Doing financial projections is one of the most confusing parts of your business plan. However, the good news is that once you have a clear business strategy in your head, financial projections are actually quite easy to do even for someone without a background in finance. Don’t be intimidated by spreadsheets. If you don’t like using spreadsheets, then don’t use them for your financial projections. The quality of your financial projections depends on how well you have backed the figures up, and not what spreadsheet formula you have used.
Ok, let’s set the scenario. You have a business idea and would like to write a business plan that includes some financial projections. You want these to be as accurate and believable as possible. The first thing to do, is to check if there are any public companies in your sector with similar products as you. For example, look at the NASDAQ and the London AIM. A good way to do this, is to use Google Finance and search within your industry sector.
Once you have done this, download their annual report which you will then have to read. Look at their business strategy and find out what their future strategy is likely to be. Then look at their Income Statement/Profit and Loss account along with the investment ratios (don’t be scared it’s all straight forward). What you’re looking for, is the expenses as a percentage of sales. Look at how much they spend on marketing, development and administration etc. It’s also a good idea to look at the “Key Financial Indicators” for your industry sector. Use these as a starting point for your projections.
The second thing to do, is find out the search volume for keywords associated with your new business. This will give you a good idea of demand. Check out the Google Adwords traffic estimator tool that will help you back up any web traffic assumptions in your projections. Once you have done this, build your projections from the bottom up. Don’t do the clichéd 1% of total market share assumption.
Here’ s an example. In year 1 you expect 100,000 unique visitors to your website. 20% of these visitors will subscribe to your mailing list and then 1% of those who subscribed to you mailing list will buy your product. As a result, the total number of sales in year 1 is 200. If you charge $1,000 for your product then your sales in year 1 will be $200,000. Simple and logical, yes?
Thirdly, like you did with your sales, build your expenses from the bottom up. Rent, light and heat, internet, salaries, marketing (pay per click?) are all easily obtained. Fourthly, subtract your expenses from your sales to get your profit/loss.
Remember the annual reports that you have read. Compare your expenses as a percentage of sales with them. Now this is important, and investors will ask you about it, so make sure you can explain any difference in your expenses as a percentage of sales particularly if they are lower than the public company’s. Another thing to remember is your industry’s key financial indicators. However, I prefer to use financial indicators from companies that I have actually read the annual reports. The reason for this is that you can better match the financial indicators with a business strategy.
Investor: Why are your selling and distribution expenses much smaller than X Plc ’s as a percentage of sales. I don’t believe you can achieve what is in your plan.
You: Our selling and distribution expenses are much smaller than X Plc because, as you can see, they have a sales team on the road but we sell 100% online. They also advertise in the newspapers while we just use Pay Per Click advertising. They sell physical software that comes with packaging. We sell our software as a web download only. We know we can attract X number of visitors because we have used Google’s traffic estimator along with Wordtracker and Overture. The web conversion rates outlined in the plan are consistent with industry averages and very realistic to achieve.
You should do projections for the next 3 years. Do not use bar charts, instead use line graphs to show increases/decreases over the three years.
Cash Flow Projections
Your Cash Flow Projections are the most important part of your financial projections. Cash is the Oxygen that keeps your business alive. Think of your business as a deep sea diver and your Cash Flow Projections as the oxygen gauge. You don’t want to run out of air halfway through a dive, do you?
These projections are also key in working out how much money you are going to seek from investors. Like all projections your Cash Flow Projections are only as good as the figures behind them.
Essentially, Cash Flow Projections are simple. They are a prediction of your money in vs. your money out. You should break your projections into 12 monthly segments for each year. This shows the amount of cash that you estimate you will or won’t have at the end of each month.
Sales, Grants and Investment etc. Most sectors have seasonality in their sales. You should reflect this in your projections. This is simply done by multiplying your total sales figure by a seasonality factor instead of dividing by 12 for each month. Remember, your cash flow is all about the month the money comes in and the month the money goes out.
Your typical expenses are included here.From basic overhead to your company’s credit card deals and transactions. If costs increase on specific items on a seasonal basis then reflect it by using the seasonality factors that you have set up. Remember, it’s all about when you pay for the expense.
Depreciation is not a cash expense and therefore should not be included in the cash flow projections.
Balances You should set up a rolling balance for each month. This is straightforward to do. It’s important to be able to track you cash balance for each month especially if much of your sales are seasonal. Your balance in month 12 is the figure you will include in your Balance Sheet.
Balance Sheet Projections
A Balance Sheet lists what the company owns and owes at a particular point in time. You will project what you think your Balance Sheet will be on the last day of each year.
The Balance Sheet should be the last thing you do in your financial projections. Basically, your Balance sheet will show your fixed assets less depreciation along with the difference in Profit & Loss (Income Statement) and the Cash Flow projections. Balancing this will be what has financed you companies activities such as an investment in the company plus the rolling Profit & Loss (Income Statement) balance that you keep in the company (this is called reserves).
Check out this free set of financial projections along with a “how to” guide.