Tips for Preparing Credible Financial Projections
Many entrepreneurs actually refuse to do financial projections beyond the first year, insisting that no one can predict the future. They need to realize that investors ask for projections, not because they believe your predictions, but because they want to understand your thought process and commitment. If you are not willing to commit, don’t expect anyone to back you.
In reality, you need to set these projections as goals for your own use, to convince employees as well as investors that you have a business which is challenging, but achievable. Projecting the financials should be the last step of your business plan preparation since it assumes you already know the opportunity size, customer buying habits, pricing, costs, and competition.
Using your data, here are the basic elements of the projection process, which are measurable by milestones, and can be tracked to show when a re-forecast is required:
- Start with sizing per-unit profitability. Margin is everything. Unless your volumes are in the millions or higher, the difference between manufacturing cost and customer price better be 50% or greater. That should be true even if your customer is really a distributor. Otherwise, sales, marketing, and operational costs will kill you.
- Next comes sales volume by channel. Here is where you need a “bottom-up” estimate from the people in your organization who have to deliver. This forecast is really their commitment. It’s tempting here to simply calculate one percent market share, and assume anyone can do at least that much. It’s not credible and won’t happen.
- Don’t forget that pesky overhead. Even with the economic downturn, it’s amazing how fast office space costs add up, in conjunction with insurance, utilities, and administrative help. Then there are computer costs, trade shows, inventory, and a thousand other things. Check industry average statistics to make sure you are in the right range.
- Cash flow is king. Your “burn rate” or net cash flow out is usually the single most important survival parameter to a startup. The holy grail is break-even when revenues first catch up with the outflow. Projecting, tracking, and controlling cash flow is the single most important job of the CEO and all other startup officers.
Beyond these basics, here are some common-sense strategy elements which will maintain your credibility with investors, and minimize your opportunity for failing:
- Add a buffer to your required investment. Calculate what you need based on the cash flow calculations above. See where your cash flow bottoms out. If the bottom is minus $400K, add a 25% buffer, and ask for $500K funding. The request size must correlate to your projections to be credible.
- Plan to re-forecast every quarter. Everyone understands the reality that startups have to adjust to market fluctuations, and financial projections are an art rather than a science. Cost projections should never be missed unless you suffer an emergency or get caught in a tsunami.
- Target aggressive but rational projections. Initial forecasts should be aggressive for credibility, but don’t shoot for the moon. Most investors have never seen a startup achieve its initial projection, so here is your chance to be a hero.
Just the process of doing financial projections allows you to see areas of strength and weakness in your proposed business model, thus enabling you to make critical adjustments sooner. For even more value, you should develop a financial model. With a few variables, like volume growth rate, and the number of salesmen, a “what if” analysis is possible on cash flow, breakeven point, and revenue growth.
Financial projections can be intimidating. But a solid financial forecast is a required cornerstone for any business plan. Without it, you will likely prove the old proverb “He who fails to plan, plans to fail.”
Related Services: Financial Forecasting.