What’s on the horizon for your business? Will you need to hire new employees? Invest innewcapital expenditures? Or maybe even consider opening a new location? Financial projectionsprovide insight for small businesses and startups to plan for the future, as well as dataand information potential lenders and investors need to understand your business.
What Are Financial Projections?
A financial projection is what your business expects to happen, based off hypotheticalsituations using the facts and data you have available. A financial projection is oftenprepared to present a course of action for evaluation. It’s a type of pro formastatement.Some examples of pro forma financial statements include projected income statements, balancesheets and cash flow statements.
Projections are based on financial modeling techniques and provide the answers to questionsthat may come from lenders, investors or other business stakeholders. Essentially, thesestatements are an answer to the questions, “If we lend you this money, what will youdo withit? And how will you pay it back?”
Why Are Financial Projections So Important for Startups and Small Businesses?
Financial projectionshelp you see when you may have financing needs and the best times to make capitalexpenditures. They help you monitor cash flow, change pricing or alter production plans.
Projections provide all the minutia that lenders might be looking for to better understandyour business: how it obtains revenue and where it spends money. Additionally, if yourbusiness is ever the target of an acquisition, the financial statements help potentialbuyers evaluate its worth.
There are subtle differences between the terms projection and forecast. But both describepredictions of future financial performance using financial models. A financial forecastpresents predicted outcomes based on the conditions you expect to exist for your business.Projections are financial statements that present anexpected financial position given one or more hypothetical assumptions.
For example, Linda’s Linens is growing its sales volume 10% each year, and that growthhasbeen steady for the last 18 months. After examining the financial forecast, it’sreasonablefor Linda to assume that growth will continue, and she should plan accordingly. This helpsher with inventory planning, hiring decisions and how much to allocate for marketing.
Linda is considering opening a second location. So she prepares a financial projection toshow her bank a “what if” scenario to see how much growth she might expect ifshe received aloan to open another store on the other side of town. The hypothetical situation of openinga new location in the financial projection is what makes it different from the sustainedgrowth she might reasonably suspect in the financial forecast.
What Are Financial Projections Used For?
Financial projections help you realize possible potential in your business. What might happenif you receive outside funding? Or purchase additional equipment? This is where you get tobe creative and explore what the future of your business might look like.
Business Plan: Financial projections and business plans go hand-in-hand.It’s a way to show that your company is stable and is financially successful.It’s a goodpractice to provide quarterly or monthly projections for the first year and annualprojections for the four years after that. These include projected income statements,balance sheets, cash flow statements and budgets for capital expenditures. You should beable to explain projections and match them to funding.
Investors: Your potential investors want to know if the business will makemoney and when they can expect a return on their investment. Some common benchmarks to watchfor include how long it will take until the company turns a profit, sales in years three andfive, and data showing how your numbers fit in context of your industry.
Loans and Lines of Credit: These are the most common sources of externalfunding for small businesses. To secure a Small Business Association (SBA) loan,you’ll needa thorough understanding of your finances so you can show the lender how your funds will beused and when the loan will be paid back.
Know your Business: Financial projections show discipline in financialmanagement – and better financial management leads to a much higher chance of businesssuccess. By using a financial model to make financial projections, you can see if, when andwhether your business will make a profit. You’ll have a better understanding of yourcashposition to make better decisions about when to hire more people, buy more inventory or makecapital investments.
7 Steps to Building a Financial Projection for Your Startup or Small Business
Some common scenarios for projections are monthly projections for year one, quarterly for thenext two years and annual thereafter. To build out your financial projections and make themas useful as possible, consider including the following:
- Sales revenue estimates
- Cost of sales or cost of goods sold (COGs)
- Operating costs
- Capital expenditures
- Gross margin by product line
- Sales increase by product line
- Interest rates on debts
- Income tax rate
- Accounts receivable collection plan
- Accounts payable schedule
- Inventory turnover
- Depreciation schedules
- The usefulness or depreciation of assets
Financial projections will usually have a detailed view in a spreadsheet, as well as asummary of some of the most important information. To create this, your business will need afinancial model, or a summary of your company’s expenses and earnings. Some of thebasicareas to start building financial projections include:
- Create a sales forecast.
What’s driving your sales? That’s where you should start with your projections.For example,if you have a subscription-based web business, correlate sales with estimated websitetraffic, and conversion rates with the source of traffic. Like a project management platformthat sees 1.5% of its traffic from organic Google searches turn into paying customers. Thesame project management company should also identify conversion rates for customers who landon the site from ads. That way they can estimate how many new customers an increased adspend or increased organic searches might attract. And finally, the platform should tracktheir churn rate, or how many customers don’t renew their subscription.
For a business that sells physical products, the sales forecast should estimate the number ofunits it will sell and the price per unit. It’s also helpful to see where and how theitemsare being sold: How many stores are carrying the products? How are each of those storesperforming? The company should factor in things that might affect sales like seasonality.For example, more ice cream and sunscreen are sold in the summer. Is there a seasonality toyour product?
- Create an expense budget.
Expenses will include the costs associated with sales, as well as operating expenses. Toforecast cost of sales or cost of goods sold (COGS), take all of the current information onthe income statement about product cost, fulfillment expense, customer service and merchantfees. Express assumptions about how that will change as a percentage of revenue. Apply thesame idea to operating expenses. Consider how headcount, salaries and benefits as well asexpenses like advertising, rent and more will change and express everything (with theexception of headcount) as a percentage.
- Create the income statement projection.
Link those assumptions to formulas built in the income statement. The financial model willforecast revenue, net revenue, COGS, gross profit, gross margin, operating expense,operating profit and operating margin. The output of the financial model is the projectedincome statement.
- Create the cash flow projection.
The projected income statement shows you, as well as potential lenders and investors, if thecompany is profitable and/or when it is expected to make a profit. The cash flow projectionshows your cash position and provides a more detailed view of monthly inflows and outflowsof cash for a specific period of time — 3 months, 6 months, 12 months, etc.
- Create the balance sheet projection.
Where the cash flow projection lets you see when there should be cash influxes and dips, thebalance sheet shows or projects the worth of your company at any given time. Cash flowprojections appear on your balance sheet as assets. On the liabilities side of the balancesheet, you’ll list things like accounts payable and debt.
- Use projections for planning.
Projections are important when seeking new funding. And they help you know when to makecapital expenditures. For planning, projections help with analyzing the impact of differentbusiness strategies. For example, what if you charge a higher or lower price? What ifyou’reable to collect invoices faster? Running and testing these various numbers shows how suchdecisions could affect finances.
Projected financial statements also help you prepare for best and worst case scenarios. Youcan use projected financial statements to drill down to the product level and know when itwill be profitable, when to ramp up production or even when it no longer makes businesssense to continue producing it.
- Monitor.
By comparing projections against actual results you can see if you’re on target or needtoadjust to reach them. Consider purchasing accounting and planningsoftware for financial projections. Tracking performance is much easier and quickerwith dashboards and charts that can show you at-a-glance information.
Plan & Forecast
More Accurately
Free ProductTour
Benefits of Using Accounting and Planning Software for Financial Projections
There are advantages to automating financial modeling. You can handle more complex datasetsand certain visualization capabilities, as well as streamline financial projections.
- All lines of businesses are connected to the same data, improving control, visibilityand trust in the numbers.
- Drill-through capability means you can spend more time drilling into the data tounderstand the source of the numbers. Finance then has more time to understand the "why"and can better help the business owners understand how their decisions affect the restof the company.
- You can easily run what-if-scenario analysis to explore different businessopportunities.
- Pre-built reports and dashboards make it easy to compare projected vs. actual results.
Automation can increase accuracy save time, and help you compare actual and forecastedresults in charts and dashboards. With so much potential, automation is a growing trend. Infact, a survey by Robert Half, a global human resources consulting firm, found that nearlyone quarter of respondents expect to automate processes behind financial forecasting.
But even if the analytics associated with financial projection aren’t automated, usingtechnology to automate other parts of the accounting process that go into building thestatic financial statements provide savings in terms of speed and accuracy.
To run a business, you need to know not just where you are financially, but where you want tobe. There is a correlation between how frequently small businesses examine their financialstatements and the financial health of their business. The U.S. Small BusinessAdministration found businesses that onlylook at financial statements annually have a 25% success rate. But those that do it monthlyhave a success rate of 75%-85%, and those that do it weekly have a 95% success rate. Ittakes more than just a good idea and dedication to make your business succeed. Andaccounting software for financial planning is an important tool to keep your company ontrack to prosperity.
