Do you have a startup business idea in your mind but are unsure of presenting the financial side of your business idea? Don’t worry; you are reading the right article that will help you understand everything about preparing financial projections for startups.
Preparing the financial forecast is crucial in attracting investors, generating leads, or securing a bank loan. However, predicting numbers for the next three to five years is pretty challenging when you have not even started your business-presenting realistic financial statements to investors, stakeholders, or potential customers.
This article will explain what is a financial projection, its key components, including the projected balance sheet, projected income statement, projected cash flow, and how to create financial projections for startups.
What is a Financial Projection? Meaning and Assumptions
Financial projections are the set of estimated revenue and expense information for your business for a specified period that will help investors, potential customers, and banks in decision-making.
If your forecasts are compelling and realistic, you can impress your investors and attract desired funding through financial forecasting.
It does not mean you need to window dress the financial health of your business, but using the right approach, you should predict where your business will be reaching financially in the coming three to five years.
Assumptions Before Starting Financial Projections for Startups
Before jumping on to making projections, you must consider a few factors such as critical assumptions, scenario analysis, and the purpose of your financial statements.
Scenario analysis helps you create two to three sets of financial statements for various possibilities, such as if the business goes well for all five years if the company works at breakeven, and if the business picks up from the third year.
The purpose of your financial projection has a crucial role to play. For example, if you are preparing financial estimates for banks or financial institutions, or investors, you have to be very careful in predicting your numbers - realistic yet growing.
However, if you are preparing the projections for your internal purpose, you will more focus on the expense and the revenue side of your statements.
Assumptions are the very basis of your financial projections. You have to assume certain things as you have not started your business, and the actual scenario may deviate from what is projected. Let’s understand which assumptions you need to make.
The financial projections for startups will start from a revenue or sales forecast assumption, and you have to assume a realistic growth rate at which you expect your sales or revenue to grow each year.
For example, you may assume your revenue will grow at a 10% rate every year, and it is not mandatory to have the same rate for each year. You need to understand your market, and based on the number of units you would want to sell, you can predict different growth rates for other years.
As your revenue grows, you will expend more - pay more salary, spend more on office infrastructure or pay more tax. Expense forecast assumption will require you to assume an expense growth rate at which your expenses will grow every year.
For example, you may assume your expense for the first two years will grow at a 7% rate, while the last three years may grow at a 10% rate considering your revenue levels. The expenses you project may be more than your revenue, and it is completely fine.
As a new business, you may not make enough revenue, and your expense side might be higher than the revenue.
Key Components of Financial Projections
For any financial forecast; projected balance sheet projected income statements, and projected cash flow statements are the essential components without which the financial forecast is incomplete.
Some financial statements also include ratio analysis, primarily when applying for a bank loan.
Projected Income Statement
The projected income statement represents your sales and expense forecast which is the most crucial statement for the investors for decision-making. It is the statement that will decide whether you will get the funding or not.
The projected income statement starts by projecting sales for the first five years of your business by applying an assumed growth rate. You will deduct all the projected expenses from the revenue using the assumed growth rate.
The net result of deducting all expenses from the revenue will give you a projected net profit. A high-level projected income statement will not have segregations such as operating profit, gross profit, profit after tax, profit after interest, and depreciation and profit available to equity shareholders.
But if you are projecting everything in detail, you must include these details in your projected income statement.
Projected Balance Sheet
Your projected balance sheet will represent what assets you will hold for the first five years, how many liabilities you will have, how much capital you will be raising, and at what pace it will grow.
Investors will be keen to know the capital section of the balance sheet as they will be investing their money into your business; they would want to know at what rate it will grow.
A projected cash flow statement will provide your investors with the information on how much cash (on hand and in the bank) you have, how much money you will receive from revenue and what cash expenses will you make to run your business.
The projected cash flow statement will enable your investors to understand how much net you will receive and where you will use all your money. If you are using too long credit periods, it may impact his investment decision.
Why are Financial Projections Important?
- It enables decision-making for your investors, banks, and other stakeholders.
- Provides you with financial planning for the next three to five years so that you can focus on executing your business idea.
- Cater's long-term strategic planning for your business as the first few years are already projected.
- It helps you set goals as your revenue goals are clearly defined in the projected income statement.
- It enables you to identify your expected profits or remunerations as capital projections in the projected balance sheet.
How to Write Financial Projections Effectively?
A financial forecast for a startup needs lots of research, study, analysis, and great team efforts to make it look realistic, predictable, and optimistic. Here are some tips on preparing effective financial forecasts for your startup business.
Perform Market Research
Have a clear idea of which market you are targeting and conduct thorough research of your target market. Studying your competitor’s strategies and business models will also help you predict your revenue for the initial years.
Set Clear Revenue Targets
Whether or not your business idea works, setting clear goals on revenue will help you make serious efforts in making your business idea successful. If your revenue targets are clear, all other steps of the financial forecast will follow smoothly.
Use Reasonable Assumptions
Assumptions are the foremost requirement for preparing projected financial statements. You have to use reasonable assumptions to provide realistic projections to your investors and potential customers.
Develop a Sustainable and Fair Business Model
The business model helps you and investors understand how to make money and your strategy to achieve your revenue targets. A sustainable business model will strongly impact the decisions of your investors, and it helps prepare your financial forecast as you already have a definitive strategy to follow.
Be Realistic with the Numbers
The purpose of the financial statements should not be to receive the desired funding; they should always be realistic and show achievable results and forecasts. The more natural your financials are, the more chances you will have to get the desired funding from the investors.
Although many financial forecast templates are available, preparing compelling financial projections for startups using accurate software or application is essential. Robust financial statements developed using the right tools and under the supervision of the finance experts add more value to the numbers.
Upmetrics can help you efficiently prepare realistic, robust, and sustainable financial projections for startups that will attract more investors and serve as a strategy for you to follow to meet your organizational goals.