Breakeven Analysis, Pro Forma Forecasting, and Growth Strategy.
by Sherron Lumley.
New Yorker Douglas Tausik is thinking outside of the box. In 2007, he founded Tropix Technology, a business that sells laptop computers to the East African market, specifically in Uganda. His big idea came from a visit to the area and a discovery that fewer than two percent of the Ugandan population owned a computer. “Our ultimate goal is to provide doctors, teachers, and students with computers,” says Tausik.
So far, Tropix has sold 50,000 computers in Uganda, a good start toward bringing computer literacy to the country via affordable computers that are made in China. To stay on track, Tausik relies upon several financial planning tools to help him answer three vital questions that every small business owner must ask:
Will the business be able to make money?
How long will it take until it’s profitable?
How will I know if the business is meeting its goals?
Breakeven analysis, forecasting, and cash flow projections—these are the things small business dreams are made of. Each tool provides a strategic starting point for making the envisioned future a reality.
In Tropix Technology’s case, profit expectations and expenses are kept to an absolute minimum in order to make the computers affordable to Ugandans, lowering the breakeven point. To break even is a simple enough concept: at a certain point, expenses will be covered and the business will start to make money. Breakeven analysis means calculating all expenses the business incurs and determining how much product or service must be sold and at what price to make a profit.
For Tropix Technology, one of the main expenses is providing after-sale service and repair in Uganda, a benefit that has never been available before. “We had to analyze how many units to sell per month to operate the service center,” says Tausik. Some of the elements that go into a breakeven analysis include raw materials, labor, utilities, fuel, marketing, fixed costs such as rent, and variable costs such as shipping, selling expenses/sales commissions, and taxes.
The U.S. Small Business Administration (SBA) offers a link to preparing a break-even analysis provided by Nolo.com, a legal publisher in Berkeley, California. Nolo also provides information on its website on preparing a profit and loss forecast, a cash flow projection and estimating start-up costs.
Pull-Quote.pngPro forma forecasts and cash flow
“We are definitely involved in forecasting and do cash flow projections,” says Tausik. “We have to fund the manufacturing of the computers, then we have to ship, then collect funds, so we have to analyze the cash requirements. Our commitment is never beyond the actual shipment because we do not do the manufacturing. We gather the orders, then when we have enough, we place the order in China,” he says.
The Latin term pro forma (as a matter of form) in business means projecting the future status of the company based on current performance, without including unusual and non-recurring transactions. Pro forma financial statements are similar to regular financial statements, except that they are educated guesses of what will happen in the future, based on the goals of the company and what is known right now. A pro forma balance sheet will include assumptions of future cash flows, assets, and liabilities. A pro forma income statement includes expected sales revenue, cost of goods sold, losses, operating expenses, equipment, depreciation and taxes. A pro forma statement of cash flow will predict inflow and outflow of cash to the business and give insight on potential shortages.
Realistic pro forma forecasts can be helpful to a small business by providing insight into needed course corrections. To make a forecast with any degree of accuracy, some actual data is needed, such as prior revenues and expenses from a known period of time. Typically, three to five years of data is considered a healthy period for discovering trends, but when the market is in mid-swing, a shorter time span may be more appropriate.
Just two years ago, Internet service became available in Uganda via a high-speed optical service built by China. The Internet Service Provider (ISP) sector is growing slowly, but in time will develop Internet access for more Ugandans, the majority of whom are still subsistence farmers. With this in mind, Tropix has plans for expansion. “It is an underserved market,” says Tausik. “Currently 30 to 35 percent of the population work in non-farming professions,” he notes, “and there is already reliable Internet service available in the capital city of Kampala.”
Tropix’ initial sales to the civil service sector was met by great enthusiasm from the Ugandan government, which provided a sales office for the company at no cost. Now, attention is focused on the country’s doctors and teachers, with a goal of 80 percent computer ownership. Additionally, there are thousands of incoming Ugandan university freshmen each year with no computers, so students will be an important target market as well. To reach the 80 percent goal the company will need to sell a total of 400,000 computers over the next five years. “We forecast the amount we have to sell each year to reach that goal and then make a marketing effort that corresponds to that,” Tausik explains. Part of the marketing effort is mobilizing a group of teachers to go from school to school.
Becoming familiar with breakeven analysis and pro forma forecasting is essential to meeting small business goals. With the knowledge of expenses and sales, a small business can calculate its breakeven point, forecast future cash flow, plan for profit, and create a growth strategy.
The U.S. Small Business Administration (SBA) provides a free online business planning course and business plan template that includes breakeven analysis, pro forma cash flow and a full list of items to include in a complete business plan. To learn more, follow the links below to other online resources.
A breakeven analysis will show you where your company begins to make a profit.
The breakeven point determines whether expenses, sales, or prices need adjustment.
Cash flow projections help prepare for shortages that can derail a small business.
Forecast realistically by using recent data considered in the context of the current market.
Pro forma calculations have many uses beyond the initial business plan, including planning for strategic growth.