Optimism is a healthy trait for entrepreneurs, who often need to stick it out through lean times before they build a successful business. When it comes to making financial projections, however, a healthy dose of pessimism comes in handy. Overly rosy income predictions could lead you to make decisions that jeopardize your business.
Whether you’re projecting the year to come or looking several years down the road, solid, reality-based financial projections provide a crucial road map for small business growth. Here are some tips to help you assess your success and make smart business decisions.
1. Plan for the Worst
While it would be great if your sales shot into the stratosphere this year, it’s more likely that your growth will follow a slower, more predictable curve. Overly optimistic income predictions can lead to pitfalls such as overbuying inventory or taking on debt your business can’t easily repay. Use your cash flow projection (see item #2) to figure out how you can weather the worst-case scenario for your business and stay afloat. If yours is an existing business, look at highs and lows in past years and map out a year of realistic growth. Do you see increases in your labor or supply costs on the horizon? What if your best customer leaves and you aren’t immediately able to replace the income? Thinking ahead and mapping out these scenarios ahead of time can give your business the edge it needs to survive and thrive.
2. Use Your Cash Flow Projection to Predict Problems
One of the most useful steps you can take to plan for smooth financial sailing is to project your cash flow. Estimate your cash on hand at the end of each month, after you have paid yourself and your employees and met your tax obligations. This allows you to calibrate big expenses such as capital purchases with times of the year that your business will have more cash on hand. By highlighting places where cash may be tight, your cash flow projection shows you where to focus your energies on increased revenue.
3. Find the Rhythm of Your Financial Cycle
If you’ve been in business for a while, studying your profit and loss statements from past years can help you predict the future. Perhaps the cost of one of your key raw materials goes up every year in June, or your appointment calendar tends to thin out in August. Maybe your business picks in the summer and falls off in winter, or vice versa. Build these assumptions into your financial projections and you may be surprised how close your predictions come to your actuals. If you are just starting your business, tap into the accumulated wisdom of your industry through trade publications or experienced mentors. Do informational interviews with entrepreneurs in your field and ask them about their annual sales patterns. Research can remove some of the guesswork — and surprises — from your first year.
4. Base Decisions on Your Break-Even Point
A crucial element of small business financial projections is a break-even analysis. Simply divide your total fixed expenses by your gross margin per unit. The result is the number of units you need to sell to break even over the course of a year. You may want to divide by 12 to calculate monthly sales goals.
Break-even point (in units) = Total fixed expenses (in $) / Gross profit margin per unit (in $)
Break-even point (in $) = Total fixed expenses (in $) / Gross margin rate (in %)
At the end of the day, you are in business to make a profit. When you want to launch a new product line or expand to a second location, plug the new expense into your financial projections to calculate how it affects your break-even point. Let your financial projections be your guide to sound business decisions.
5. Project, Revise, Repeat
Keep close track of your financial projections throughout the year to assess your business’ health. Compare projections to actuals to help you make more accurate predictions in the future. When you can adjust your projections to take account of changes in your business, it takes you a long way toward creating a road map to future opportunities — and avoiding pitfalls — that you can use to guide you all year long.