The Healthcare Breakdown No. 013 - Breaking down how to build an income statement so you don’t look insane

Brought to you by my many discarded pitch decks

What we’re breaking down: Legit pro forma income statements

What you’ll learn: How to build a proper pro forma income statement

Why it matters: If you do it wrong, no one will take you seriously

Read time: Faster than a speeding bullet (9 minutes for real though)

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True story alert!

The first time I built a “legit” pro forma income statement I put down that we were going to make $50M in revenue in year 5 and that we would be profitable in year 1 to the tune of around $400K I believe.

The $50M part I remember, the year 1 profitability is a little hazy since it was so long ago and I have burned any trace of that embarrassment.

I thought, in my youth without the torment of years of grizzly experience, that investors wanted to see big numbers, huge growth rates, and lots of profit.

And I mean, they do. But there’s a critical point of distinction.

Reality vs. delusion.

Delusion is easy. And I don’t mean delusion as a pejorative term, I just mean that you haven’t really thought through the realities of what you are about to get yourself into.

I certainly didn’t.

Side note: I launched that business and we never came close to touching $50M, so I get it.

Reality is harder. Much harder. And just like how I think of delusion I don’t think of reality in terms of being right. In fact, it has little to do with being right. It has everything to do with a thought process grounded in reality.

Think of it this way, can you explain, justify, and show a path to what you are projecting? If so, is that path realistic?

Like, I can tell you I will climb Mt. Everest next week. And I guess, in theory that’s true. But, do I know how to travel there? Do I have all the right equipment? Am I in the right shape? What’s the weather like this season? Have I committed enough time to summit? Do I have a guide? Do I need a guide? Do I know where I’m staying? Do I have or need a team? Who should be on that team? How do I find them? Can I find them? There’s a million more questions to answer.

That’s delusion.

Reality can look like me answering all these questions, having a well thought out plan, and still failing to reach the summit!

Ok, now that we have beaten this metaphor to death, let’s talk about what this means for a pro forma income statement.

Well, your pro forma income statement is the financial reflection of how well you have thought through everything.

It’s the snap shot of whether you know what in the world you’re talking about.

Not like your cousin who fancies himself an expert on U.S history because he watched National Treasure 26 times.

Are you your cousin or are you Nicolas Cage? That’s what I’m asking.

Like the movie version in National Treasure. Definitely not in real life. That dude burned all his money on an island. Don’t do that.

Onto the build!

They key that I will belabor is making a bunch of REALISTIC assumptions.

Like these:

What are you selling?
How much are you going to sell it for?
How much do you think you can sell each month?
How many people do you need to hire to pull this off?
How much will it cost to make the thing or provide the service?
How many customers are out there that you can reasonably capture?

And on. And on.

Here is what not to do:

Say to yourself, “the market size is $5B. If we capture just 1% of the market we’ll make $50M.”

Then build everything around that.

Hard pass. Immediate no. That’s a lazy game, Susan.

(Sorry if your name is Susan and you’re reading this. Just trying to be funny. Please don’t unsubscribe!!)

Your assumptions will drive everything and will show how well you think.

Ok, so you know me. Let’s make this real.

Today’s fictional company is CleverHeatlh Inc. which is the latest and greatest digital health company. We’ll for sure revolutionize healthcare. Casue like, AI.

Awesome. And away we go!

Start here: assumptions

I will start direct to consumer. Then, after showing how awesome I am, I’m going to pitch my game to payors to throw me some PMPM (per member, per month) covered lives. THEN! I am going to nefariously, I mean ethically, sell my patients’ deidentified data to pharmaceutical companies.

They love that stuff.

I also want to start narrow, so I am only going to help patients who suffer from chronic tennis elbow.

I will also want to hire some sales people but can’t afford salaries to start, so I’m going 1099 commission only.

Why sales people? Because doctor referrals are a channel to get customers. And who better to sell doctors stuff then 1099 sales reps. Preferably with a pharma background. Preferably with a really high car payment.

I have to build the thing and an digital health platforms ain’t cheap. It also needs maintenance, updates, upgrades, service, implementation.

See, starting to add up.

I like to be fancy so I am going to need some slick WeWork space. Work computer, phone line, lots of coffee, and a beer tap.

I will need some insurance probably. Then there’s marketing. I won’t hire a CFO but I need taxes done and some financial help, so let’s find a fractional gal and a CPA. Better if that’s the same person.

Got to pay for hosting, web development and maintenance, cloud voodoo, HIPAA jazz, and even more stuff that I honestly have no idea about.

HL7 and FHIR am I right?

Sorry, EHR joke. Yikes.

I’ll need some additional services. People need to be licensed. Will I bill insurance? I don’t know man, I’m just starting over here!

As you can see, this is a thinkin game. Not a numbers game.

Do this next: turn your assumptions into expenses

Put it all in a spread sheet. A super messy list will suffice.

Look at this mess that I made:

There’s more steps: assumptions again, but this time about revenue

Now that you have your assumptions and your messy list of costs, time to see about the money making bit.

Revenue fun.

How much do I charge?
How many customers can I get?
When will I get my first customer?
Are customers going to leave and when?
What’s the sales cycle on something like this?
How many customers can I continue to get and keep adding?
How long between landing a customer and getting implemented so they start paying?

See? Fun.

For this, it’s important to note patient visit frequency. You may land a bunch of new patients through referrals but then, they don’t use the platform every month. They may only pay per visit (like in this case). Then you need to ask how often they need to be seen.

For this, I assume that out of each crop of new patients, 10% will need to be seen the next month. It’s a smoothed out way to suggest that patient visit frequency will be roughly a little more than once a year.

This isn’t perfect, but again, it’s all about the thought process. And you can for sure get more sophisticated than this. But I am nothing if not unrefined.

I put some of those assumptions here:

Those drive everything.

And here are the customer assumptions:

Basically I have thought through how many people we can get onto the platform.

210 in the first year seems reasonable. All about the foundations in Y1 and growth the following years.

Keep the assumptions up top.

The next thing: build the stinkin pro forma

You have your revenue assumptions.

You have your expenses.

You know your plan.

Now, just put it in a nice orderly excel format.

I like to go monthly.

Here’s everything together for year 1:

Ok, don’t panic.

It looks like a lot, but you already have all the pieces. The building blocks. You just have to bring them together.

You will notice some blank space. But that brings us to our next point…

One last thing and then we are going to bring this puppy home: growth

You want to grow.

You have to grow.

To grow, you need to invest more.

More sales people. Sales people going from 1099 to W2. A CFO. A COO. A VP of sales. More marketers. More leaders. More cloud storage (whatever that means). More server space. Inhouse engineers. Bigger offices.

As you grow, the expenses grow.

That’s what all those blank spaces are for. More headcount and investments as we grow.

Gander at year 3:

Will we make $3.5M in operating income? I don’t know. I mean we sure as heck fire would try.

Here are some things to consider:

Maybe I am underestimating Engineering.
Maybe I am overestimating sales, revenue, and new customers
Maybe I am underestimating the sales cycle and marketing required
Maybe I am missing some things that I won’t even realize until I get started

There’s a whole lot that can be missed. But this shows a thought process. It shows a fairly firm grasp. It shows more reality and less delusion.

It’s also a starting point. It can be pressure tested. I will get feedback and make it better. I will learn what I don’t know and refine this. I will make multiple versions where my costs are much higher and my revenue is much lower (more on that in 43 seconds).

Sweet sauce, let’s wrap this thing up!

Sorry, really one last thing: play like a champ

Make multiple versions. Do a reality one. Do a low one. Do a bootstrap one. Do an everything goes wrong one. Being prepared for multiple outcomes is best. And sorry, not sorry, you’re reality one, the one that’s 50% less than the rosy one you started with, is still too high. I totally still love you though.

Adjust. This thing is going to be messy. It’s going to be wrong. You’re going to think of more things. Keep working on it. Keep adjusting. Keep refining.

3 years is enough. You’re going to be wrong anyways. Projections in year 4 are so far away, you probably won’t even be in the same business by then.

Link as much as you can in a spreadsheet so you can make adjustments easily. There’s nothing worse than having to go back and change values in 67 cells with complicated formulas. Or hard coding. Don’t do it.

Don’t put the amount of detail I showed in your pitch deck. You need a summary. Three years rolled up, only showing major categories.

That looks like this:

If you use this to build a digital health company, I expect a cut.

No, just kidding.

But I would love to know if you do build something super awesome and this was helpful!

And if you forget everything that I have said, remember this: National Treasure is a national treasure. Super underrated movie.

Later gator.