What the Hell is a Financial Projection?
Unless you’re an accountant, financial analyst, or have an odd love affair with numbers, chances are the phrase “financial projection” gets tucked away into your brain’s pocket of boredom to be reevaluated only on a need-to-know basis. This sort of perception is dangerous. Despite the less-than-compelling first impression, understanding financial projections is imperative to the sound decision-making of any entrepreneur.
Deep down, you may already know that financial projections are important. But where do you start? This article will break down the importance of financial projecting and explain the process. By the end of this article, I hope to turn the hypodermic needle that is financial projecting into a chewable gummy vitamin (the kind that you always end up eating more than the suggested serving size of).
1. What A Financial Projection Is
A financial projection is an estimate of future financial outcomes for your company. Financial projections start with a solid understanding of simple unit-level details such as: How much am I selling my product/service for? How much does my product/service cost? How many customers do I estimate? Do I need to pay for rent, insurance, or other overhead costs? Using these foundational estimates, you should be able to piece together a higher-level view of your business.
2. What A Financial Projection Isn’t
There are a lot of misconceptions about financial projecting. First and foremost, financial projections are not used for tax purposes. In fact, financial projections aren’t regulated or standardized at all. Companies don’t typically use financial projections for external purposes. Instead, financial projections clarify the internal understanding of a business venture. It is also important to note that financial projections do not require super-genius math skills. Most projections require nothing more than addition, subtraction, and multiplication. Lastly, and most importantly, a financial projection will not stay the same for long. Entrepreneurial business ventures change incredibly fast and their financials must mirror that constant iteration.
3. Why Are They Done?
As mentioned earlier, financial projections are mainly applied internally. However, they are occasionally necessary for external purposes.
Internally, financial projections help an entrepreneur visualize the future of his or her business and clarify the steps necessary to reach quantitative goals. Once an understanding of the future has been outlined, an entrepreneur can evaluate whether the business is financially valid and establish the key quantitative aspects to reach success. These key aspects could include the number of users, the cost of the product, or the number of lip-syncing videos uploaded — any quantitive measurements relevant to your business.
Externally, financial projections are mainly used by institutions and investors. These external parties will use your financial projections to estimate the value of the company and the risk it entails.
4. What does a financial projection contain?
A financial projection consists of three main reports: an income statement, a cash flow statement, and a balance sheet.
An income statement (a.k.a. a profit & loss statement) is an itemized breakdown showing your revenue, your expenses, and your profit or loss. This is the foundation of the two other reports, and it is the first one you should complete.
A cash flow statement is a report showing when you will actually have cash at your disposal. Many companies sell goods on credit, have presales, or implement some other sales tactic where the goods are given to the customer before they receive the cold, hard cash. For this reason, you need to know the “when” and “how much” of your cash.
A balance sheet is a cumulative report showing what your company owns and owes. The balance sheet includes your assets (what you own), liabilities (what you owe), and equity (what you own - what you owe). This report might seem very contrived in the beginning but it’s important.
5. What’s the key?
Keep it simple. Often, entrepreneurs feel incompetent when putting together a financial projection is because it feels like a guessing game. The reality is, it IS a guessing game. For this reason, I say keep things simple. Use Google sheets instead of excel, use the internet to estimate numbers, don’t project for multiple scenarios, and most importantly, understand the projections you are making. A simple projection is easier to keep up-to-date as your venture changes rapidly.
For further reading, I encourage you to check out the following references:
How To Write The Financial Section Of A Business Plan | Inc.
