Guide to Business Plan Financial Projections for Startups

Business Plan Financial Projections November 05, 2020

Hanh Truong

Writer

Creating financial projections is a crucial factor in developing a startup business plan. With forecasts that provide insight into an organization's overall cash flow and profitability, businesses can create actionable goals and foresee their performance.

Financial projections will allow businesses to present their credibility to investors and assess their growth potential. Once a startup begins operating, projections can be utilized for analysis. For instance, organizations can see if their business models are working as intended or if budget plans need to be realigned.

2 Types of Forecasts to Prioritize

Financial projections are integral to startups, as these forecasts can attract investors and lenders. When meeting with these entities, it is crucial to present pro forma statements, which are financial reports based on hypothetical scenarios.

The 2 main forecasts to include in these statements are-

1. Sales Forecast

A sales forecast should estimate potential sales in future fiscal years. It is recommended that businesses focus on monthly sales for their initial year before transitioning to quarterly assessments for the next 2 years.
This form of forecast generally includes estimations of customer turnout, the number of products sold, and inventory-related costs. Organizations can use these estimates to predict future revenue and gross profit during a given period.

When calculating the net income or actual profit in a sales forecast, businesses can use the formula-

Net Income = Gross Profit - Operating Costs

2. Expense Budget
This refers to expenses that businesses must pay to operate, such as monthly rent for the facility, equipment, or costs of marketing campaigns. By understanding the general amount of expenses, businesses will have more visibility into budgeting so that future profit margins are maximized.

Key Financial Statements

When developing projections, various financial statements will provide insight into a business's performance.

1. Income Statement

An income statement is a fundamental financial report for businesses, as it shows a summary of revenue, gains, expenses, and losses over a certain period. Also known as a profit and loss statement, an income report can be used to indicate a business's overall profitability using the net income.

It is suggested that startups examine monthly income statements for their first year to consistently monitor performance. Then, in the second year, quarterly statements can be created. As the business continues to steadily operate in following years, annual income statements should be made.

2. Cash Flow Statement

Cash flow statements provide information about income that moves in and out of businesses. This report is linked to income statements because the outward flow of cash affects net income.

Components of a cash flow statement, include-

Operation - During regular business operations, money is consistently exchanged with an inventory item. Cash also flows inward and outward with accounts receivable and payable, which are customer transactions made by credit cards and bills that organizations must pay to creditors.

Investment - Investing activities contribute to cash flow, as businesses sell their assets and make high-priced purchases, such as property.

Financing - Financing refers to the movement of money from banks and investors into businesses and payments made to shareholders. These figures will reveal total profits and expenses that a business has accrued during the month, quarter, or year.

3. Balance Sheet

A balance sheet enables organizations to assess their financial health. 3 components that are featured in a balance sheet include-

Assets - Assets are generally money, property, inventory items, or any other resource that has economic value.

Liabilities - Liabilities refer to debts, accounts payables, or loans that businesses are obligated to pay back. Resolving liabilities can take less than 12 months or longer, depending on the agreed contract.

Owner's Equity - The owner's equity is a business owner's right to all assets after liabilities have been paid off. Also known as retained earnings, the owner's equity is the amount left over when dividends paid are subtracted from the net income.

Balance sheets are usually created annually for financial estimations. Organizations can use the following formula to make a balance sheet.

Total Dollar Amount of Assets = Total Dollar Amount of Liabilities + Owner's Equity

Businesses should estimate their financial projections for 3 years in advance to estimate their break-even point. This is a key point for brands, in which total revenue can cover total expenses.

How to Create Financial Projections

It may seem difficult for a startup to develop financial projections since it has not begun its operations and there is no internal sales data to consider. However, organizations can overcome this challenge by doing research into their industry and markets.

Startup executives can follow the 3 general steps to create their first financial projections.

1. Tap Into Previous Industry Experiences

Some entrepreneurs will already have previous experiences in industries related to their new ventures. This knowledge will help with developing realistic financial projections, a timeline of growth, and expected profit margins.

2. Employ an Experienced Accountant

An accountant that has industry experience is key to creating reliable financial projections. They will be able to expertly assess a small business and determine expected profits and expenses.

3. Conduct Thorough Market Research

Market research, such as insights on consumers and demographics, is key to an efficient business plan. This will allow companies to shape their models according to their target audience.

Once a business is running, incorporating forecasting software systems will help to continually monitor its finances and market conditions. These tools will provide accurate and automated sales projections using algorithms based on historical data, enabling preparation for day-to-day operations.

Although projections are hypothetical, they must be realistic. Financial projections of a small business should be able to demonstrate its ability to pay back loans with data-driven reports. Lenders and investors must see that a startup is credible, their profitability is attainable, and that there is growth potential.