While the former deviation is a tough sell, the latter is possible to overcome with a plausible explanation. In fact, with a really good explanation, it’s a selling point. After all, breakthroughs in technology, manufacturing techniques, or management styles can change the economics of doing business and create exciting investment opportunities. So if you’ve got it, flaunt it. But be prepared to offer lots of evidence that illustrates why your operation breaks the mold.
Another important strategy for computing the gross margin is to pull it back a bit from what might be suggested by the numbers alone. For instance, if your actual projected gross margin is 45 percent, it’s wise to increase the cost of goods sold so that the gross margin in the projections you show investors is a more realistic 40 percent. "Most of the time when you’re talking about gross margins you’re talking about utopia with no stock-outs, absenteeism, shrinkage or teamsters strikes.
Selling, general and administrative costs: If ever there were a place in the projections to simply let costs increase each year by a set factor, general and administrative costs are it. Supplies are not expensive. Calculating the cost of running centralized operations is fairly straightforward.
Estimating selling costs, on the other hand, can be a bear if the entrepreneur is uncertain how products will be distributed. And if the entrepreneur suggests too many different types of selling methods in the financial projections, investors will know he or she is clueless about how to sell his or her product or service.
Specifically, if the selling costs include advertising, trade shows, manufacturer’s representatives, sales staff and telemarketing, it could be an indication that the distribution channels are unknown and thus overstated. There are legitimate instances where the precise distribution channel is unknown and as a result, so are the precise selling costs. But the burden of selecting the most likely channel, based on experience or due diligence, rests with the entrepreneur, not the investor. When the financial projections indicate a shotgun approach to selling, the entrepreneur is saying, in effect "I’m going to try all these things to see which works," which often prompts the investor’s response "Not with my money, you’re not."
Operating income: As far as financial projections go, operating income or the operating margin, which is defined as gross sales less selling, general and administrative costs, is the bottom line. Many of the guidelines for projected gross margins apply to operating margins as well. For instance, be conservative rather than extreme in your estimates so you leave yourself room to exceed the projections rather than fall short of them. Where operating margins exceed industry averages, provide a tenable explanation. In the same way technology, management style and manufacturing techniques can cause a breakthrough on gross margins, so too can they have a healthy effect on operating margins.
Another important aspect of the operating margin is its absolute value. In general, a small operating margin, as a percentage of sales, is a turn-off for most investors; it leaves little room for error, and it’s harder to create the kind of profits that offer an opportunity for investors to cash out.
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