Why Your Business Needs Financial Projections
Do you have specific goals for growing or improving your business? Are you planning to hire more employees, expand your product line, or add to or renovate your space? In order to plan for the future, you will need to learn to create detailed financial projections. Financial projections provide the insight necessary for business owners to make the right decisions. They also give potential investors or lenders the data they need to understand your business.
What Are Financial Projections?
As the name suggests, a financial projection is a summary of what is expected to happen with your business based on the data gathered either from your own reports or from other businesses in your industry. Often people will create financial projections when they are making choices about what is best for the company moving forward. They will gather financial data on income and cash flow, as well as balance sheets, and extrapolate from that data what they expect to happen in the future. They can then make the necessary decisions about how to proceed in order to meet their goals.
If you don’t understand the past, how can you hope to predict the future? You can’t.
Financial projections are also necessary if your business is seeking capital. Before they commit to giving your company the capital you need, lenders and investors will ask detailed questions. These questions are designed to ascertain risk. Essentially, they want proof on paper that your business is successful (or will be) and worthy of investing in. They want to know that they will get a return on their investment in your company. Financial projections can give them that peace of mind.
Part of the Financial Planning Process
A solid financial plan involves:
- Deciding on realistic personal and financial goals
- Determining where you are financially now and where you want to be
- Creating a plan to reach those goals
- Putting that plan into motion
- Evaluating your progress periodically to determine success
- Adjusting the plan accordingly
Financial projections are part of Step 2 of this process. They are financial statements that extrapolate a future financial outcome or position given one or more hypothetical assumptions. You need three financial statements to do this: a balance sheet, an income statement, and a cash flow statement.
For example, Michael owns a successful collision repair business, and he’s considering opening another location. He’s had year-over-year growth for several years. By gathering data on his sales revenue, operating costs, capital expenditures, cash flow, taxes, and more, he can understand how well his business is doing. He’ll know if business is regular or if there are periods of greater or lesser productivity, such as during the summer or winter holidays. He can look at his labor costs, benefit costs, and overall productivity and determine if adding more staff or expanding his current location would be enough to meet demand.
In creating a financial projection, Michael has the information he needs to make decisions about staffing, inventory, marketing, or expansion. He can also take this information to a lender if he decides that his plans for the future require further capital investment.
Financial projections aren’t only useful for determining the advisability of new projects, of course. They are useful for making day-to-day decisions as well such as changing pricing, products, or production. Businesses will have short-term projections covering the upcoming year and broken down month by month, as well as long-term projections for the next three to five years.
A new business owner may not have enough of his own data to accurately project. In this case, a financial projection will involve collecting data on companies in his industry and area. Entrepreneurs in the planning stages will also need to create projections to write a business plan.
Sometimes, financial projections prove to be inaccurate. Business owners, no matter how carefully they plan, can’t always predict recessions or prolonged periods of lockdown. They can’t know if a storm or flood will do damage to their building or what federal trade policy will be. It’s still very worthwhile to do financial projections, however. If a situation arises and sudden decisions have to be made, having that data to look over will be very helpful.
About the Author
Vincent B. Mastrovito, CEPA, is a certified exit planning advisor as well as the founder and president of Prometis Partners. He may be reached at 616- 622-3070 or firstname.lastname@example.org.
Prometis Partners is an MMA Premium Associate Member and has been an MMA member company since September 2018. Visit online: prometispartners.com.