Financial projections are important for every type of business. But they can be somewhat daunting and difficult to get right, as you are trying to predict the future growth of your business while also attempting to anticipate your expenditure over a given period in the future. However, making realistic projections can be easy when you know how.
Billdu has put together this essential guide offering everything you need to know about financial projections: what they are, how to calculate them, and how having the right software system supporting your business can make a world of difference to the accuracy of your projections.
What are financial projections and why do they matter?
A financial projection is essentially an educated estimate of the revenues and expenditures of your business at a specific point in the future. Financial projections are important for several reasons. They enable you to forecast the predicted growth and success of your business so that you can make essential decisions regarding production, investments, and expansion. They also form a vital part of your business plan if you are trying to attract investors, as they demonstrate the predicted ability of your business to make the most of market opportunities and handle threats, so your financial projections have a direct impact on the valuation of your business.
There are generally two types of financial projection, and most businesses use both of these:
- Short-term projections: these account for your first year of business. They are usually broken down month by month.
- Mid-term projections: these usually cover the coming three years, and are broken down into yearly projections.
Both types are important, especially for start-ups and small- to medium-sized businesses wanting to attract investment.
Financial forecast vs. projection: what’s the difference?
Many people confuse the concepts of financial forecasts and financial projections, and they can be quite similar. However, there are subtle differences between the two, and it is important to understand these if you want to get your financial projections right.
1. Financial forecast
A financial forecast is defined as a prospective financial statement that presents the expected financial position, results of operations, and cash flows of your business, to the best knowledge and belief of the person or people responsible for preparing the forecast. It is based on assumptions about the most likely courses of action you expect your business to take, within the economic conditions which are most likely to exist over the given period.
As a financial forecast deals with the most likely scenarios, this is the information most often given to external stakeholders, such as potential investors, as this is considered the most important information when placing a valuation on your business.
2. Financial projection
A financial projection is also a prospective financial statement presenting the expected financial position, results of operations, and cash flows of your business, to the best knowledge of the person or people responsible for preparing it. However, instead of just being based on the most likely actions of your business and most probable market conditions, a financial projection will include one or more hypothetical assumptions which might be less likely to happen.
For this reason, financial projections are more often used internally to help you make business decisions, because they enable you to predict what could happen to your business in a variety of different specific situations, offering hypothetical answers to many “What if…?” questions. These can be highly useful when it comes to making decisions about, for example, new product lines or hiring new staff.
Why the difference matters
As the methods used to create financial projections and financial forecasts are different, it can have a significant impact on your business if you don’t know the difference between the two, as they can produce completely different figures. Projections are more hypothetical, so the figures they produce are usually not as realistic as those produced by forecasts, which are based on the most likely set of conditions. If, for example, you get a business loan based on a financial projection rather than a forecast, you could find yourself struggling to meet your repayments if you have valued your business too highly.
However, as we have seen, both types of reports have a valuable place in the life of your business and can help you meet the varying challenges of the future more successfully.
How to create financial projections
Creating accurate financial projections and forecasts is essential for every start-up and small business owner, particularly those looking for investment, as they will form an important part of your business plan. Even if you are not trying to attract investors, the insights provided by these statements are highly useful in setting your budgets and making plans for the future so your business can expand successfully and react appropriately to market conditions.
Because of this, it is important to know how to create financial projections, and what information you need to include, as these figures need to be as accurate as possible. Some businesses choose to use a financial projection template to make this process easier, but if you want to create one from scratch, you will need to include the following documents:
1. Sales forecast
This is usually a spreadsheet which predicts your expected sales over a specific period. If you are an established business, you will probably be covering the next three years. You can break these down monthly for year one, and either monthly or quarterly for years two and three. Each different line of sale should be presented in a different section showing the number of unit sales, pricing, cost of sales and gross margin, based on past and current sales.
If you are a start-up business, you will only be forecasting sales for your first year, month by month. The presentation should be the same. However, as you do not have any previous sales figures to base your predictions on, you should provide your best estimates based on a thorough understanding of your industry and market trends. If you can demonstrate that you have done your homework rather than just guessing, potential investors will be impressed.
2. Expenses budget
This is where you need to show how much it will cost your business to make the predicted amounts of sales. This section should be broken down into fixed costs and variable costs.
Your fixed costs are those that are more or less the same every month. These can include things like:
- Office rent
- Phone and internet costs
Your variable costs are those that are different every month or only occur occasionally. Examples can include:
- Advertising and promotional activities
- Cost of raw materials
- Credit card fees
- Seasonal workers
You will also need to work out the amounts of taxes and interest you expect to pay, based on your predicted numbers of sales.
3. Cash flow statement
Your cash flow statement shows the actual amounts of money you expect will be moving in and out of your business during the period you are forecasting. If you are an established business making predictions for the next three years, you should base these figures on your previous profit and loss statements and balance sheets to produce realistic estimates.
If you are a new business forecasting for your first year, you will need to do some research as you do not have any previous figures to base your estimates on. You should look carefully at your sales forecast and expenses budget to make your best assessments. You also need to remember that you will not get paid straight away for every sale – some of your invoices may not be paid for two or three months, so you need to account for this. You should work on the assumption that only 80 percent or less of your invoices will be paid within 30 days.
4. Income projection statement
This is a forecasted profit and loss statement detailing your expected profits or losses over the next three years. You should work these out using the figures you have used in your sales forecast, expenses budget and cash flow statement. A figure for each year should be included, as well as a total for the three-year period.
5. Balance sheet
Your projected balance sheet needs to account for all the assets and liabilities of your business. These are items which can’t be included in your sales and expenses figures.
For example, your assets would include any property or equipment your business owns, unsold inventory, and any invoices that have not yet been paid. Your liabilities are amounts that your business owes to other people, such as the amount you owe on a business loan or invoices from your suppliers that you have not paid yet.
The balance is the difference between the total value of your assets and the total value of your liabilities.
6. Break even projection
The point at which your business breaks even is when the amount of money it is making overtakes the amount it is spending, including interest. If your business is viable and you have worked out your figures accurately, you can use your financial forecasts to work out the predicted date when you expect it to break even. This is extremely important for potential investors, who want to see evidence that your business will grow.
How Billdu can help with your financial projections
When you are making financial forecasts or projections, you need your numbers to be as accurate as possible, so you should base them on previous figures wherever possible. Because of this, it is important to have all your essential documents, such as invoices and records of sales and payments, organized neatly in one place, so you can easily find the information you need.
Billdu makes this process quick and easy. Our cloud-based app organizes all your documents neatly in order, making it simple for you to find the information you are looking for. Thanks to the mobile apps for iOS and Android which come with the system, you can also download this information onto a smartphone or tablet, not just a PC. This means you can work on your financial projections from home if you choose, freeing up your time in the office to concentrate on other important aspects of running and growing your business.
If you would like to find out more about the difference Billdu can make to your business, click below to start your FREE trial.