Financial projections give startups a glimpse into the future
Financial projections, also known as financial forecasting or sales forecasts, give you a look into the future value of your business. As a startup or small business owner, having even the slightest glimpse into your financial future can result in more accurate business planning, better cash flow projections, and even better chances of securing potential investors.
But, what exactly is a financial projection, and how do you do it? Set down that crystal ball and grab a pen and paper, it's time to do some financial projecting.
What is a financial projection?
When you're a new business, the future is often unclear. This is true for a good portion of your first year. But, it doesn't have to be that way. A financial projection is a collection of estimations and forecasts that give you a data-backed view of your company's financial future. This is accomplished by using pre-existing financial data, or financial estimations in the case of a new business or startup, to make predictions about your business’ future.
Financial projections can be done for a business as a whole or for a project or department. This is especially useful when a large, costly project is proposed. A financial projection allows you to have a more educated view of how the project may impact your revenue, what it may cost, and whether it will harm your cash flow in the short-term or long-term.
In short, a financial projection is essentially a financial statement from the future, based on trends, historical data, and a little foresight. Generally, there are two types of financial projections to create: a short-term plan that covers one year of business, and a mid-term projection that estimates three years of business.
You can also do a long-term projection that looks even farther into the future, but these aren't as common. Predicting anything beyond three years leaves a lot to chance, which can make them far less reliable than short and mid-term projections. But, when exactly do you need a financial projection?
When is a financial projection needed?
Financial projections require a fair amount of work, but they're always useful, especially under the following situations.
- You're looking for funding: Whether you're looking for an investor or a business loan, the party giving you financial backing will want to see that your business is stable. This is especially true for startup businesses. A financial projection will show investors that your business has a bright future while lenders will be able to get a more in-depth look at your finances and the likelihood you'll be able to pay the loan back.
- You're drafting a business plan: Business plans are in-depth documents that cover nearly every facet of a business, from the core idea of the business to the financial model. A financial forecast of future revenues allows you to create a more accurate business plan by having a more realistic view of your financial model. This information also helps you determine what kind of growth you can expect, which makes life easier when you look to secure investors. With a financial projection, your business plan will make a more compelling argument for why your business should exist, as you have data to back it up.
- You need a better understanding of your finances: Even if you're not actively pursuing a loan or investor, a financial projection is a great way to get a clear view of your business performance and finances. Because a financial projection goes well beyond a simple income sheet or balance sheet, you're able to see not only how your business is doing, but how it could be doing in a year. That information can help you make more-informed decisions regarding marketing or products, and it can help you avoid unwanted surprises.
- You want a better idea of potential startup costs and projections: Even if you don’t have a business yet, you can use a financial projection to understand what your startup costs might be. This can be done by examining the performance of similar businesses, and then estimating costs for starting up in your area.
Business can be full of surprises, but with a financial projection you can be better-prepared for many of these twists and turns. But, accurately performing your financial projection is key to ensuring it's useful.
Performing a financial projection
A financial projection takes time and careful preparation to complete, but in most cases, it doesn't require outside assistance. That being said, if you have a financial adviser or accountant, they can likely make the entire process easier for you.
For those wanting to complete the process themselves, the following steps will help you with each part of a financial projection.
1. Gather necessary documents
In order to complete the many parts of a financial projection, you'll need to gather numerous documents and pieces of information. These include:
- Complete inventory: You'll need a current count of your inventory, as well as any records of inventory changes in the past.
- Total value of your assets: Outside of inventory counts, you'll also need to total up the value of any existing assets. This includes land, software, rights, and so on.
- Income statements: Gather any available income statements. These should show profits and losses for the period of the statement.
- List of liabilities: List any debts you currently owe, no matter how big or small. Your liability should include balances on any line of credit your business has taken out.
- Total expenses: Total up your expenses and list them out. These should be any regular expenses, but you don't need to include one-off expenses that won't occur again.
2. Create your balance sheet
A balance sheet is a rundown of your company's total value. Your balance sheet examines:
- Assets: Total up your assets. This is anything owned by your company, including property, equipment, actual cash, and inventory on hand. Don't forget to include raw materials used to manufacture goods.
- Equity: Your equity is the amount you'd have if you were to liquidate your company right now. This can be found by taking your total assets and subtracting total liabilities.
- Liabilities: Your liabilities are anything owed. This includes any loans, credits, debt, rent, wages, and utilities.
To complete your balance sheet, simply add your liabilities and equity. Use a spreadsheet program, such as Excel or Google Sheets, to keep yourself organized during this process.
3. Create your income statement
An income statement provides a view of your company's income for a set period. You can create an income statement using these three steps:
- Choose a time period for your income statement. This can be quarterly, monthly, or weekly. Ideally you should be creating income statements monthly, at least.
- Total up gross revenue for the period you chose. You can find your gross revenue by totaling up your payments for the period chosen. Include any payments you're owed, even if you haven't received them. Then, subtract the cost of goods sold and operating expenses from your total income for the period. You'll also want to include income taxes paid during this period, as this is coming out of your earnings.
- Create your income statement. With the above information you're ready to create your income statement. Create a template or find an existing one to streamline this process.
4. Create a cash flow projection
A cash flow projection gives you an idea of your cash flow for a period set in the future. This is based on existing data as well as trends and predictions, so it's never going to be 100% accurate. That said, you can make your cash flow projection as accurate as possible by following these steps:
- Total up your cash for the previous period. Simply look at the previous period and subtract all expenses from your income (or look at your balance sheet from earlier).
- Project next period's income. You can do this by looking at previous data and tracking how your sales performed, while factoring in any industry-wide trends. Be mindful of any holidays or seasonality and think about how they may impact your sales.
- Subtract projected expenses from your projected income. Follow a method similar to the previous step and look at your previous expenses to estimate what your upcoming expenses could be. Again, think about trends, holidays, and so on to get a good idea of your estimated expenses. For example, if it's going to be cold in a few months, you'll likely be spending more on heating.
- Add your projected amount to your existing balance. Now that you've projected your cash flow, you need to couple it with the current balance for the beginning of the projection period. For example, if you're currently sitting at $150,000 and you project next year could see your cash flow going up by $200,000, you'll have $350,000.
5. Make sense of it all
With all three of the above documents created, you'll be able to make educated financial projections about your business. Each document gives you an idea of where your company is and where it could be.
Think carefully about industry trends and upcoming events, be mindful of outside factors such as weather and the unexpected (such as a pandemic or disaster), and continue to project as frequently as possible. The market can turn quickly, and the more often you're looking ahead, the more likely it is you won't crash.
Projecting a healthy future
The future is always uncertain, and no amount of projecting can ever completely eliminate that uncertainty. But, with diligence, you can be better-prepared in case the worst happens. And, you can properly pitch your business to investors, secure valuable loans, and rest easy at night knowing you're aware of how your money is growing and where it could be a year from now.