Financial forecasts are essential tools for planning and budgeting for future revenues and costs, whether you’re an entrepreneur beginning a new firm or a member of the finance team at a well-established organization. But, before creating accurate financial projections and making financial planning, you must evaluate market demand for your product.
They show potential investors that your company can generate enough profit to cover its costs, encouraging them to invest in your business. Here are five key elements to consider when creating accurate financial projections:
Analyze Past Performance
The financial projections section of a business plan is an essential component of any startup’s fundraising presentation. Solid projections can inspire confidence in investors and make your startup attractive to further investment opportunities as it grows.
Creating projections requires thoroughly analyzing your business’s past performance and future growth. You must review your company’s most recent income statement, cash flow statement, and balance sheet.
Accurate projections can help you determine whether your startup can achieve its goals and identify ongoing problems before they spiral out of control. Additionally, it’s a great approach to ensure your budgeting is accurate and you’re getting the best results possible for your company. The distinctions between financial forecasting, modeling, and predictions must be understood and be asked by experts like Mark Hirschhorn for more reliable financial ideas.
Consider Variable Costs
Having an accurate projection is crucial for a startup. It can help you reassess your business’s weaknesses and strengths, predict potential risks and create a clear goal to progress.
Using your chosen approach (top-down or bottom-up), forecast the revenue your startup will generate and the expenses associated with reaching that level of sales. These will include fixed costs that will remain the same regardless of sales, such as location rent and internet bills, and variable costs that will change depending on your sales, such as payroll and cost of goods sold.
Then subtract your expenses from your revenue to calculate your projected operating income or net income. This will give you a number to plug into the three fundamental financial statements: an income statement, a cash flow statement, and a balance sheet.
Evaluate Market Demand
Finance forecasts are essential tools for planning and budgeting for future revenues and costs, whether you’re an entrepreneur beginning a new firm or a member of the finance team at a well-established organization. But, before creating accurate financial projections, you must evaluate market demand for your product.
You must break it down into smaller categories for analysis to forecast total industry demand. For example, a team studying the demand for industrial components divided it into its consuming industries and asked experts to provide production forecasts. This led to a forecast within 1% of the actual figure three years later.
Reliable public information exists on historical demand levels for many large domestic industries, such as steel, automobiles, and natural gas. However, for foreign markets or lesser-researched industries in the United States, you may need to commission research to obtain independent estimates.
Create a Cash Flow Statement
A cash flow statement (CFS) is a financial report that tracks future incoming and outgoing cash. It’s a separate document from an income statement and a balance sheet and excludes the non-cash items reported on the balance sheet, such as accumulated depreciation.
This document typically consists of three sections: operating cash flow, investing cash flow, and financing cash flow. The operating section represents cash received from customers less the company’s annual recurring expenses such as salaries, utilities, and supplies.
The CFS is a valuable tool for predicting how well your company will perform over the long term. A sustained negative cash flow can be problematic, whereas a steady positive cash flow may indicate your business has a bright future. Ideally, you should perform a CFS quarterly or monthly and continue to update it as conditions change.
Include a Break-Even Analysis
Even though revenue is the lifeblood of a business, it may take some time for the company to convert those sales into cash. That’s why it’s essential to include a break-even analysis in your financial projections to know when to expect positive cash flow.
Whether you’re an entrepreneur starting up your very first small business or are part of a large corporation, creating financial projections is a vital exercise that provides insight into your company’s potential highs and lows. This can be instrumental in attracting potential investors or ensuring your company remains profitable.
To create a financial projection, you must combine your revenue and expenses forecast, cash flow statement, and balance sheet. If you need help with this, consider working with a CFO to apply both their knowledge of finance and experience in helping businesses scale.
