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Your business is chugging right along, and now you’re thinking about the future. How much will sales grow from this year to the next? What will revenues look like in five years? Or, maybe you’re in the start-up phase of a venture and want to know how long it will take before your business becomes profitable.You don’t have a crystal ball, but you still can make an educated guess about what the future looks like for your business. These “guesses” are called financial projections.Financial projections use existing or estimated financial information to help you predict your business’s future income and expenses. They often involve playing with different scenarios so you can see how changes to one aspect of your finances (such as higher sales or lower operating expenses) might affect your profitability.Making financial projections may sound intimidating, but if you can create an income statement or a balance sheet, you will be able to create financial projections. Here’s what you need to know.
What Are Financial Projections?
Similar to creating a budget, financial projections are a forecast of what your business revenues, expenses, and profits will look like in the future. Typically, the projection will use internal or historical business data, along with a prediction of how external factors might change in the future.Financial projections can help owners of existing businesses make informed decisions, attract investors, and qualify for different types of business loans. For a startup, financial projections are an important part of preparing a business plan.You will likely want to create both short-term and long-term financial projections for your business. A short-term projection usually covers a year and is broken down by month. A long-term financial projection typically covers the next three to five years and is broken down by year.
How Do Financial Projections Work?
Financial projections use the data you already have about your income and expenses to predict what they may be in the future. A financial projection also typically creates a “what if” scenario, where something about your company or industry is different in the future. For example, if your business is currently open five days a week and you’re wondering what would happen if you added another day, that would be a financial projection.The process of making financial projections for your business involves creating three statements:
Income statement projection
Cash flow projection
Balance sheet projection
Once you’ve made all three statements, you can compile your data into a report format, then share it with your team members, as well as external parties (such as investors or lenders).
What Are Financial Projections Used For?
At a base level, financial projections can be useful to you internally in your company. You can make decisions based on projections for certain scenarios. For example, If you think that demand for your product or service will increase in the future, creating a financial projection with that in mind can help you plan for that potential outcome. You can also use financial projections to monitor business performance. Comparing your projections to your actual financial statements on a regular basis can help you see how well your business is meeting your expectations.Financial projections are also useful if you’re currently exploring business loans. For one reason, you can include them when you apply for a loan to demonstrate how the funds you want to borrow will help you increase revenues over time. For another, financial projections can help you determine how much capital you need – and can afford – to borrow.Finally, if you want to bring on investors, they will likely want to see a financial projection that outlines variables such as expenses, revenue, and growth patterns to make sure that investing in your company will be profitable.
How to Make Financial Projections
Before you start, you’ll need to collect all of your financial records. If you’re creating a projection for a startup, you can use data and research on your industry. Though projections are estimates, the more data you use, the more reliable your estimate will be.You’ll need three financial statements — a balance sheet, income statement, and cash-flow statement — for any financial projections you create. You can use data from your accounting software in order to prepare financial projections. However, the software probably won’t help you in the preparation itself. Fortunately, there are free templates for making financial projections for both existing businesses and startups available online.
Limitations of Financial Projections
It’s important to remember that financial projections are an educated guess. You can’t predict the future, and what you project might not actually happen exactly like the projections lay out. That said, financial projections can provide valuable data that can help you understand “what if” scenarios and lead you to making informed decisions.Another limitation to be aware of is if you run a startup without a history of sales. It’s difficult to forecast the future if you have no past. While you can use industry data, it may not provide an accurate projection, given your company’s unique qualities.
What to Include in a Financial Projection
Financial projections typically include the following statements.
Income Statement Projection
An income statement shows your company’s revenues, expenses, and profit for a particular time period. This is a key statement because it provides a view of the net income of your business after things like cost of goods sold, taxes, and other expenses have been subtracted.You can create an income statement projection by using your current income statement to estimate your projected net income for the next one to three years. You can include any factors you expect to change, such as an increase in the cost of supplies, sales price, or demand.The key sections of an income statement are:
Revenue This is the money you will earn from whatever goods or services you provide.
Expenses This includes direct costs of producing your goods or services (like materials, equipment rentals, employee wages) and general and administrative costs (such as accounting fees, advertising, insurance, office rent).
Total income This is your revenue minus your expenses, before income taxes.
Income taxes This is the money your business pays to the government.
Net income This is your total income after income taxes.
Cash Flow Projection
Cash continually flows in and out of a business each month. Cash flow is calculated by totaling your accounts receivable and deducting it from your accounts payable, plus any cash on hand. Calculating cash flow for the near future (what you expect to come in and expect to go out) is a cash flow projection. A cash flow projection can be useful for deciding if it’s a good time to invest capital into your business or if now is a better time to save. If you decide the timing is right to take out financing, your cash flow projection can show lenders that you can afford to pay back debt.The three sections of a cash flow projection include:
Cash revenues This is an overview of your estimated sales for a given time period.
Cash disbursements This lists all of the cash expenditures that you expect to pay during that time period.
Reconciliation of cash revenues to cash disbursements This involves subtracting cash disbursements from your total cash revenue. You can carry over any balance from the previous month and add it to your total cash revenue.
Balance Sheet
The balance sheet shows what your business owns and what it owes (and its net worth) at a particular point in time. When thinking about a balance sheet vs an income statement, a balance sheet is like a snapshot in time, whereas an income statement shows a company’s performance over a period of time, like a quarter or year.A balance sheet projection provides a summary of your business’s financial data in three categories:
Assets These are the tangible objects of financial value owned by your company, including cash, supplies, equipment, and real estate.
Liabilities This include any debts your business owes, such as loans, payroll, upcoming payments for materials.
Equity This is what you get when you subtract your business’s total assets from its total liabilities.
When creating a balance sheet projection, you can use your current balance sheet totals to predict where your business will be one to three years down the road.If you’re still in the planning stages of your business, you can create a balance sheet using information you have collected from industry research.
Report
Once you’ve created the above three financial projection statements, you can compile your data into a report format that works well for your organization. You may want to include charts and tables to summarize the information and make it easier to digest.
The Takeaway
Creating financial projections can give you a picture of what your business’s finances may look like in the future and can help you make strategic decisions. Is this a good time to bring on investors or take out a loan? Will your company be seen as a low-risk investment? Seeing the big financial picture can help you get a clear plan for next steps for your company.
3 Small Business Loan Tips
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If you are launching a new business or your business is young, lenders will consider your personal credit score. Eventually, though, you’ll want to establish your business credit.
SBA loans are guaranteed by the U.S. Small Business Administration and typically offer favorable terms. They can also have more complicated applications and requirements than non-SBA business loans.
Frequently Asked Questions
What is included in financial projections?
Is there a difference between financial forecast and financial projections?
How are financial projections calculated?
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About the Author
Susan Guillory
Susan Guillory is the president of Egg Marketing, a content marketing firm based in San Diego. She’s written several business books, and has been published on sites including Forbes, AllBusiness, and Cision. She enjoys writing about business and personal credit, financial strategies, loans, and credit cards. Follow her on Twitter @eggmarketing.
