Why are financial projections so important? Let us count the ways.
As a startup, you’ll use financial projections to get funding from investors and lenders. Financial Projections aren’t optional. These institutions require them.
Did you know that 9 out of every 10 startups fail? Investors and lenders are skittish! They need to see a solid plan before they’ll dish over cash.
Learning how to create solid financial projections is one of the most critical skills you need to develop as a business owner. Read this article to learn how to make financial predictions like the boss you hope to be!
The Essential Pieces of a Projection
Even when your business is on its feet, projections serve as a benchmark for growth. They help you organize and plan for your goals. And they keep you motivated to reach those goals.
It’s best to project out three years into the future. That’s what most investors or funding sources want to see. And it’s more difficult to project out further and provide reliable information.
Prepare projections for different time frames. We suggest monthly, quarterly, and annual forecasts for the first year. Then quarterly and annual an excellent for years 2 and 3.
Set up your numbers in a spreadsheet. It’s easier to organize and cleaner to look at. And you’ll have an easier time linking information from one projection to the next.
All projections have three statements: Income statement, balance sheet, and cash flow statement. Let’s go over each of these now.
1. Income Statement
Your first step in creating an income statement is to project sales. Let’s say your new company manufactures widgets. To project sales, you must know how many widgets you can realistically sell.
Then determine how much you plan to charge for each widget. The price point depends on the market and your expenses. So you may have to change it up after you get your income statement finalized.
Remember, the key word here is realistic. You want to present a realistic forecast to investors. We’ll discuss where you can get this information later in this article.
Now that you have an idea of your first-year sales and expenses think about how much growth you want to see in year 2 and year 3. Then factor that growth percentage into your sales figure to project the next two years.
For example, if you sold 1,000 widgets the first year at $25 per widget, your gross sales are $25,000. Based on industry analysis, a reasonable sales growth for year 2 is 10%. And another 15% for year 3.
That means that in year 2, you expect to sell 1,100 widgets. And in year 3, you expect to sell 1,265. Gross sales for your projections will show as follows:
- Year 1 – $25,000
- Year 2 – $27,500 (1,100 x $25)
- Year 3 – $31,625 (1,265 x $25)
You may also want to account for an increase in pricing. Maybe you plan to raise prices in year 3 based on the improved quality of the widgets. It’s all based on your expectations and historical industry trends.
Next, it’s time to calculate expenses or costs of creating your product. Break up expenses into two categories: fixed and variable.
Fixed expenses include things like building rent, utilities, and insurance. They remain the same no matter how many widgets you produce.
Variable expenses are things like marketing costs, commissions, and manufacturing costs. They rise and fall depending on how much product you’re producing. These expenses increase year over year based on your sales growth.
Interest expense depends on the type of loan your business has. Term loans have a decreasing interest pay scale determined by the length of the loan term. Interest on a line of credit fluctuates depending on how much you use the line.
Use an online payment calculator to figure monthly payments on term loans. Then include the interest portion in your expenses. Estimate line of credit interest based on how you plan to use the line throughout the period.
Now that you have income and expenses figured out deduct expenses from income to come up with your net income for the year (or net loss in the case of a deficit). It’s okay to show a net loss the first year. But you want your projections to prove that eventually, your business will post a profit.
2. Balance Sheet
The balance sheet is a visual representation of the financial health of your company. It lays out company assets, liabilities, and equity.
Start with business assets. What stuff do you have to start your company? Starting assets might include:
- Manufacturing equipment
- Office equipment
- Land and buildings
- Intangible assets (customer lists, patents, digital products)
Liabilities and equity offset assets. For a startup, liabilities include any proposed debts you’ll need to start your business.
For your widget business, it might be an equipment loan to buy the manufacturing equipment. And an operating line of credit to cover startup costs.
Business equity is the difference between the value of the business assets and the loans against them. Your balance sheet must balance every year. Here is the balance sheet equation:
Assets = Liabilities + Equity
Investors want to see how you plan to pay down debt and improve equity. They also want to see how well you use your assets to create profit (also called return on assets). That’s why the balance sheet is so important.
3. Cash Flow Statement
Thesummarizes how cash flows in and out of a business. But a word of warning: Cash flow is different than an income statement.
Most industries have a lag time between when you bill for services and when you receive the cash. Record cash only when it comes into your bank account, not when you bill for the services.
Start with the amount of cash you’ll have when your business starts operating. Let’s look at an example.
You’ve received a $50,000 line of credit for your widget business. This supplies your initial injection of working capital, or cash, in this case. That’s the start of your cash flow statement.
This initial cash injection is offset on your balance sheet by a $50,000 liability for the line of credit balance. As you spend money to get your business set up, you’ll deduct these cash expenses from $50,000. When you plan to collect cash from your customers, add that money to the remaining balance.
The cash flow statement shows you how much cash you’ll have on hand (or as a deficit) at the end of any period. This tells you when you’ll need additional working capital from investment sources. It also shows investors that you’re prepared and that you’ve done your homework.
Where to Find the Right Information
You might scratch your head and wonder, “Where the heck will I find this information?” That’s okay! The key to getting your projections right is one word: Research.
When you present financial projections to investors, back the numbers up by showing them your research. This gives the projections a level of reliability versus you pulling the numbers out of thin air.
First, if you have experience in the industry already, reference this. Let your investors know why you know what you’re talking about.
Now research the market. You’ve probably done this already when you put together your business plan.
Make sure you’re comparing apples to apples. Using financial statements from large, publicly traded firms is a way to start. An established business is a great way to benchmark where your company should be in a few years.
But for startup projections, you’ll need to find a similar company with historical figures. Get to know your industry and the main players in your area. Talk to other professionals to get their sense of how the numbers might play out.
The Small Business Administration (SBA) is a great reference for new businesses. There’s tons of information available on this site that will make your projections more reliable. Also, check out industry-related sites that focus on the financial realities of that industry.
Enlist the help of professionals. Talk to an accountant that works within the industry. Accountants will often help with projections for a small fee.
How to Make Financial Projections Like a Boss
These are a few useful tips on how to make financial projections. Hopefully, this gives you a good jumping off point.
Projections must include three statements. The income statement shows income and expenses. The balance sheet shows the financial health of your new company.
A statement of cash flows shows the investor how cash will flow in and out of your business. It’s a good benchmark to know when you’ll need more capital to support operations.
Find all the information you need by consulting with an accountant. Then do some solid research into your industry. The more research you reference, the more reliable your projections.
Are you ready to get your new business up and running? Apply for a business loan today through Dealstruck. We’re a top choice for small business lending!