Financial projections are not just numbers thrown onto a spreadsheet; they are an actionable road map for your business’s future. They help you plan, make decisions, and secure investment. In this guide, you’ll learn what financial projections are, their role in various aspects of business, how to prepare for making them, and a step-by-step guide to crafting your own.
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Understanding the basics of financial projections
Financial projections are estimates of your business’s future revenue, expenses, and cash flows. These are usually presented in the form of financial statements like income statements, balance sheets, and cash flow statements. Beyond simple speculation, financial projections are grounded in your company’s historical data and market analysis. They are crucial for internal planning, securing investment, and demonstrating to stakeholders that you have a sustainable business model.
Essential groundwork before creating projections
Identifying your business objectives and time frame
Before you start crunching numbers, it’s essential to have a clear understanding of what you hope to achieve with your financial projections. Are you looking to secure a bank loan? Are you aiming to find potential investors? Or perhaps you’re developing a five-year business plan? The objectives will guide the type of projections you need to create and the data you require. Similarly, the time frame, whether short-term or long-term, has a bearing on the level of detail and the type of information you’ll include.
Collecting historical financial data and market research
Solid financial projections are grounded in reality, and that reality comes from your business’s historical financial data. Gather your income statements, balance sheets, and cash flow statements from the past years. If you’re a startup, analyze data from your test markets or pilot phase.
Recommended reading: How to create an effective financial forecast with no historical data
Additionally, market research can provide valuable context. Knowing the size of your target market, consumer trends, and the competitive landscape will not only make your financial projections more accurate but will also make them more credible to external stakeholders.
What are financial projections used for?
Business planning and strategy
- Resource allocation: Allocating funds efficiently to various departments or projects.
- Risk assessment: Identifying potential risks and preparing contingency plans.
- Milestones and KPIs: Setting realistic milestones and performance indicators for the team.
- Budgeting: Establishing a realistic budget to monitor costs.
Investment pitches
- Profitability: Demonstrating potential return on investment (ROI).
- Sustainable growth: Indicating steady revenue and market share growth.
- Risk mitigation: Showing plans to reduce business risks.
- Capital allocation: Indicating how investment funds will be used.
Loan applications
- Repayment plan: Provide a plan detailing how the loan will be repaid.
- Cash flow forecasts: Show positive cash flow as assurance of loan servicing.
- Debt-to-income ratio: Indicate a favorable ratio to prove creditworthiness.
Step-by-step guide to crafting your financial projections
1. Creating your sales forecast
Crafting accurate financial projections often begins with a robust sales forecast. First, identify your various revenue streams, such as product sales, subscriptions, or services. Then analyze past sales to glean trends and seasonal fluctuations that could inform your future projections. Market research is equally vital; it offers data about your market size and growth rate to shape your sales predictions. Choose a forecast period, be it monthly, quarterly, or annually, and then calculate your future sales. It’s crucial to keep these projections realistic to make them actionable.
2. Projecting your expenses
The next phase in financial planning is understanding your expenses, essential for assessing your business’s future financial health. Fixed costs are expenses that remain constant, such as rent and salaries. Variable costs, on the other hand, fluctuate with production volumes; examples include raw materials or freelance services. Don’t forget to account for future costs, like new hires or marketing campaigns. Finally, sum these up to arrive at your total projected expenses.
3. Constructing your balance sheet
A balance sheet offers a snapshot of your business’s financial status at a specific moment. It comprises assets, which are things your business owns like property and cash, and liabilities, which are obligations like loans and vendor payments. Equity represents the ownership interest in the business and is calculated as Assets minus Liabilities.
4. Building your income statement
The income statement, also known as the profit & loss statement, encapsulates your revenues, costs, and expenses over a designated period. Begin with the sales forecast you previously crafted. The Costs of Goods Sold (COGS) should include all costs directly related to the production of your goods or services. Then, add operating expenses, which are the business expenses not directly tied to production. The Net Income is calculated as Revenues minus (COGS + Operating Expenses).
5. Preparing your cash flow projection
Cash flow is pivotal as it reveals how changes in the balance sheet and income statement impact your cash reserves. Start with your opening cash balance. Cash inflows encompass all projected income sources, not merely sales. Cash outflows comprise all projected cash expenditures, including expenses and loan repayments. The ending cash balance is calculated as the Opening Balance plus Cash Inflows minus Cash Outflows.
Financial projections example
Here’s a simplified example using an accounting or consulting business:
Practical example: ABC consulting firm’s financial projections
1. Creating your sales forecast
For ABC Consulting, there are two primary revenue streams: consulting services and financial audits. Last year, they made $100,000 in consulting and $50,000 in audits. Market research suggests a 10% growth in demand for both services.
- Consulting services: $100,000 x 1.1 = $110,000
- Financial audits: $50,000 x 1.1 = $55,000
- Total projected sales: $165,000
2. Projecting your expenses
Last year’s fixed costs (rent, salaries) totaled $50,000, and variable costs (travel, freelance hires) were $20,000. They expect a 5% increase in fixed costs and a 10% increase in variable costs.
- Fixed costs: $50,000 x 1.05 = $52,500
- Variable costs: $20,000 x 1.1 = $22,000
- Total projected expenses: $74,500
3. Constructing your balance sheet
- Assets: $100,000 (Cash) + $50,000 (Accounts Receivable) = $150,000
- Liabilities: $30,000 (Loan) + $20,000 (Accounts Payable) = $50,000
- Equity: $150,000 (Assets) – $50,000 (Liabilities) = $100,000
4. Building your income statement
- Revenues: $165,000 (from sales forecast)
- Costs of Goods Sold (COGS): $22,000 (from variable costs)
- Operating Expenses: $52,500 (from fixed costs)
- Net Income: $165,000 – ($22,000 + $52,500) = $90,500
5. Preparing your cash flow projection
- Opening cash balance: $100,000
- Cash inflows: $165,000 (from sales)
- Cash outflows: $74,500 (total projected expenses)
- Ending cash balance: $100,000 + $165,000 – $74,500 = $190,500
By following these steps, ABC Consulting projects a net income of $90,500 and an ending cash balance of $190,500 for the next year.
How can Brixx help you
Brixx is a software tool designed to simplify financial planning and analysis, crucial for business plans, investment pitches, and loan applications. It offers easy-to-use features for creating 10-year and cash flow forecasts, effectively serving as a financial road map for your strategic planning and resource allocation. The platform automates complex accounting tasks, letting you focus more on planning and strategy. With Brixx, you can quickly conduct ‘what-if’ scenario analyses, adding flexibility to your planning. Brixx also supports real-time collaboration, ensuring that your team stays aligned. Using Brixx’s user-friendly tools can make your financial planning process both manageable and precise.
FAQs on financial projections
How often should projections be updated?
Financial projections should be a living part of your business plan, updated at least quarterly. Rapid changes in the business environment or within your business could warrant even more frequent updates.
What are some common errors to avoid?
- Overestimating sales: Be conservative in your estimates to avoid cash flow issues.
- Ignoring seasonality: Not all businesses earn steady revenue year-round.
- Underestimating costs: Whether it’s the cost of raw materials or unexpected operational costs, expenses can creep up quickly.
- Lack of detail: Financial projections need to be as detailed as possible to be useful.
- Ignoring past data: Always use past performance as a guide, but adjust for new strategic elements.
What’s the difference between financial forecasts and projections?
While often used interchangeably, they are not the same:
- Financial forecasts: These are based on historical data and assume ‘business as usual’ conditions. They are more conservative and serve as short- to medium-term predictions.
- Financial projections: These are more speculative and often based on ‘what-if’ scenarios. They are usually created for longer periods and can be more optimistic, detailing the financial picture under various conditions.
