Creating financial projections is an important part of your startup’s business plan. If you’re seeking financing, financial projections help convince prospective lenders and investors that your business will be profitable by offering them a good return on their investment.
If you’re not seeking financing, you may think you don’t need financial projections and can just “wing it.” Big mistake. Financial projections are vital to you, too. First, they enable you to plan and budget for your new business. Second, they serve as a yardstick.
By comparing your actual financial statements to your projections, you’ll be able to see if your business is consistently falling short of your projections or surpassing them. If your projections are falling behind, then you’ll need to make some changes by raising prices, cutting costs or rethinking your business model. Conversely, if your income surpasses your projections, then you may need to hire employees, expand your facility or seek financing sooner than you expected.
In general, financial projections for a startup should go three years into the future, as it’s hard to project further than that without some historical data to use. To get started, create:
- A sales forecast. Project your sales out for at least three years, including monthly sales for the first year, then quarterly for the following years. How many customers can you expect? How many units will be sold? What is the cost of goods sold? How will you price your products?
- An expense budget. Include both fixed costs (e.g. rent for your location) and variable costs (e.g. marketing expenses). You don’t need to do an incredibly detailed breakdown, such as listing the cost of every chair you plan to purchase, but you do need general figures.
Financial projections include three basic documents that make up a business’s financial statements.
- Income statement: This projects how much money the business will generate by projecting income and expenses, such as sales, cost of goods sold, expenses and capital. For your first year in business, you’ll want to create a monthly income statement. For the second year, quarterly statements will suffice. For the following years, you’ll just need an annual income statement.
- Cash flow statement: The cash flow statement is kind of like a checking account register, but goes into more detail on how much money will flow into (income) and out of (expenses) your business. At the end of each period (e.g. monthly, quarterly, annually), you’ll tally it all up to show either a profit or loss.
- Balance sheet: The balance sheet shows the business’s overall finances including assets, liabilities and equity. Typically you will create an annual balance sheet for your financial projections.
Projecting three years in the future should enable you to forecast the break-even point, which is the point at which your business stops operating at a loss and starts to turn a profit. Most startups break even in about 18 months, although that threshold will vary based on your business model and industry.
Along with your financial statements and break-even analysis, include any other documents that explain the assumptions behind your financial projections.
“But I Don’t Know What My Sales Will Be,” You Say
The challenge for any startup entrepreneur is how to create financial projections when your business is not actually up and running. By gathering information about similar businesses, however, you will actually have a lot of data to work with.
- If you have experience in the type of business you are starting—for example, you worked at a similar business before striking out on your own—you will probably have some idea of realistic financial projections, or may be able to talk to someone who can give you more information.
- Enlisting an accountant familiar with small businesses and startups in your industry will help. An accountant will know what type of expenses, sales and profits a well-run business in your industry can expect, and will be able to help you come up with realistic financial projections.
- Use the market research you conducted in developing your business model and writing your business plan. Financial projections should be the last part of the business plan you write, because you’ll need all the other information from the plan to generate them. Industry associations and publications can help you compile accurate financial information. Look at publicly available information such as Census data about businesses and assistance from small business advisors such as those at SCORE and your local Small Business Development Center (SBDC). You can also find industry data at BizStats, BizMiner and in RMA’s Annual Statement Studies (available only in book form at libraries). You can find sample financial projections at BPlans.
Lenders and investors know that your financial projections aren’t set in stone, but you do need to make sure they are realistic. Financing sources know that startup entrepreneurs tend to be overly optimistic about their “babies,” and they will look at your figures with a skeptical eye. Your financial projections must be positive enough to get lenders and investors excited about your business, but not so pie-in-the-sky that they think you’re naïve.
Finally, discern between the types of financing you’re seeking with your financial projections. Investors are more willing to take risks, as long as you can prove your risk-taking is backed with hard data. Lenders are more cautious. They don’t need your business to be the next Facebook as long as you pay them back on time and with interest.
By carefully gathering information, understanding your financing source’s goals and striking a balance between optimism and realism, you’ll create financial projections that not only guide your business, but can help you obtain financing to start it.