Short-term and medium-term financial projections are a required part of your business for investors or lenders. Short-term projections typically cover a year and are broken down into months whereas mid-to-long-term cover 3 to 5 years.
When creating financial projections for your business, similar information is required whether it is a startup, or it is an already running business. What is different is whether you are creating your projections using historical financial data, or if you are starting from scratch. Creating projections from scratch is based on your own experience in the field, or through some market research in the industry in which your business will operate. Ideally, whether the plan is for a startup or for a business that is already running, the key sections of a financial plan and projections include:
- Sales Forecast
- Expenses Budget
- Cashflow Statement
- Balance Sheet
- Income (Profit and Loss) Statement
- Break-Even Analysis
Of importance is to follow to the latter the accounting standards set forth by the Financial Accounting Standards Board applicable for a given jurisdiction (GAAP, IFRS, etc.), which vary depending on the country in which you are residing or where your business is located.
Let us get into detail for each of the sections.
1. Sales Forecast
The section to first build up is the sales forecast. Startup businesses do not have past results to review, which makes forecasting sales difficult. It can, however, be done if you have a good understanding of the market, you are entering and industry trends. You can infer from peer businesses to get an idea of the financials. Sales forecasts based on a solid understanding of industry and market trends will show potential investors that you’ve done your homework and your forecast is more than just guesswork. Businesses that are already in existence have an easier time since they can refer to their past sales. Practically for easier understanding and flow, you should break down your revenues by daily or monthly sales with entries showing the units being sold, their price points, and how many you expect to sell. When getting into the second year of your business plan and beyond, it’s acceptable to reduce the forecast to quarterly sales. In fact, that’s the case for most items in your business plan.
2. Expenses Budget
Next is to outline your expenses. What you’re selling has to cost something, and this budget is where you need to show your expenses. This includes the cost to your business for the production of the units being sold in addition to overhead. It is advisable to break down your expenses into fixed costs and variable costs. For instance, certain expenses will be the same or close to the same every month, including rent, insurance, and others. Some costs (variable) likely will vary month by months such as advertising or seasonal sales help.
3. Cashflow Statement
This statement summarizes the amount of cash and cash equivalents entering and leaving a company on a monthly basis. As with sales forecast, cash flow statements for a startup require doing some market research since you do not have historical data to refer to. You could also use your sales forecasts and your expenses budget to intelligently estimate your cash flows. One aspect to keep in mind is that revenue will often trail sales, depending on the type of business you are operating. This may be because of delayed payments or the nature of the business, for instance, if you have contracts with clients, they may not be paying for items they purchase until the month following delivery. Some clients prefer operating on credit hence a lag in payments. You need to account for this lag when calculating exactly when you expect to see your revenue.
4. Balance Sheet
The balance sheet is simply a summary of your assets and liabilities that aren’t in the profits and loss statement. For example, any property, plant, machinery, equipment, or unsold inventory you own is an asset with a value that can be assigned to it. The same goes for outstanding invoices owed to you that have not been paid. Even though you don’t have the cash in hand, you can count those invoices as assets. This is most common where there are delayed payments or when there is an option of purchasing goods on credit. In cases where the business is being financed by a loan, the amount you owe as the business loan or the amount you owe others on invoices that are yet to be paid would count as liabilities. The balance is the difference between the value of everything you own vs. the value of everything you owe.
5. Income (Profit and Loss) Statement
Once you have generated your sales statement, expenses budget, and cash flow statement, they should be able to feed into your income statement. You could then project how much you expect in profits or losses through the three years included in your business plan. You should have a figure for each individual year as well as a figure for the full three-year period. In an income statement, sales can be projected using an industry forecasted rate mostly found in industry or sector reports. Also, remember to deduct corporate tax expenses and loan expenses in the case where the business is servicing a loan.
6. Break-Even Analysis
A break-even analysis enables you to identify a date when your business becomes profitable, that is when you will have sold enough to cover your costs. As a startup business, this is not expected to happen overnight, but potential investors would want to see that you roughly have a date in mind and that you can support that projection with the numbers you’ve supplied in the financial section of your business plan. Having done a good job in the financial statements, this should be automatic since you do not need to add any new figures. This analysis enables investors or lenders to determine the viability of your business. It is also important for potential investors, who want to know that they are investing in a fast-growing business with an exit strategy.
Create Two Scenarios
Some investors require to see the performance of your business from two angles, best-case scenario, and worst-case scenario. They are usually very interested in how a business plan will play out in both these scenarios, allowing them to better analyze the robustness, resilience, and potential profitability of the business. In such a case you will be required to use your assumptions to create two sets of financial projections that exhibit the two very different scenarios.
Conduct a Ratio Analysis
Ratio analysis is an effective way to evaluate the financial results of your business to gauge performance over time. It is important to understand the average industry financial ratios, including operating ratios, profitability ratios, return on investment ratios, and the like. With that information, you can then compare your own estimates with these ratios to evaluate costs you may have overlooked or find data to support your projected performance. These ratios help to ensure your projections are neither excessively optimistic nor excessively pessimistic.
Every entrepreneur wants to see their business operating successfully. It is therefore very easy to get carried away when dealing with estimates, especially for startups, and you end up with very optimistic projections that will feel untenable to an objective audience. Investors are quick to notice, and question inflated figures. Rather than excite investors, such scenarios will compromise your legitimacy.
Writing a business plan with complete financial planning and projections is not the easiest of things to do, especially for a startup. To successfully come up with a comprehensive financial projection, you need to have intensive market knowledge or do thorough market research. A thorough financial plan and projections will help you assess the viability of your business and at the same time attract funding from investors. Here at Vaisus, we are a team of business plan professionals and experts who are ready to assist you in creating a comprehensive, customized, and funding-reading business plan with an extensive financial planning and projections section. Schedule an appointment with us to speak to one of our consultants today!