You’re thinking about the future of your business. How much will sales grow from this year to the next? What will revenues look like in five years? Or, maybe you’re in the startup phase of a venture and want to know how long it will take before your business becomes profitable.
You don’t have a crystal ball, but you can make an educated guess about what the future looks like for your business. These “guesses” are called financial projections. They use existing or estimated financial information to help you predict your business’s future income and expenses. They often involve playing with different scenarios so you can see how changes to one aspect of your finances (such as higher sales or lower operating expenses) might affect your profitability.
Here’s what you need to know about making financial projections.
What Are Financial Projections?
Similar to creating a budget, financial projections are a forecast of what your business revenues, expenses, and profits will look like in the future. Typically, the projection will use internal or historical business data, along with a prediction of how external factors might change in the future.
Financial projections can help owners of existing businesses make informed decisions, attract investors, and qualify for different types of business loans. For a startup, financial projections are an important part of preparing a business plan.
You will likely want to create both short-term and long-term financial projections for your business. A short-term projection usually covers a year and is broken down by month. A long-term financial projection typically covers the next three to five years and is broken down by year.
How Do Financial Projections Work?
Financial projections use the data you already have about your income and expenses to predict what they may be in the future.
A financial projection also typically creates a “what if” scenario, where something about your company or industry is different in the future. For example, if your business is currently open five days a week and you’re wondering what would happen if you added another day, that would be a financial projection.
The process of making financial projections for your business generally involves creating three statements:
• Income statement projection
• Cash flow projection
• Balance sheet projection
Once you’ve made all three statements, you can compile your data into a report format, then share it with your team members, as well as external parties (such as investors or lenders).
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What Are Financial Projections Used For?
At a base level, financial projections can be useful to you internally in your company. You can make decisions based on projections for certain scenarios. For example, If you think that demand for your product or service will increase in the future, creating a financial projection with that in mind can help you plan for that potential outcome.
You can also use financial projections to monitor business performance. Comparing your projections to your actual financial statements on a regular basis can help you see how well your business is meeting your expectations.
Financial projections are also useful if you’re currently exploring small business loans. For one reason, you can include them when you apply for a loan to demonstrate how the funds you want to borrow will help you increase revenues over time. For another, financial projections can help you determine how much capital you need — and can afford — to borrow.
Finally, if you want to bring on investors, they will likely want to see a financial projection that outlines variables such as expenses, revenue, and growth patterns to make sure that investing in your company will be profitable.
7 Steps To Make Financial Projections
Here’s a look at seven key steps involved in making financial projections.
1. Collect Your Financial Records
The first step is to collect all of your financial records. If you’re creating a projection for a startup, you can use data and research on your industry. Though projections are estimates, the more data you use, the more reliable your estimate is likely to be.
You’ll need three financial statements — a balance sheet, income statement, and cash-flow statement — for any financial projections you create. You can use data from your accounting software in order to prepare financial projections. However, the software probably won’t help you in the preparation itself. Fortunately, there are free templates and tools for making financial projections for both existing businesses and startups available online.
2. Create a Sales Projection
Next, you’ll want to project how much your business will make in sales. If your business is already in operation, you can use past performance records (such as how your sales did in the same season or time of year in the past) to project sales over the next period. However, you’ll also want to factor in any expected changes in the economy, industry, or supply chain. New businesses will need to conduct research to get an accurate gauge on what upcoming sales might look like.
3. Create an Expense Projection
It’s generally easier to predict upcoming expenses than the buying habits of your current and potential customers. For an existing business, you’ll want to look at all of your ongoing fixed expenses, such as rent or mortgage, utilities, and payroll. While it’s impossible to know what may happen in the future — and what large one-time expenses may be coming your way — you may want to simply tack on a 15% cushion to cover unexpected costs. Startups will need to estimate their upcoming expenses.
4. Create an Income Statement Projection
An income statement projection offers a prediction of your net income (or profit) after all expenses have been paid. If your business is already in operation, you can refer to your past income statements to come up with income statement projections for the next one to three years. Take note of how your statements tend to change from one period to the next. You’ll also want to consider factors you expect to change, such as an increase in the cost of supplies, sales price, or demand. If you’re just launching a business, you’ll need to make rough estimates, trying to stay as realistic as possible so you don’t overstate your company’s income potential.
5. Create a Cash Flow Projection
Cash continually flows in and out of a business each month. Cash flow is calculated by totaling your accounts receivable and deducting it from your accounts payable, plus any cash on hand.
Calculating cash flow for the near future (what you expect to come in and expect to go out) is a cash flow projection. This type of projection can be useful for deciding if it’s a good time to invest capital into your business or if now is a better time to save. If you decide the timing is right to take out financing, your cash flow projection can show lenders that you can afford to pay back debt.
Existing businesses can create a cash flow projection using their past cash flow financial statements. A startup will need to do some industry research in order to create a cash flow projection.
6. Create a Balance Sheet Projection
The balance sheet shows what your business owns (assets), what it owes (liabilities), and its net worth at a particular point in time. A balance sheet projection can provide further insight into your company’s financial position and overall health. Existing businesses can use past and current balance sheet totals to predict where the business will be one to three years down the road.
If you are just launching a business, your balance sheet projection will have to be based on industry research, since you don’t have any past records to refer to.
7. Create a Report
Once you’ve done all the above steps and calculations, you can compile your data into a report format that works well for your organization. You may want to include charts and tables to summarize the information and make it easier to digest.
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Limitations of Financial Projections
It’s important to remember that financial projections are an educated guess. You can’t predict the future, and what you project might not actually happen exactly like the projections lay out. That said, financial projections can provide valuable data that can help you understand “what if” scenarios and lead you to making informed decisions.
Another limitation to be aware of is if you run a startup without a history of sales. It’s difficult to forecast the future if you have no past. While you can use industry data, it may not provide an accurate projection, given your company’s unique qualities.
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3 Things To Include in a Financial Projection
Financial projections typically include the following statements.
1. Income Statement
The key sections of an income statement are:
• Revenue This is the money you will earn from whatever goods or services you provide.
• Expenses This includes direct costs of producing your goods or services (like materials, equipment rentals, employee wages) and general and administrative costs (such as accounting fees, advertising, insurance, office rent).
• Total income Your total or gross income is your revenue minus your expenses, before income taxes.
• Income taxes This is the money your business pays to the government.
Net income This is your total income after income taxes.
2. Balance Sheet
A balance sheet projection provides a summary of your business’s financial data in three categories:
• Assets These are the tangible objects of financial value owned by your company, including cash, supplies, equipment, and real estate.
• Liabilities This include any debts your business owes, such as loans, payroll, upcoming payments for materials.
• Equity This is what you get when you subtract your business’s total assets from its total liabilities.
3. Cash Flow Statement
The three sections of a cash flow projection include:
• Cash revenues This is an overview of your estimated sales for a given time period.
• Cash disbursements This lists all of the cash expenditures that you expect to pay during that time period.
• Reconciliation of cash revenues to cash disbursements This involves subtracting cash disbursements from your total cash revenue. You can carry over any balance from the previous month and add it to your total cash revenue.
The Takeaway
Creating financial projections can give you a picture of what your business’s finances may look like in the future and can help you make strategic decisions. Is this a good time to bring on investors or take out a loan? Will your company be seen as a low-risk investment? Seeing the big financial picture can help you develop a clear plan for next steps for your company.
If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.
FAQ
What is included in financial projections?
Financial projections help forecast the financial performance of a business over a specific period, usually for the next one to five years. They typically include projected revenue, expenses, cash flow, profit margins, balance sheets, and income statements.
Is there a difference between financial forecast and financial projections?
Yes. A financial forecast looks at what your business will look like if all things stay equal in terms of costs and revenues. A financial projection looks at variables that may change, like the price of your products or cost of supplies.
How are financial projections calculated?
Financial projections are typically calculated based on a combination of factors, such as historical sales and expense numbers, market research, sales forecasts, expense estimates, and industry trends. The process involves making assumptions about future business conditions and applying them to the relevant financial models or spreadsheets.
What is the difference between a financial projection and a budget?
Financial projections are forward-looking estimates of a company’s financial performance, providing insights into future revenue, expenses, and profitability. They help in strategic planning and investment decisions. A budget, on the other hand, is a detailed plan that allocates resources, sets spending limits, and tracks actual financial performance to manage day-to-day operations and control costs.
What is the most widely used means for financial projection?
The most widely used means for financial projection is the use of financial modeling and spreadsheet software or specialized financial modeling tools. These software platforms can help you create financial projection reports and charts by incorporating formulas, data analysis, and scenario testing.
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