How to… write a financial plan

How to write a financial plan Tom Wrenn

Attracting investment from private equity and venture capital firms requires careful preparation. They want to see solid financial projections before parting with cash. We asked Tom Wrenn of ECI Partners what he looks for in a financial plan, and the pitfalls to avoid

Your financial plan should know how valuable you are

Wrenn says: “The best way to demonstrate this is by providing a profit and loss account and cashflow figures for the preceding two years, the current year and three years’ forecast.

Financial statements may not be the perfect way to describe how valuable your business is, but if prepared with the right level of detail they can give potential investors a great insight into the value of your business. As investors, we are also looking to understand the dynamics of your revenue and cashflow.

For instance, what proportion of your revenues are contractually recurring as opposed to a one-off contract? The more comfort we can take in the predictability of the revenues the bigger the valuation we will place on your business.”

Can you deliver the numbers?

“A common mistake we see in business plans is over-optimistic assumptions about growth. Private equity and venture capital firms want to back ambitious management teams but make sure your three-year plan is credible and well thought through.

Hockey stick-shaped graphs promising surging sales and profits, without the detail to back them up, will only diminish our views on the chief financial officer and chief executive officer – are they ramping the business for a sale with no regard to how they deliver these numbers?

Remember, you will have to live with your forecasts and be judged on how you perform against them.”

Provide a sensible level of detail

“Companies can experience significant, one-off working capital swings, perhaps due to a major new contract or a one-off investment in new plant and machinery. Help investors to better understand your business by showing this capex separately from the ‘normal’ year-to-year numbers.

A recent information memorandum on a business that we reviewed showed cash conversion of about 60 per cent of operating profit for the last two financial years but 90 per cent for the current and forecast years – with no explanation.

In this case, the acquisition of another business part way through a month had impacted working capital in one year and significant capex related to an office move affected the other. Once stripped out, historic cash conversion was indeed around 90 per cent.”

The beauty of pro-forma figures

“The costs of overseas expansion, of product launches or acquisitions can mask the true profits of your business.

Showing current or historic earnings before interest, tax, depreciation and amortisation (Ebitda) on a pro-forma, or adjusted, basis can be helpful in presenting the true underlying profits of the business before such distortions. A word of caution, however: if this becomes too aggressive it can be counter-productive.

The multiple of profits a buyer is prepared to pay is a function of the confidence they have in the profit number.”

How to reflect a good recession

“If you had a ‘good’ recession during 2007-2010, with strong growth and financials, it is worth showing this, perhaps using a graph to show your long-term revenue and profit trends.

However, be warned: using, say, 2010 as a starting point for your financials will inevitably trigger questions from potential investors about whether that is a low point from which there is a cyclical bounce-back rather than part of long-term growth.”

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Director magazine

Director magazine

Director is the magazine for business leaders. Free to IoD members and available to purchase through subscription, each edition is full of insightful interviews with entrepreneurs and company directors.

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