companies are worth the “present value” of “future cash flows”
The point being that the past doesn’t matter too much when it comes to valuing companies. It’s all about what is going to happen in the future. And that requires projecting the future.
There is another big reason why projections matter. They are used for goal and expectation setting. Generally speaking goal setting is used to manage the team and expectation setting is used to manage the board, investors, and other important stakeholders.
And finally, projections matter because they tell you what your financing needs are. It is critical to know when you will need additional financing so you can start planning and executing the process well in advance of running out of cash (I like 6 months).
There are three important kinds of projections. I’ll outline each of them.
1) Projections – These are a set of numbers, both financial and operational, that you make about your business for various purposes, including raising capital. They are aspirational and are often done with a “what could be” perspective.
2) Budgets – These are a set of numbers, both financial and operational, that the management team prepares each year, usually in the fall, that outline what the company plans to achieve in the coming year. They are presented and approved by the board and the management team’s compensation is often driven by them.
3) Forecasts – These are iterations of the budget that are done intra-year by the management team to indicate what is likely to occur. They reflect the fact that the actual performance is going to vary from budget (in both positive and negative ways) and it is important to know where the numbers will actually end up.
Over the coming weeks, I will go through the processes companies use to project, budget, and forecast. Because I do not do this work myself, I’ve enlisted one of our portfolio companies to help me with these posts.
I’ve been working with Return Path for ten years now. Matt Blumberg, CEO, and Jack Sinclair, CFO and sometimes COO, have done over ten sets of projections, budgets, and forecasts for me and other investors, board members, and team members. In the process they have evolved from a raw startup to a well oiled machine. With their help, I will talk about the how three “model companies” go about projecting, budgeting, and forecasting. These companies will be 10 person, 75 person, and 150 person. These are the typical sizes of companies that I work with and are probably also the sizes of companies that most of the readers of this blog are dealing with.
I’ll end this post with a picture that Matt sent me last week. This is ten years worth of board books that include Return Path’s projections, budgets, and forecasts. The goal of MBA Mondays in the coming weeks will be to get all of you to a place where you can create something similar.
The nice thing about this way of presenting the subject is that it splits the financial forecast into (a) long term (projections), (b) short term (budgets), and (c) real time (forecasts/adjustments). For digital media, I continue to find (a) an impossible exercise, and it will be really interesting to see if discussions in coming weeks begin to converge upon (b) and (c) mostly.
With that long stack of books from 10 years worth of financial planning, it should be possible to determine the true viability of (a) based on actual results. Maybe it’s wrong to dismiss long-term projections… I would be curious. (I don’t mean whether long term targets were realized, but rather if the business that the company thought they would be in ten years ago, has turned out to be their business.)