Planning for the future is important for business owners, whether with growth in mind or simply maintaining the status quo. Part of this planning effort includes creating financial projections for sales, expenses, and, if all goes well, profit.
Even if your business is a startup that hasn't opened yet, you can still make predictions. Here's how to prepare financial projections for your business plan so your company thrives.
What is a financial forecast in a business plan?
A financial forecast in a business plan is a company's estimate or prediction of its financial performance at some point in the future. For existing businesses, use historical data to detail how the company expects metrics such as revenue, expenses, profits, and cash flow to change over time.
Companies can create financial forecasts for any time period, but typically one to five years. Many companies review and revise these forecasts at least once a year.
Creating financial projections is an important part of developing a business plan. Because realistic estimates help company leaders set business goals, make financial decisions, manage cash flow, identify areas to improve operations, raise capital from investors, etc. This is because it is useful when
What are financial forecasts used for?
Financial forecasting serves as a useful tool for key internal and external stakeholders. It is often used to:
business plan
Accurate financial forecasts help businesses set growth and other goals. It is also used to determine whether an idea, such as a new product line, is economically viable. Forward-looking financial estimates are a useful tool for business contingency planning, including considering the financial impact of adverse events and worst-case scenarios. It also provides benchmarks. For example, if revenue is lower than expected, a company may need to make changes to get its business operations back on track.
Forecasting can reveal potential problems, such as unexpected operating expenses that exceed cash inflows. Negative cash flow forecasts may suggest that a company needs to secure funding through external investments or bank loans to increase sales, improve profit margins, or reduce costs. .
Investor
When potential investors consider putting money into a venture, they are looking for a return on their investment. Business forecasting is an important tool used to make that decision. Forecasts are useful in establishing business valuations, equity stakes, exit plans, and more. Investors can also use your forecasts to ensure your business meets their goals and benchmarks.
loan or line of credit
Lenders will decide whether to provide a business loan to your company based on financial projections. They want to see historical financial data such as cash flow statements, balance sheets, and other financial statements, but they also look very closely at multi-year financial projections. Good candidates can receive higher loan amounts with lower interest rates or more flexible payment plans.
Lenders can also use the estimated value of a company's assets to determine collateral to secure a loan. Like investors, lenders typically use your projections over time to monitor your progress and financial health.
What information is included in a company's financial forecast?
Before you can sit down and create your projections, you need to collect some data. An existing business owner can take advantage of the three financial statements he likely already has: a balance sheet, an annual income statement, and a cash flow statement.
However, new businesses don't have this historical data. Therefore, market research is very important. Review competitors' pricing strategies, scrutinize research reports and market analysis, and scrutinize other publicly available data to help make predictions. Starting with conservative estimates and simple calculations will help you get started, and you can always add more projections over time.
Although one company's financial forecasts may be more detailed than another company's financial forecasts, forecasts typically rely on and include the following information:
Cash flow
As the name suggests, a cash flow statement shows the inflows and outflows of money, or cash, flowing into and out of a business over time. Cash flows are divided into three main categories:
1. work activities. These are cash flows related to core business activities: inflows from the sale of goods and services and outflows from salaries, rent, and taxes.
2. investment activities. This is anything related to long-term investments such as physical property (land and equipment), non-physical property such as patents and intellectual property, and other long-term assets that are not cash equivalents. This includes stocks, bonds, and other securities that have been held for at least one year and then sold.
3. Fundraising activities. This flow represents the financial activities of raising funds through loans from investors and banks, paying interest on that debt, issuing or buying back shares, and paying dividends.
Profit and loss statement
A projected income statement, also known as a projected income statement (P&L), predicts a company's revenues and expenses over a period of time.
Typically this is a table with multiple items per category. Sales forecasts can include sales forecasts for individual products or services (many companies break this down by month). Expenses are set in the same way. List expected costs by category, including recurring expenses such as salaries and rent, and variable costs such as raw materials and transportation.
This exercise also provides a forecast for net income, which is the difference between income and expenses, including tax and interest payments. This number is a forecast of profit or loss, which is why this document is often called an income statement.
Balance sheet
A balance sheet provides a snapshot of a company's financial position at a particular point in time. Balance sheet items include three important elements:
- assets. Assets are any items of tangible value that a business currently has or will have in the future, such as cash, inventory, equipment, and accounts receivable. And intangible literally means something that has no tangible form. Intangible fixed assets refer to estimates such as patent rights and product ideas.
- liabilities. Liability refers to anything a company owes, including taxes, wages, accounts payable, dividends, and unearned income such as payments to customers for undelivered goods.
- net worth. The shareholders' equity figure is calculated by subtracting total liabilities from total assets. This reflects the amount of money or equity that would remain in the company if the business paid or liquidated all its debts at once (this number can be a negative number if its debts exceed its assets). Business capital is the amount of capital contributed to the company by the owners and other shareholders.
It is called a balance sheet because assets always equal liabilities and equity.
5 steps to create financial forecasts for your business
- Identify the purpose and time horizon of the forecast
- Gather relevant historical financial data and market analysis
- Spending forecast
- sales forecast
- make financial forecasts
The following five steps will help walk you through the process of creating a financial forecast for your company.
1. Identify the purpose and time horizon of the forecast
The details of the forecast may vary depending on its purpose. Is it for internal planning, pitching to investors, or monitoring performance over time? Setting the time period (monthly, quarterly, yearly, multi-year) will inform the rest of the steps.
2. Gather relevant historical financial data and market analysis
If possible, collect historical financial statements such as balance sheets, cash flow statements, and annual income statements. Startups without this historical data may need to rely on market research, analyst reports, and industry benchmarks. All of these should also be used by established companies to support their own hypotheses.
3. Forecasting expenses
Identify future expenses based on the direct costs of producing goods and services (cost of goods sold, COGS) and operating expenses, including recurring and one-time costs. Take into account expected changes in expenses. This is because it can change based on business growth, time on the market, and new product launches.
4. Sales forecast
Shows project sales for each revenue source by month. These forecasts may be based on historical data or market research and should take into account predicted or expected changes in market demand and prices.
5. Make financial projections
Now that you have a forecast for your expenses and revenue, you can incorporate that information into Shopify's cash flow calculator and cash flow statement template. This information can also be used to forecast income statements. These steps then inform the calculations on the balance sheet and also record assets and liabilities on the balance sheet.
Frequently Asked Questions about Business Plan Financial Forecasting
What are the main components of financial forecasting in a business plan?
Generally, most financial forecasts include revenue, balance sheet, and cash flow projections.
What is the difference between a financial forecast and a financial forecast?
These two terms are often used interchangeably. Depending on the context, a financial forecast may refer to a more formal and detailed document, one that includes the analysis and context of several financial indicators in a more complex financial model.
Do you need accounting or planning software for financial forecasting?
necessarily. Depending on factors such as the age and size of your business, you may be able to create financial projections using a simple spreadsheet program. However, large and complex businesses typically use accounting software and other types of sophisticated data management systems.
What are the limitations of financial forecasts?
Forecasting is inherently based on human assumptions, and of course humans cannot truly predict the future, even with the help of computers and software programs. At best, financial forecasts are estimates based on information available at the time and are not guarantees of future performance.
