At any given time, all six steps must synchronize well with each other, like music is conducted in a symphony.
Isn’t it just accounting?
Far from it. The accounting will begin the day you commence your business. Though there is a lot of similarity in the discussions that involve trial balances, profit & loss statements, balance e sheets, cash flows etc., a financial projection is a futuristic view-the way things will be, say four years hence. It is like predicting your own health and planning to live by it. Your business health chart, in other words. In summary, your projections are what you plan to have happen, and your accounting records what actually did happen.
Is it all data then?
Most projections don’t involve a lot of data crunching. Not at least, in the beginning. Most projections are built before companies have generated a large amount of sales. Data crunching is typically base on analysing the past whereas projections are an attempt to predict the future. And that is what your financial projections are – a scientific blend of realistic and calculated guess work.
Are projections built brick by brick?
There is no one single way to create projections. There is no particular sequence. Parts of your future comprise the full forecast. While the steps mentioned at the beginning of the blog, are what they are just that – steps. Many times you will move up and down along the steps. Your sales forecast may be ready, but not the expenses. Because you do not (yet) know the cost of your operating expenses. The key factor is to complete all the steps, either sequentially or otherwise. Before finished, you will need to address all of the areas, including your cash flow statement, income flow as well as your assets and liabilities.
How will I project sales?
Open the spreadsheet and start feeding in data month by month (or by growth percentage), and then, year by year. Start simple and be realistic. It is better to be very realistic when building your sales forecast. As you gain more confidence, you can include the planned cost of sales. If you are already in the business, or have an idea of how your business works, things will flow easier, based on empirical evidence.
How much will I have to spend?
Draw a line-literally, between your fixed costs and variable costs. Fixed costs are rent, salaries, lease, insurance etc., while variables are those intangibles like marketing expenses. These include ads, exhibitions, promos and the like. Start with your monthly out-flow of cash and multiply them for a year and then plan the appropriate increases or decreases of each line item expense. Expense budgets are typically done over a three to five year span.
Where is the cash?
Most new businesses don’t have the amount of cash they need. You might need credit, as well. You have bills maturing based on vendor terms, and at the same time you have receivables due from customers. Therefore, your cash flow projections must include the schedule of cash (both in and out). Potential lenders and investors will analyse this carefully to make sure you will have ample opportunity to pay them back.
Where is my income?
Your net profit is your net income. You arrive at your margin by deducting cost of sales from your actual sales. From this margin, when you deduct your operating expenses, you get your net profit. So it goes without saying that your sales forecast should be developed first, and then your expense budget, to arrive at your income projections.
How much is my business worth?
When you project your balance sheet, you will have your assets compared to your liabilities. The balance between the two is how much negative or positive equity in your company. Assets include new physical things like cash, accounts receivable, machinery, furniture, equipment, and building. At the start, though, it will be things you can sell to get your money. Liabilities on the other hand, may be fixed costs like payroll, rent, lease, insurance, cost of procurement, and variable costs like interest on your loans, and various bills that are to be paid.
When do I break even?
Most businesses hope to break even after three years or less. That means there should be enough financial strength to keep the operation active and running. This is the phase when things should begin to look good to shareholders. There are exceptions, of course. If your business plan is good, you will reach a point earlier in the phase when revenues overtake your expenses. The contrary can also happen when even three or four years later, there is no break even in sight. The important point of building financial projections is to have a financial road map so that you have a good standard from which to measure your progress.
In summary, most companies build projections to obtain working capital. This should not be the end. The projections, when done properly should be used monthly or quarterly to carefully monitor your business and to identify areas of potential improvement.