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.
What are the main advantages of financial projections?
Developing precise financial projections for your startup or small and medium business offers numerous advantages. Here are some of the main advantages that financial projections offer you.
- Strategic Planning: Projections guide long-term strategy.
- Informed Decisions: Basis for smart choices.
- Risk Mitigation: Identify and mitigate financial risks.
- Investor Attraction: Attracts investors with stability.
- Resource Allocation: Optimizes resource use.
- Budget Management: Foundation for budgeting.
- Performance Evaluation: Benchmarks for improvement.
- Tax Planning: Estimates and optimizes taxes.
- Compliance: Meets reporting requirements.
- Stakeholder Transparency: Offers transparency.
- Long-Term Vision: Guides long-range plans.
What Are Financial Projections Used for?
The significance of financial projections cannot be overstated in the world of business. They serve as a dynamic tool with multifaceted applications, benefiting both established business owners and enterprising individuals embarking on startup ventures. When meticulously crafted in adherence to best practices, financial projections fulfill several pivotal roles, which include:
- Strategic Planning: Financial projections are instrumental in setting and aligning long-term strategic goals for a business. They help leaders make informed decisions about growth strategies, market expansion, and resource allocation.
- Budgeting: Financial projections provide the foundation for creating detailed budgets. They allow businesses to estimate their future income and expenses, enabling effective budget management and resource allocation.
- Investor Relations: Accurate financial projections are essential when seeking investments from venture capitalists, angel investors, or crowdfunding platforms. They demonstrate the potential return on investment and financial stability of the business.
- Loan Applications: Lenders often require financial projections as part of loan applications. These projections serve as a basis for assessing a business’s ability to repay the loan and manage its financial obligations.
- Performance Evaluation: Financial projections serve as benchmarks for assessing the actual financial performance of a business. Comparing projections to actual results helps identify variances and areas for improvement.
- Risk Assessment: By modeling different scenarios, financial projections assist in identifying potential financial risks and developing strategies to mitigate them. This proactive approach enhances risk management.
- Resource Allocation: Projections aid in optimizing resource allocation, including staffing, inventory, and marketing budgets, to maximize efficiency and profitability.
- Tax Planning: Accurate financial projections are crucial for estimating tax liabilities and identifying opportunities for tax optimization, reducing the overall tax burden.
- Mergers and Acquisitions: Financial projections are used in valuing potential acquisition targets and assessing the financial benefits and risks of mergers or acquisitions.
- Compliance and Reporting: Various industries and regulatory bodies require businesses to provide financial projections for compliance and reporting purposes, ensuring adherence to legal and industry standards.
- Stakeholder Communication: Financial projections offer transparency and clarity to stakeholders, including shareholders, board members, and employees, regarding the financial direction and objectives of the company.
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. Here are some of the main differences:
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| Provides a strategic financial plan, often including best-case, worst-case, and most-likely scenarios. | Estimates future financial trends and outcomes based on historical data and trends. |
| Incorporates various assumptions, including market trends, business strategies, and external factors. | Generally relies heavily on historical data and past performance. |
| Offers greater precision by considering a wider range of variables and scenarios. | Tends to be less precise due to its reliance on historical data and limited assumptions. |
| Used for long-term planning, securing investments, attracting investors, and assessing strategic initiatives. | Commonly used for short-term budgeting, day-to-day financial management, and immediate decision-making. |
| More adaptable to changing market conditions, allowing for scenario analysis and strategic adjustments. | Typically less flexible and adaptable to changing circumstances. |
| Valuable for identifying, analyzing, and managing financial risks through scenario planning. | Less suitable for assessing and mitigating potential risks. |
| Often meets reporting and compliance requirements, making it suitable for external stakeholders and regulatory purposes. | May not always meet reporting and compliance requirements for certain industries or regulatory bodies. |
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.
9 Common mistakes with financial projections
Financial projections can be tricky, and mistakes are not uncommon. In this section, we’ll highlight nine common errors in financial projections.
To enhance the efficiency of your invoicing processes and reduce the occurrence of invoicing mistakes, we highly recommend delving into the following article focused on common invoicing errors.
1. Unrealistic Profitability
Many business plans project unrealistically high profits, often too early. Startups typically prioritize growth over profits in the early stages.
2. Underestimated Marketing Expenses
Marketing costs, especially for tech businesses, can be substantial, often accounting for around 30% of sales.
3. Neglected Development Costs
Don’t overlook expenses like development, testing, certifications, and regulatory compliance.
4. Channel Sales Impact
Selling through distributors and retailers can impact profits and cash flow due to their margins and payment timelines.
5. Unrealistic Sales Forecasts
Avoid projecting sales based on a small percentage of a large market; use drivers like web visits, conversions, or channel assumptions.
6. Cash Flow Consideration
Profitability doesn’t guarantee cash flow. Incorporate cash flow projections to assess your liquidity.
7. Accounts Receivable Impact
Selling on account (B2B) means sales generate accounts receivable (AR), which affects cash flow but may not reflect immediate cash in hand.
8. Sales Cycle Underestimation
Lengthy sales cycles in B2B scenarios can strain cash flow and need to be accurately accounted for.
9. Inventory’s Cash Flow Impact
Inventory expenses can impact cash balances before they appear in the profit and loss statement.
How 7 Industry Experts Use Financial Projections?
Looking for something more specific? Don’t worry. We’ve compiled advice and insights from seven industry experts to offer you valuable tips and guidance.
We asked each expert 4 key questions.
- How often should a business update its financial projections?
- What common mistakes do businesses make when creating financial projections?
- What advice would you give to someone creating financial projections for the first time?
- Can you provide any examples where financial projections greatly impacted a business decision?
Thought leader: Adam Hoeksema
Position: Co-Founder and CEO
- Although I think there is value in creating a living financial projection that is updated quarterly based on your actual results, in my 10 years of experience at ProjectionHub I have found that businesses tend to create financial projections for one primary reason, their potential investors or lenders have asked for their projections. When financial projections are the thing standing in the way of securing funding from investors or lenders, the task of forecasting moves from your nice to do list, to your must do list. I understand that most business owners are incredibly busy, so even though it might be nice to always have an updated set of financial projections, I realize that for many businesses, just creating projections on an as needed basis is okay too!
- The two most common mistakes that I see businesses make when creating financial projections are:
–No assumptions to back up revenue projections – Often when I see client revenue projections, all I see is a monthly revenue number with no detail or assumptions to demonstrate how they got to that revenue number. Projections should be built from the ground up based on a set of assumptions that are backed by data when possible.
-Ratios and margins are outside of industry norms – I often see projections where a client is projecting to generate a profit margin that is far higher than an industry average. For example, if you are projecting a 50% profit margin for your coffee shop which is probably 5 to 10 times the industry norm and significantly higher than a best in class coffee shop like Starbucks, then you are probably doing something wrong in your projections. - I am biased here, but I would say use a template. I have seen so many Excel files where the business clearly started with a blank Excel sheet and just started building their forecast, but inevitably after hours and hours they reach a point where it becomes quite difficult to get the pro forma financial statements to actually come out correctly. Often the projected balance sheet doesn’t balance. Even for a seasoned accountant, building a balance sheet forecast from scratch is not an easy task, so starting out with a battle tested template can save so much time and frustration.
- One of my favorite examples is when a client was trying to build a marketplace that connected independent musicians with service providers that could provide a specific type of promotion service. My client’s platform would take 10% of each transaction made on the platform. As we built out the projections we realized that the business just didn’t make sense. The client estimated that independent musicians might need about $10 million worth of this service per year and if their platform captured 100% of the market they would only get 10% of the transaction, so their total revenue potential was $1 million per year. The client was looking to raise millions in investment to build out the platform, but after realizing that the maximum revenue was just $1 million per year it became clear the business model was not investable. The projections actually helped save the client from wasting millions of dollars and years of his life building a business that just couldn’t work.
Thought leader: A group of experts
Position: Financial Experts
- Building your financial projections properly isn’t a simple (or particularly enjoyable) task, so founders need to strike a balance between remaining current and reflecting meaningful change. Typically, reasons for an update might include updating valuation for ESOP issuance or fundraising, or when a company goes through a major change in strategy or pricing. Up-to-date projections might be required in the event of opening a bank account or getting access to credit. The ease of updating projections will also vary significantly based on stage and business model:
– At one end of the spectrum, you have a very early stage company building a hardware product. Their projections will be stacked with uncertainty, and may hinge upon key milestones around development, testing and manufacturing before they’ve even got to testing sales performance.
– At the other end, you have a well established SaaS company with reliable subscription based revenue and fairly predictable growth. Their projections could be automated with reporting from sales data or accounting software.
- Most of the time, financial projections are viewed as an output, and as a means-to-an-end with regard to valuation and fundraising. In truth, they can (and should) be a much more useful process in developing your business and pitching it to investors. We have a simple framework that we advise founders to apply when thinking through all of this:
Generally, businesses begin with an ‘ambition’, the big goal they are aiming for. This evolves into the second stage of ‘strategy’, where that ambition is converted into a series of actions. These actions should then form the basis of your financial projections, meaning both the strategy and the projections should be singing the same tune. Often, that connection is overlooked or underworked. Consider particularly how costs will scale with revenue growth, in terms of sales staff, tools, marketing and support personnel, etc.
The final step is to close the loop by reconciling your financial projections with your ambition. That is, are you actually heading in the right direction to achieve that ambition? Should you have a slightly less ambitious target, or should you raise a little more to get there? Working your way through this loop is a great way to ensure that your business plan is as solid as possible, and the vision you are presenting to investors is coherent – which is the best way to reduce perceived risk.
- An interesting observation we’ve made over the years is the difference between the projections of startups that have zero revenue, and startups that have even just a small amount of revenue.
Pre-revenue startups are generally very optimistic about revenue growth. Coming at the problem from a position that is almost entirely based on assumptions allows them to forecast the stereotypical hockey-stick style growth. You just throw a bunch of money at Facebook ads, and everyone will recognise how valuable your product is, right? This changes significantly as soon as the founders have had to actually go out and close a few sales, and get a better understanding of what conversion rates look like, how long procurement cycles are, or which channels actually work for them. Projections immediately become much more reasonable, and much more trustworthy.
So the advice we would give to founders is that even if you are technically a ‘pre-revenue’ startup, it’s well worth validating as much as you can about the sales process for your product in advance.
- A few years ago we were speaking to a small business selling artisanal goods. The founders were trying to raise money for better equipment and increased output, but were having a hard time getting the attention of investors.
Looking through their financial projections, it was clear that they were barking up the wrong tree. They had good revenue and strong margins, with a loyal customer base, but – due to the nature of their product – relatively slow growth. It wasn’t a proposition with the kind of massive return potential that typical investors look for; it was never going to be a unicorn – at least not in the next decade. Instead, a simple bank loan would be a much more appropriate avenue for additional capital – and a bank would look favourably on the quality of their financial performance.
This is a good example of aligning financial projections with ambition and strategy. Sometimes you have to look at a problem via the numbers to see the truth of the situation.
Thought leader: Jonathan Merry
Position: Founder and Finance Expert
- The frequency of updating financial projections depends on your business’s nature and the market’s pace. Generally, a thorough forecast once a year gives a big picture, while lighter updates every quarter capture shorter-term changes.
In the financial services sector, I’ve seen that annual deep dives help align long-term goals with financial strategies, considering both internal shifts and market trends. But because business isn’t static, lighter quarterly updates catch immediate trends and let you adjust strategies accordingly. Remember, financial projections look ahead 2 to 5 years. This range balances staying relevant in the face of change while allowing time for strategic plans to unfold.
- Starting with top-down assumptions might seem logical, but it’s often better to work from the bottom up. Using terms like “conservative” can backfire – investors are already aware of startup risks. Assumptions need to be data-driven, not just guesswork. Instead of relying on broad estimates, dive into specific market data. Also, don’t mix up Cost of Goods Sold (COGS) with other expenses – COGS should only cover costs directly tied to producing and selling. Depreciation is another factor often overlooked. Even though it’s a non-cash expense, including it in projections shows long-term thinking that can impress investors.
- While templates are handy for making financial projections, I can’t stress enough the game-changing role that accounting software can play in making these projections rock-solid, especially if you’re aiming to attract investors or secure more funding. When you’re pitching to potential investors or lenders, having accurate numbers and clear trends can seal the deal.
You can rely on spreadsheets and manual bookkeeping to handle business finances and projections, but as things get more complex, you will definitely see their limitations become obvious. Accounting software can not only make creating projections smoother but also boost accuracy and the ability to whip up comprehensive reports.
- During the early stages of my startup, we pivoted. Our existing business model seemed promising, but there were uncertainties lingering around its long-term sustainability.
Our financial projections played a pivotal role in shaping our course of action. We analyzed deep into the numbers, running scenarios, projecting revenues, and all. The projections didn’t just nod in agreement with our status quo. They kind of waved red flags in our faces. So, we took a leap, switched gears, and embraced a more sustainable model that syncs with where the industry was headed.
Thought leader: Mark Stewartcpa
Position: Finance Expert
- Businesses can update its financial projections annually, quarterly or monthly for a more strategic business plan, it is important that they leave the financial projection system flexible enough when unforeseen projections need to be done. For example to improve investor relations, or to overcome disruptions.
- Two common mistakes that businesses make while creating financial projections are:
Over reliance on past data: While past data can be a useful tool to create financial projections, it is also important to input present situations and potential future changes. The business environment is dynamic and certain shifts and data for financial projection cannot be captured by historical data alone.
Making unrealistic projections: It is absolutely encouraging to aim for the top. However, while creating financial projections, making unrealistic projections will put your business under unnecessary pressure. - When making financial projections for the first time, get advice from experienced people outside your team who know your industry. They can give you useful insights and point out things you might have missed in your projections.
- Financial projections play a crucial role in guiding our business decisions, particularly during times when enhancing our business visibility is important. We rely on projections to determine if we can naturally boost our visibility or if we should invest extra effort to ensure our success during specific business seasons.
Thought leader: Niclas Tim
Position:Investor and Financial Expert
- In the ever-changing startup ecosystem, I always advise our clients to revisit their financial projections quarterly. Real-time data and market feedback play crucial roles in refining these numbers to better reflect reality.
- At Spectup, we’ve observed many startups making overly optimistic revenue projections without considering real market size, costs, or unforeseen challenges. They often neglect seasonal fluctuations and underestimate the time to market, which can lead to liquidity issues.
- For those embarking on creating financial projections for the first time, it’s vital to ground your projections in tangible data. Don’t just use your intuition. Dive deep into industry reports, consult mentors, and engage in thorough market research. It’s better to be conservative and surpass your projections than to over-promise and under-deliver.
- There’s a case I recall where a startup in the EdTech space was eyeing rapid expansion. Their aggressive projections highlighted potential cash flow issues in the third quarter. Upon our advice, they sought additional funding beforehand, avoiding a financial crisis and ensuring sustainable growth.
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.
