,
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essentially the monetization model that
we're looking at and how we extract
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value from customers to provide them the
value that we give them in the form of
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goods or services.
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Right.
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So how does that transaction looks?
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So how does it take place?
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For instance,
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is it a simple transaction where customers
give you money and they get goods or
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services in return?
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Or is it something like
a subscription model?
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When does it take place?
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So just because we have a number of
customers that we expect from marketing
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doesn't mean we actually monetize
those customers right away.
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So based on the interaction,
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the first interaction that we
have with customers as a business,
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when in time do we monetize them
and then how much of course,
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so the dollar amount
that they actually pay.
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And once we get a sense of when all
these factors start to take place and how
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they take place,
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then we can get a sense of
what our actual revenue is.
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And just to make this a
little more straight forward,
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we'll actually do a quick example here.
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And so we will say that we will forecast
new customers for the first month here
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of 100 they will pay an
average price of again of $10,
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and then based on those two factors,
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we simply multiply them together
and we get revenue of $1,000.
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So pretty straight forward.
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And then once we actually want to
go about forecasting future months,
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we again,
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we focus on the revenue driver because
that's the thing that we have control
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over,
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right?
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So we want to increase,
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if we're going to increase anything,
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it's going to be based on revenue driver,
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which is the exact opposite way
that we did for existing businesses.
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So we're going to focus on the things
we control add a certain percentage of
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growth and then arrive at
revenue based on that growth.
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So pretty straight forward,
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much different,
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and I know then we covered in
the existing business scenario,
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but that is generally how most investors
would suggest that you approach this.
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And so you can take those revenue numbers,
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input them in the revenue line item
in your pro forma income statement,
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and then we can start to take
a look at what the costs are.
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And so this is going to be very different
depending upon your business model,
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your industry,
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you know,
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the capital expense requirements.
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It really is going to have an almost
unlimited number of factors that determine
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how you fill in the costs.
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Because again,
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we can't just simply look at historical
common size formats and convert our
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costs into a percentage of revenue
because there is no historical costs.
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So we actually start,
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need to start googling,
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for instance,
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what are the startup
costs for this business,
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or start up cost budget.
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And I actually found a pretty helpful
resource here by Fundera that lists out
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the common small business startup costs.
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So I will include that in
link in the description here.
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But generally you're going to want to
do a lot of googling for your particular
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industry or your particular business.
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If you can get more specific,
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the better to get an understanding of
what your costs are going to look like.
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So then you're going to want
to start grouping these costs,
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once you have a list of them,
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into two different categories.
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And the first is the cost of goods sold.
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So these are the direct
costs of producing revenue.
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Okay?
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So these are the things that without these
costs we would not be able to provide
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our goods or services.
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And the second is the cost of
running the business or the sales,
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general administrative,
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also known as operating expenses,
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things that support the general
running of the business.
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So group,
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once you have a list of all your costs
and group them into those two categories
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and then that's going to give you a
better sense of what the various profit
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margins are,
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going forward.
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And so once we get those costs
grouped into two different areas,
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then we can start to look at very
similarly to what we did with the existing
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businesses,
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what the variable costs
are versus fixed costs.
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Because your variable costs are going
to be a lot more important going forward
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or in the future.
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Your fixed costs are going to matter more
in the beginning because it's going to
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comprise a higher percentage
of your overall costs,
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but your variable costs are going to
affect the scalability of your business
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model.
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So variable costs are things like sales
commissions or materials for instance,
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and your fixed costs might be something,
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again,
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like rent.
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But when we look at it in the beginning,
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in the early days of business
here at let's say a hundred units,
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your variable costs are going to be very
small percentage of your actual costs
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because you might not be
doing that much business yet.
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But your fixed costs are going
to stay the same no matter what.
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You still need to pay salaries.
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You still need to pay rent,
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right?
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But as you grow the
business within a certain,
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at least window of the
size of your business,
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at least you are going to increase the
amount of business you're doing in terms
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of revenue or the number of units
you're selling in this example.
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And your variable costs are going to
become a higher and higher percentage of
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your overall costs while your fixed costs
are going to diminish as far as their
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overall percentage.
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So as you grow,
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your variable costs become more important.
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They actually affect the overall
scalability of your business.
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So in the early stages especially,
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you're going to want to identify what
those variable costs are and forecast
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them,
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according to the growth in revenue.
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And you're going to want to be very
conservative about how that happens.
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Because again,
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the bigger,
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the small percentages,
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small percentage changes in variable
costs will have a much larger and larger
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impact as you grow the business.
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So they might not seem like
a lot in the beginning,
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but when you actually scale the business,
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they're going to have a drastic impact
and could really affect your overall
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profitability and assumptions underlying
whether the business is even viable in
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the first place.
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So now all we need to do is out our
income statement as we group our cost
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together into cost of goods sold versus
operating expenses and fill them out
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according to how they grow over time.
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And then we can fill in our profitability
and we have our pro forma income
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statement.
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So it's a lot more research focused here.
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But generally this approach is really the
only way to go about it because again,
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you don't have any costs yet.
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So this is the best way we can do that,
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is rely on what others
have done in our industry.
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So now all we need to do to
actually forecast this out
further is understand how
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to use sophisticated financial models
or how to build sophisticated financial
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models,
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which is very time consuming process.
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But generally most
forecasts or pro forma's,
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are built within,
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something like Microsoft Excel.
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But if you are doing
this for a new business,
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you can also try our software Poindexter,
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which will do what we've just done in a
fraction of the time that it would take
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in spreadsheets and certainly
reduce your stress levels,
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I think overall,
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when starting the business.
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So thank you.
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I hope you found this helpful,
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and if you'd like to leave some
comments in the comment section,
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I would be happy to respond.
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