Financial projections can seem like a daunting task for many small business owners. The idea of predicting the future, especially in financial terms, might feel like gazing into a crystal ball. However, financial projections are an integral part of any business plan and crucial for obtaining financing and guiding your company toward sustained profitability. This blog post will give you an introduction to financial projections and provide practical tips on how to create them.
Why Financial Projections Are Important
Investor and Lender Requirements: Most investors and banks require financial projections to understand the profitability potential and risk involved in your business.
Internal Planning: Projections help you set achievable goals for revenue, costs, and profitability, serving as a roadmap for future business activities.
Resource Allocation: They assist in understanding where to allocate resources for maximum ROI (Return On Investment).
Risk Mitigation: By anticipating challenges, you can create strategies to mitigate potential risks.
Here at Mainvest, we talk a lot about planning for your business, and how initial planning tools- like a business plan and projections- are not just important external documents, but essential internal guides. A good rule of thumb is that if you're struggling to complete projections or a business plan, it's indicative of more work to be done before going out to raise funds. Putting good effort into projections forces you to think critically about each element of your sales and expenses, benefitting you long-term.
Types of Financial Projections
Short-Term Projections: These are generally for up to one year and are detailed, often showing weekly or monthly projections.
Long-Term Projections: These span multiple years and are generally less detailed than short-term projections, offering a bird's eye view of the business’s financial future.
Scenario-Based Projections: These take into account different scenarios like best-case, worst-case, and most-likely scenarios to prepare for various business conditions.
How to Create Basic Financial Projections
Start with Sales Forecasts: Estimate the amount of revenue you expect your business to earn in a specific period. Consider factors like seasonality, market trends, and past performance.
Calculate Expenses: Identify all possible expenses, both fixed and variable. Don't forget costs like rent, salaries, utilities, materials, and marketing expenses.
Estimate Cash Flow: Knowing when money comes in and goes out will help you manage liquidity. Use your sales forecasts and expenses to estimate your cash flow.
Determine Profit and Loss: Subtract your expenses from your revenue to get an idea of your business's profitability.
Plan for Capital Expenditures: Large purchases like equipment or property should be factored into your projections.
Best Practices
Be Conservative: It's better to underestimate your revenues and overestimate your expenses to avoid unwelcome surprises.
Consult Historical Data: Use your business's past performance as a guide but remember that past success doesn’t guarantee future results.
Update Regularly: Your projections should be dynamic documents that are updated as you get more information.
Seek Professional Help: For complex projections or if you're new to business finance, consult a financial advisor.
Conclusion
Financial projections are a fundamental tool in your small business toolkit. They not only help you understand your business better but also instill confidence in stakeholders like investors and lenders. By dedicating the time and effort to create accurate, realistic projections, you set your business on a path for both short-term and long-term success.
Resource: To get you started on creating your own financial projections, download our Financial Projections Template here.
Disclosure: Mainvest does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.