A lot depends on how well small firms and startups can develop realistic financial estimates as part of their business plans. After all, good finances can help new enterprises determine a direction that will lead them over the challenging first year and into a fruitful and prosperous future. Good financials are a powerful lure for investors.
But even as startups grow into established companies, business owners still need to plan ahead in order to raise capital, boost earnings, and make wise financial decisions. This is why business plans with financial projections aren’t just for new companies. Existing companies can also make use of them by gathering knowledge from their current financial records, developing sales projections, and making other financial forecasts that direct and enhance their ongoing business planning.
What do financial projections in a business plan mean?
In order to create a course for growth, innovation, and competitive strength, successful businesses think ahead and cast an eye as far into the near and far future as they are able to. Financial projections employ a company’s financial statements to assist business owners in forecasting their anticipated spending and revenue in a strategically advantageous fashion, both as part of an original business plan and as part of continuous business planning.
The two forms of financial estimates that most organizations utilize are:
- Short-term projections
Monthly forecasts for the near future, which typically span the next 12 months, are made. They offer a roadmap that businesses may use to track and modify their financial activity in order to define and meet goals for the fiscal year. Short-term forecasts will be fully estimated in the first year, but past data can be used to assist fine-tune them in later years for higher accuracy and tactical usefulness.
- Long-term projections
Looking three to five years into the future is the goal of long-term predictions, which are often used to seek investment (both initial and ongoing), build a strategic roadmap for the company’s growth, or both.
Making financial estimates is part of a company’s first business plan. Presenting financial forecasts that banks and other investors may use to evaluate the financial viability of a firm is essential to acquiring the money and investments needed to begin a business.
Financial forecasts are useful for luring investors who want exact estimates of upcoming revenue, expenses, and potential growth for established businesses—for which an original business plan has evolved into effective business planning. They’re helpful in securing business loans and lines of credit from financial institutions for the same reason. Even if you are not aiming to raise money or attract investments, financial predictions can provide a useful framework for developing budgets that are focused on growth and competitive advantage.
The most crucial thing is to think of financial projections as an ever-evolving reference tool—a device that can aid in realistic growth planning and budgeting. Whether you’re a tiny business owner, an ambitious tycoon launching a new business, a part of the financial team at an established corporation, or all three, you can achieve this while still setting aspirational goals for your company.
Financial Projections: Key Elements
The same financial statements—an income statement, a cash-flow statement, and a balance sheet—are required to create financial projections, whether you’re doing so to supplement your business plan outline or as part of it.
- Income statements
The thorough information about your company’s revenue and expenses for a specific time period (such as a quarter, year, or multi-year period) is sometimes referred to as profit and loss statements.
- Cash flow projections
Give a complete picture of how money is coming into and going out of a business. They keep track of all cash flow from investing, operating, and financing activities.
- Balance sheets
They display a company’s assets, liabilities, and owner equity over a given time period.
What purposes serve financial projections?
Key stakeholders inside and outside of the company can benefit from financial forecasting. They are frequently used for:
Business strategy
A business can set growth targets and other objectives with the aid of accurate financial estimates. They are also used to assess the viability of concepts, such as a new product line. For corporate contingency planning, which takes into account the financial impact of unfavorable occurrences and worst-case scenarios, future financial predictions are useful tools. They also serve as a benchmark: for instance, if sales are not meeting expectations, the company may need to make adjustments to keep its operations on course.
Projections could identify prospective issues, like unforeseen operating costs that exceed financial inflows. A negative cash flow estimate may indicate that the company needs to raise money through bank loans or outside investments, boost sales, increase margins, or reduce costs.
To attract investors
Investors seek a return on their investment when they are thinking about investing in a business. They will employ a critical instrument to help them decide—business projections. The estimates can be used to determine your company’s valuation, equity stakes, exit strategies, and more. Investors may also use your projections to see whether the company is meeting goals and standards.
To get loans or credit lines
Lenders use financial forecasts to determine whether or not to provide your firm with a business loan. They will want copies of your balance sheet, cash flow statements, and other prior financial documents, but they will pay close attention to your long-term financial forecasts as well. Good candidates might be qualified for larger loans with more lenient payment terms or lower interest rates.
Lenders may evaluate the collateral required for a loan based on the anticipated worth of a company’s assets. Like investors, lenders frequently use your projections to monitor your progress and financial health over time.
How to Create Financial Projections for a Business Plan
Whether you’re writing a business plan or forecasting for an existing company, the process of making financial estimates is the same. The main distinction is whether you’ll employ historical data (for established organizations) or your own research and knowledge (for new enterprises or startups).
Remember that even though you will generate the essential documents independently, you’ll probably complete them by referring to each one as necessary. For instance, after creating your cash-flow statement, your sales prediction can vary. The best strategy is to think of each document as both a standalone component of the financial projection jigsaw and a resource for the others. By doing this, you can make clear and thorough financial projections.
Cash Flow
A cash flow statement, as its name suggests, displays the inflows and outflows of cash for a given period of time for a corporation. There are three basic categories of cash flows:
1. Business operations: These cash flows—inflows from sales of products and services and outflows for wages, rent, and taxes—relate to essential business operations.
2. Investment objectives: This includes any purchase or sale of long-term assets other than financial equivalents, including real assets like land or machinery, intangible assets like patents or intellectual property, or any other long-term assets. This includes stocks, bonds, and other securities that have been sold after being held for at least a year.
3. Financial operations: This flow indicates financial activity, including borrowing money from banks or attracting investors with a business plan, paying interest on the loan, issuing or repurchasing shares, and disbursing dividends.
Income statement
Known alternatively as projected profit and loss statements (P&Ls), projected income statements predict the company’s revenue and expenses for a specific time period.
This is often a table with a number of lines for each category. The sales forecast for each distinct good or service can be included in sales projections (many businesses divide this down by month). The arrangement for expenses is similar: Include recurrent costs like salary and rent on your list of anticipated costs, as well as variable costs like raw materials and transportation.
A projection of your net income, which is the difference between your revenue and costs, including any taxes or interest payments, will also be given to you as a result of this exercise. This document is sometimes referred to as a P&L because that figure represents a forecast of your profit or loss.
The balance sheets
A balance sheet provides a moment in time snapshot of your company’s financial situation. The following three components are listed as balance sheet items:
- Assets
Any tangible thing of value that the business currently has or will have in the future, such as cash, inventory, equipment, and accounts receivable, is referred to as an asset. Copyrights, trademarks, patents, and other forms of intellectual property are examples of intangible assets.
- Liabilities
Taxes, salaries, accounts payable, dividends, and unearned revenue, like payments from clients for things you haven’t yet provided, are all examples of liabilities.
- Ownership equity
In order to calculate shareholder equity, total liabilities must be subtracted from total assets. It depicts how much money, or capital, would be left over if the company paid off all of its debts at once or went out of business (this number may be negative if liabilities outweigh assets). The amount of capital that the owners and any other shareholders have committed to the business is known as equity.
Because assets always equal liabilities plus shareholder equity, they are known as balance sheets.
Guidelines for Making the Most Effective Financial Projections
Do your research
Invest in financial statement analysis and ratio analysis, focusing not only on your own business but also on the market as a whole and your industry. Learn the current ratios that are used for debt, profitability, and liquidity analysis and compare them to your own to gain a more in-depth and practical understanding of how your business functions both internally and in relation to the marketplace.
Keep it real
When predicting the future of your company, it can be all too tempting to fall victim to unrealistic optimism. Rose-colored glasses aren’t just for new companies and tiny enterprises; if established companies don’t practice excellent data discipline and temper their ambitions with realistic realities, over-inflated forecasts can cripple them as well. You won’t need to be concerned about lenders or investors looking at your diligent work if you concentrate on developing realistic but optimistic estimates.
Hoping for the best, but planning for the worst
When making your financial estimates, consider two scenarios: the best-case scenario, in which everything goes according to plan, and the worst-case scenario, in which Murphy’s Law reigns supreme. Although actual performance will surely lie somewhere between the two, investors and lenders who are evaluating your company’s financial viability will find it more appealing to have an upper and lower border.
Business planning