September 12, 2011
Financial projections are the backbone of a business plan—they support the claims made throughout the business plan, and they show the strength of the business. Financial projections are also the most complex part of a business plan. If you’re looking to raise growth capital, investors will analyze your projected financial statements alongside the rest of the business plan to determine the viability of your company—and to determine how much money they can potentially take out of your business.
Typically, a business plan should include balance sheets, income statements, and cash flow statements for up to 5 years of projections. A general rule of thumb is that the upcoming year should be broken down by month, and the second year should be broken down by quarter. Years three and beyond can be annual statements, depending on how far out your projections go. Here are three tips to consider as you build your financial forecast:
Be realistic. While all potential investors would jump at the opportunity to invest in the next Facebook, most businesses rarely see hockey-stick growth. Investors who see unrealistic growth quickly dismiss the plan. Even though projections are essentially educated guesses, you’ll establish credibility if you use numbers supported by realistic assumptions. For example, you know your current cost of goods sold and employee expenses. You can realistically estimate how these expenses will grow based on your projections for sales and new hires. Be sure to include a summary of your assumptions that explains your reasoning.
Keep it simple. Business plans should only include financial projections for a single scenario: the realistic, likely outcome. Showing multiple scenarios, like the break-even outcome or worst-case scenario, may unintentionally indicate to investors that you do not fully believe in your likely outcome. Investors will more seriously consider your company if you show sound reasoning for your financial projections.
Use the projections. Many times, financial forecasts are carefully crafted, presented to investors, and then tossed aside. If you spent time and effort crafting realistic projections, your executive team can use the numbers as a benchmark. Set time aside each quarter to compare the financial projections to your actual figures. Are you under or over your original projections? Why are the figures different? An analytical approach to comparing your forecasts with actuals will let you identify potential problem areas and make changes as necessary.
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