Projecting Business Income from Your New Small Business

Before I started uVest Advisory Group, LLC, my Registered Investment Advisor firm, I wanted to be sure that it made sense to do so from a “numbers” standpoint. Basically, I wanted to project business income for my then hypothetical small business. Projected financial statements are called “proforma” financial statements. I used these statements to map out just how much margin for error I had in the early years of my business. I did this because I needed to know just how much I could spend on various business needs without sinking the ship. Here’s how you can create proforma income statements to project business income.

Start with Projecting Revenue

The first thing I did was to make revenue projections. The way you do this is to take whatever it is that generates revenue for your business and project how many units of that product or services you will be able to sell. 

uVest proformas from late 2017/early 2018

For my business, at the time, the main driver of revenue was the assets that I managed for clients. I had a little bit of a head start because I had already accumulated some assets and was managing them before I even started. I could therefore play with different growth rates in client assets to see different scenarios. If you do not have this luxury, i.e. you are starting from zero, you should create a few different scenarios. You should create a “base case”(the most likely scenario), “bear case”(the worst case scenario), and “bull case”(best case scenario). 

uVest proformas from late 2017/early 2018 bear case scenario

uVest proformas from late 2017/early 2018 bull case scenario

Let’s say you are trying to decide whether it makes sense to become a realtor. You want to try to figure out how much you could reasonably expect to make as this will help you decide whether you should leave your current position or not. Your first step is to project your revenue. To do this you need to pinpoint what drives your revenue. In this case, I would say that the number of houses you can buy or sell are what drives revenue. If you are just starting from scratch, you need to sit down and think about how many houses you could reasonably expect to buy or sell in your first year. 

The way I would do that is by asking a number of real estate agents how many houses they were able to sell in their first year or two. How many houses were they able to sell in subsequent years? What rate does that number grow at? It would be safest to throw out any outliers (i.e. realtors who don’t sell any houses and realtors who sell hundreds of houses) and then average the remaining answers you get. The numbers you are most interested in are average first-year transactions and the percentage growth rate in the number of transactions in subsequent years.

In this way, you should be able to come up with a number of houses and the price you will be able to buy or sell those houses for (I would use the average market price for the price of the house).  The average growth rate in transactions is what you’ll use to estimate future years of revenue. For example, in my first proforma income statement, I estimated that I would gain an additional $1m in client assets/year and that the market rate of growth for those assets would be 7%. So for all future years of estimated revenue I just increased the previous years assets under management by 7% and added $1m to that number. This will make up your base case. Your “bear” and “bull” case will be a % of your “base” case.

Don’t be afraid to cast a wide net here; the point of the exercise is to see where the edges of the map are so to speak. For example, make your “bear” case 50% of the revenue as in the “base” case, i.e. 50% less houses than you were expecting. After we plug our expenses in you’ll be able to see exactly how many houses you need to keep your head above water. The “bull” case is less important from a risk management perspective but it’s an important motivator to help you frame just what might be possible. Show yourself what’s possible and you just might make it happen.

Plug in Projected Expenses

Now that you have estimated how much revenue you are likely to generate in year 1, you need to figure out what your expenses are likely to be. The first few years are likely to have more expenses than the following years. For example, in my first year I had thousands of dollars of legal expenses to get my business set up appropriately, have my contracts and policies vetted, and so forth. I also have thousands of dollars in marketing expenses like setting up my website. When the dust settled on year 1, I had a pretty substantial loss; closer to my bear case than my base case. But it was ok, but I had already planned for that and decided that it was survivable. 

In the case of a realtor starting out, you’re likely to have licensing fees and other various marketing and administrative expenses. Just like I have my expenses plugged in below, you’ll want to estimate and plug in your own expenses.

Be generous when estimating your expenses. It’s safer to be wrong but far more profitable than be wrong but far less profitable than you were expecting. For example, I even included an “extraneous” category in my projected expenses where I estimated that I would inadvertently spend $1,000 more each year than I was planning to. Furthermore, I was sure to estimate very conservatively all of my other expenses. That way, even if my revenue which is harder to predict, was way off, my expenses, if they are off, should error on the higher side. 

uVest proformas from late 2017/early 2018

Earnings Before Interest and Taxes, Profit and Profit Margin

After you total all of your expenses, you should subtract them from your revenue and the result is your Earnings Before Interest and Taxes or EBIT. The last step is to estimate your taxes and subtract that from EBIT and you have your Profit (or loss) from year 1. To calculate your profit margin, you simply divide your profit by your revenue.

uVest proformas from late 2017/early 2018 base case scenario

uVest proformas from late 2017/early 2018 bear case scenario

uVest proformas from late 2017/early 2018 bull case scenario

Projecting Taxation

If you are thinking of forming a sole proprietorship or LLC, your taxes will be calculated the same way as if you brought home a regular paycheck. The profit you make from a sole proprietorship or LLC “flows-through” to you and is taxed at your income taxation rate. Your business expenses are technically “above the line deductions” just like an IRA contribution, and reduce your adjusted gross income (your income before the standard deduction and other “below the line deductions”)

Don’t forget to take advantage of the qualified business income tax deduction (20% of your net business income). This deduction is a below the line deduction for net income from your business. Also, don’t forget to add in your spouse’s income when figuring your tax bill if you are married and file jointly. After subtracting the standard deduction, you will be left with taxable income, from which you can derive your actual tax bill.

If your spouse works a w-2 job, you may need to estimated taxes withheld from their paycheck either from their w-4 or from last years taxes. The amount of taxes withheld will reduce what you owe the IRS.

That’s all there is to it really. Of course, you can make more sophisticated assumptions than the ones detailed here. If you’re interested in more detailed spreadsheets, I highly encourage you to reach out to me with the form below. But if not, this is all you need to get started on projecting your own future business income and expenses!

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