Understanding Financial Projections and Forecasting
In order to get the attention of serious investors, it is important to have realistic financial projections incorporated into your business plan. Projections can be a tricky business as you try to anticipate expenses while trying to predict how quickly your business will grow. With a quick outline and some forethought, though, you can easily get a handle on your business’ financial projections.
What Is a Financial Projection?
In its simplest form, a financial projection is a forecast of future revenues and expenses. Typically, the projection will account for internal or historical data and will include a prediction of external market factors.
In general, you will need to develop both short- and mid-term financial projections. A short-term projection accounts for the first year of your business, normally outlined month by month. A mid-term financial projection typically accounts for the coming three years of business, outlined year by year.
Formatting Your Financial Projection
There are many online templates for financial projections that are a good place to start when you are preparing to draft your projections. It is also recommended that you include charts and tables when explaining copious amounts of numerical data; it is a much cleaner and engaging presentation than just paragraphs of numbers and figures.
Key Elements of Your Financial Projection
All financial projections should include three types of financial statements:
Income Statement: An Income Statement shows your revenues, expenses and profit for a particular period. If you are developing these projections prior to starting your business, this is where you will want to do the bulk of your forecasting. The key sections of an income statement are:
- Revenue – This is the money you will earn from whatever goods or services you provide.
- Expenses – Be sure to account for all of the expenses you will encounter, including Direct Costs (i.e. materials, equipment rentals, employee wages, your salary, etc.) and General and Administrative Costs (i.e. accounting and legal fees, advertising, bank charges, insurance, office rent, telecommunications, etc.).
- Total Income – Your revenue minus your expenses, before income taxes.
- Income Taxes
- Net Income – Your total income without income taxes.
Cash Flow Projection: A Cash Flow Projection will demonstrate to a loan officer or investor that you are a good credit risk and can pay back a loan if it’s granted. The three sections of a Cash Flow Projection are:
- Cash Revenues – This is an overview of your estimated sales for a given time period. Be sure that you only account for cash sales you will collect and not credit.
- Cash Disbursements – Look through your ledger and list all of the cash expenditures that you expect to pay that month.
- Reconciliation of Cash Revenues to Cash Disbursements – This one is pretty easy: you just take the amount of cash disbursements and subtract it from your total cash revenue. If you have a balance from the previous month, you’ll want to carry this amount over and add it to your cash revenue total.
- Note – One of the key pitfalls of working on your cash flow projections is being overly optimistic about your revenue. Watch this video for additional tips on how to accurately create your financial forecast.
Balance Sheet: This overview will present a picture of your business’ net worth at a particular time. It is a summary of all your business’ financial data in three categories: assets, liabilities and equity.
- Assets – These are the tangible objects of financial value owned by your company.
- Liabilities – These are any debts your business owes to a creditor.
- Equity – The net difference between your organization’s total liabilities minus its total assets.
- Note – You will want to be sure that the information contained in the balance sheet is a summary of the information you previously presented in the Income Statement and Cash Flow Projection. This is the place to triple-check your work – investors and creditors will be looking for any inconsistencies, and that can greatly impact their willingness to extend your company a line of credit.
To complete your financial projections, you’ll want to provide a quick overview and analysis of the included information. Think of this overview as an executive summary, providing a concise overview of the figures you’ve presented.
While preparing your financial projections, it’s most important to be as realistic as possible. You don’t want to over- or underestimate the revenue your business will generate. It’s a good idea to have a trusted friend or business partner review your financial projections. Also, be sure to avail yourself of all the online resources available – it’s best to learn from people who have created projections before.