Whether you're looking to grow or just maintain your current status quo, planning for the future is important for any business owner. Part of this planning work is making financial projections of your sales, expenses, and, if all goes well, profits.
Even if your company is a startup that hasn't even opened its doors yet, you can still make projections. Here's how to create financial projections for your business plan to help your company thrive.
What are financial projections in a business plan?
A financial projection in a business plan is a company's estimate or prediction of its financial performance at some point in the future. For an existing business, it will leverage historical data to detail how the company expects metrics like revenue, expenses, profits, and cash flow to change over time.
Companies can prepare financial forecasts for any period, but typically between one and five years. Most companies review and revise these forecasts at least annually.
Creating financial projections is an important part of writing a business plan because realistic estimates help company leaders set business goals, implement financial decisions, manage cash flow, identify areas for operational improvement, raise funds from investors, and much more.
What are financial projections used for?
Financial forecasts serve as a useful tool for key stakeholders inside and outside a company. They are often used to:
business plan
Accurate financial forecasts help businesses set growth targets and other goals. They are also used to determine whether ideas, such as a new product line, are economically feasible. Future financial projections are a useful tool for business contingency planning, considering the financial impact of adverse events and worst-case scenarios. They also provide a benchmark; for example, if revenue is below forecast, a company may need to make changes to get operations back on track.
Forecasts can reveal potential problems, such as unexpected operating expenses that exceed the amount of cash coming in. A negative cash flow forecast suggests that a company needs to secure funds through outside investment or bank loans, increase sales, improve profit margins, or cut costs.
Investor
When potential investors consider putting money into a venture, they want a return on their investment. Business forecasts are a key tool they use to make that decision. Forecasts are taken into account when determining business valuations, shareholdings, exit plans, etc. Investors may also use forecasts to see if the business is meeting their goals and benchmarks.
Loans or lines of credit
Lenders decide whether to give your company a business loan based on financial projections. Lenders will want to see historical financial data, such as cash flow statements, balance sheets, and other financial statements, but they will also closely review multi-year financial projections. Good candidates may receive higher loan amounts with lower interest rates or more flexible payment plans.
Lenders may also use the estimated value of a company's assets to determine what collateral they can provide to secure a loan. Like investors, lenders typically look at long-term projections to monitor progress and financial health.
What information is included in a company's financial projections?
Before you start creating your projections, you'll need to gather some data. If you're an existing business owner, you can leverage the three financial statements you probably already have: your balance sheet, your annual income statement, and your cash flow statement.
But new businesses don't have this kind of historical data, which is why market research is key. Look at your competitors' pricing strategies, scrutinize research reports and market analyses, and scrutinize other public data that can help you make predictions. Starting with conservative estimates and simple calculations will help you get started, and you can always add more projections over time.
One company's financial forecasts may be more detailed than another's, but forecasts are usually based on and include:
Cash flow
As the name suggests, a cash flow statement shows the funds that flow in and out of a business over time, i.e., cash inflows and outflows. Cash flows are divided into three main categories:
1. work activities. These are cash flows associated with your core business activities, such as inflows from the sale of goods and services and outflows from payroll, rent and taxes.
2. Investment activities. This relates to buying and selling long-term investments such as physical assets (land and equipment), non-physical assets such as patents and intellectual property, and other long-term assets that are not cash equivalents. This includes stocks, bonds, and other securities sold after being held for at least one year.
3. Fundraising Activities. These flows represent financial activities such as raising funds through loans from investors or banks, paying interest on that debt, issuing or repurchasing shares, and paying dividends.
Profit and loss statement
A projected income statement, also known as a projected profit and loss statement (P&L), forecasts a company's revenues and expenses for a specific period of time.
Typically, this is a table with multiple line items for each category. Your sales forecast can include projected sales for each product or service (many companies break this down by month). Expenses are set up similarly: you list your expected costs by category, including recurring expenses like payroll and rent, and variable expenses like raw materials and shipping.
This exercise also results in a net profit forecast, which is the difference between income and expenses, including taxes and interest payments. Because this figure is a forecast of your profit or loss, this document is often called a P&L.
Balance sheet
A balance sheet provides a snapshot of a company's financial position at a particular point in time. There are three main balance sheet items:
- assets. Assets are tangible items of value that a company owns now or will own in the future, such as cash, inventory, equipment, accounts receivable, etc. Intangible assets include copyrights, trademarks, patents, and other intellectual property.
- liabilities. Liabilities are any debts a company owes, such as taxes, wages, accounts payable, dividends, and unearned revenue (such as customer payments for goods not yet delivered).
- net worth. The stockholders' equity figure is calculated by subtracting total liabilities from total assets. It reflects how much money, or capital, a company would have left if it paid off or liquidated all of its debts at once. (This figure can be negative if liabilities exceed assets.) In a company, stockholders' equity is the amount of capital that the owners and other shareholders have tied up in the company.
It is called a balance sheet because assets always equal the sum of liabilities and shareholders' equity.
5 steps to creating a financial forecast for your business
- Identify the objective and time period of your forecast
- Gather relevant historical financial data and market analysis
- Projected Cost
- Sales forecasting
- Make financial projections
The following five steps will help break down the process of creating a financial forecast for your company.
1. Identify the objective and time frame of your forecast
The details of your forecast will depend on its purpose: is it for internal planning, an investor pitch, or to monitor performance over time? Setting the time period — monthly, quarterly, annual, multi-year — will determine the rest of the steps.
2. Gather relevant historical financial data and market analysis
If possible, gather historical financial statements such as balance sheets, cash flow statements, and annual income statements. A startup that doesn't have this historical data may have to rely on market research, analyst reports, and industry benchmarks — all of which incumbents should also use to support their assumptions.
3. Cost Estimates
Identify future expenses based on the direct costs of producing your goods or services (cost of goods sold, COGS) and operating expenses, including recurring and one-time costs. Take into account projected changes in expenses, as they may change based on business growth, time in the market, and new product launches.
4. Sales forecasting
Forecast sales for each revenue stream on a monthly basis. These forecasts may be based on historical data or market research and should take into account expected or likely changes in market demand and pricing.
5. Prepare financial projections
Once you've forecasted your expenses and revenues, you can enter that information into Shopify's cash flow statement and cash flow statement template. This information can also be used to forecast your income statement. These steps then feed into your balance sheet calculations, which also account for your assets and liabilities.
Frequently asked questions about financial projections for business plans
What are the main components of financial projections in a business plan?
Typically, most financial projections include revenue, balance sheet, and cash flow projections.
What is the difference between a financial forecast and a financial projection?
These two terms are often used interchangeably. Depending on the context, a financial forecast can refer to a more formal and detailed document that may include analysis and context of multiple financial measures in a more complex financial model.
Do I need accounting or planning software for financial forecasting?
Not necessarily. Depending on your company's age, size, and other factors, you might be able to create financial projections using a simple spreadsheet program. However, larger, more complex companies typically use accounting software or other sophisticated data management systems.
What are the limitations of financial projections?
Forecasts are inherently based on human assumptions, and of course, humans cannot accurately predict the future, even with the help of computers and software programs. Financial forecasts are, at best, estimates based on information available at the time and are not a complete guarantee of future performance.