How to Make Financial Projections for a Startup
Whether you’re starting a new business or making plans for an existing one, creating financial projections will give you a significant advantage.
For a new business, financial projections help you get funded and determine whether or not your business is on the right financial trajectory.
For an existing business, your projections will also help you forecast future revenue and expenses, plan for growth, decide if and when you need to fundraise, and will help you see where your business is headed.
But where exactly do you start?
In this guide, we’ll break down everything you need to know about creating financial projections. This will include what they are, what to include, and some of the most common mistakes you should avoid.
Table of contents:
- What is a financial projection?
- What should your financial projection include?
- How to make the most of your financial projections
What is a Financial Projection?
A financial projection is a forecast of how much revenue you expect to generate and what your expenses will be, broken down month by month.
In other words, it’ll answer: How much cash will flow in and out of your business in the future?
One of the most important reasons to do a financial projection is to figure out whether or not your business will be financially viable in the short, mid, and long term.
Taking the time to forecast revenue, expenses, and cash flow will show you what your financials will look like within a specific period of time.
Plus, if you’re seeking investors, you’ll need financial projections to show that you have a plan for how they’ll make a return on their investment and how long it’ll take.
One thing to note ,though, is that financial projections aren’t meant to be 100% accurate. Like any type of financial forecasting, there’s a long list of variables that can alter your projections.
For instance, if your sales team over or underperforms, it can change your sales projections. Your conversion rates can also impact revenue. Additionally, unexpected market conditions and the economy can play a role (2020 anyone?).
My point is, don’t obsess too much over trying to make your projections perfect because perfect projections and forecasts don’t exist.
What to Include in Your Financial Projection
Financial projections typically include several pieces of information that are organized into three financial statements:
- P&L or income statement
- Cash flow projection
- Balance sheet
Now, let’s dive deeper into all the parts of your projection.
Without revenue, you don’t have a business. Your projection should answer the question: How much revenue will your business generate in the next 6, 12, or 18 months (or whatever time period you’re forecasting)?
Your revenue projections help you understand how much you expect to sell and how much money you’ll have to spend on operating and growing the business.
Cost of Goods Sold (COGS)
It takes money to make money. Your cost of goods sold (also known as cost of sales) projections will help you understand how much it’s going to cost you to produce your product or service.
If you’re selling physical goods, for instance, your production costs will likely increase in relation to your sales since you need to buy materials or products in order to sell your goods.
In addition to your COGS, you’ll also have other expenses that go along with running and growing your business. Software, equipment, sales and marketing, accounting services, legal fees, and all the other costs of doing business need to be included in your expense projections.
Payroll is one of the largest expenses for most startups.
Not only should you project payroll as a whole (i.e. we expect to spend “X” amount in salaries per month), but you can also break it down by department. For instance, you can budget how much you expect to spend on salaries for sales, engineering, customer service, marketing, and all of your other teams.
|Note: You can (and should) present your revenue, COGS, expenses, and payroll projections in a profit and loss statement (P&L). Finmark makes it easy to create your P&L forecast without having to use spreadsheets and calculations. Try it free!|
Cash Flow Projections
In addition to laying out your revenue and expenses, you should also include a cash flow projection.
A cash flow projection (also known as a cash flow forecast or cash flow statement) is a monthly breakdown of:
- Accounts receivable: Cash you expect to collect. This includes the revenue from sales and any other forms of incoming cash.
- Accounts payable: Cash you expect to pay out. This includes things like the expenses we mentioned above like payroll, office rent, and supplies. It also includes other costs like loan repayments and taxes.
You subtract your accounts payable from your accounts receivable to get your monthly cash balance. That cash balance gets carried over to the next month and added to your cash balance. Here’s an example from Wave of what a cash flow projection might look like.
Cash flow projections show whether or not your company is generating cash, and how much. This will allow you to know how much cash you’ll have at any given point in time.
You can use that information to plan how to use a projected cash surplus, or anticipate when to be more conservative if you’re projecting a cash shortage.
Last but not least is your balance sheet. Your balance sheet summarizes your company’s:
- Assets: What your company owns.
- Liabilities: What your company owes.
- Shareholder equity: How much your shareholders have invested in the company.
In summary, if you’re doing financial planning in anticipation of fundraising or to take on a loan, investors or lenders will use your balance sheet to calculate your company’s projected net worth and financial efficiency.
A balance sheet projection is also handy to have for your own purposes, as well, particularly as you grow. You might not have plans to sell or seek investments today, but having the information on-hand and updated will save you a lot of stress and aggravation if and when the time comes.
Tips for Creating Financial Projections
On the surface, creating a financial projection for your business seems simple enough. It’s just a combination of different types of projections. However, there are some mistakes you’ll want to avoid. There are also a few best practices to follow in order to get the most from all the financial planning you’re doing.
First and foremost, you need to be honest with your projections. When you’re pitching to investors, it’s tempting to paint the best picture of your company. However, if your numbers are overly optimistic, it can come back to bite you if you don’t deliver.
With that said, your projections should be based on data. The longer you’re in business, the more data you’ll have to build your projections. However, if you’re creating projections for a new company, things might not be as straightforward and there’s going to be more guesswork involved.
For those situations, it can be helpful to work backwards from your target goals in order to build your projections. In our revenue forecasting guide, we walk through an example of how to project revenue growth if you don’t have historical data. You can use that same process here as well.
The gist of the process, though, is to root your projections in reality. An easy way to do that is to figure out the “why” and “how” behind any assumptions you make for your projections.
For instance, if you project 40% revenue growth MoM for the first year of your business, you need a plan for how you’re going to achieve that.
Create Multiple Scenarios
If you’ve ready some of our content, you’ll know we’re all about scenario planning and analysis. Way too many founders make the mistake of creating one financial plan and running with it.
However, you also need to prepare for what happens if things go better or worse than expected.
Not only will this help you as a founder, but it’s also re-assuring for investors. Showing them that you’re prepared in case things don’t go as planned is a good sign that you’ll be financially-ready through the ups and downs.
We recommend having three scenarios for your financial projections:
- Base plan: This is your working/operating plan that’ll likely be what you present to investors and stakeholders. It’s your base-level plan.
- Upside plan: This is your best case scenario that has assumptions of faster and larger growth.
- Downside plan: This is your “worst case scenario” that has assumptions of slower growth.
Don’t worry–you don’t need to manually create each scenario. For example, if you use a tool like Finmark you can easily create and maintain multiple scenarios for your financial model and projections. Check out our scenario analysis guide to see how the process works.
Consider Doing a Rolling Forecast
A common question founders have is: “How far out should my financial projections be?”
There are two general approaches:
- Create an annual forecast: You create a model that projects the current year (i.e. January-December)
- Create a rolling forecast: You create a model that projects the next 12 months. So in March 2022, you’d see the projections through March 2023.
A rolling financial forecast can be beneficial for a few different reasons. For one, it gives you a more dynamic view of your business. Instead of creating projections once and just sticking to it, you can update your projections in real time and see where you stand in the coming months.
On top of that, a rolling forecast is more forward looking. In October, you want to see what you’re projected to do through the beginning of the next year, not just over the last few months of the current year.
Keep in mind, a rolling forecast is easiest if you’re using a tool that takes care of the legwork for you rather than having to manually copy/paste data and formulas every month.
Check (And Update) Your Projections Regularly
Staying on the theme of making your projections dynamic, be intentional about checking and updating your projections.
It requires a bit of a mindset shift, but when you stop looking at your financial projection as just a collection of documents and more of a tool to plan growth, it becomes much more useful.
For instance, if your original projections forecast that you’ll reach $500K in MRR within the next few months, but you’ve noticed your lead volume has been declining, use that as an opportunity to dig into why you’re generating fewer leads. From that point, you can decide what you need to do to get back on track and you may have to update your financial plan based on a lower lead volume.
Your financial projections can help you gauge whether your business is growing fast enough, as well as help you predict issues before it’s too late.
Have You Made Your Financial Projections?
Financial projections paint a picture of your company’s financial performance today and in the future.
In short, whether you’re a bootstrapped startup, seed-stage company seeking funding, or a growth company that’s well funded, taking the time to create financial projections will give you a huge advantage as you build and grow your business.