Building Quality Financial Projections

Probably one of the most uncomfortable things a first time entrepreneur has to attempt is their first set of financial projections.  Frequently I hear the following:

  • “Well…I don’t know how many people will buy from me!”
  • “I just took a WAG (wild ass guess).”
  • “This is so stupid…why am I doing this!”
  • “How the hell am I suppose to know?!?”

To all of them I answer “YOU are the expert in the business you are starting and You have to set some expectations for the banks and/or investors.” 

As you may have heard, “Financial projections are part art and part science”. 

So what does that mean?  It means that you won’t know how to do them until you have done them.  Sure there are some things you can estimate based on your knowledge and experience with a particular type of business, but the rest has to come from research. And, that research, is part of the overall business plan.

In other words, the “part art” is the educated guess or the assumptions you base your projections on, which inturn is based on your expectations. 

Your expectations are based on the research you completed in the written section of your business plan, that is the “part science”.

Regarding the comments above, the last one: “How am I suppose to know?!?” is peticularaly troubling. As mentioned before, you are suppose to be the expert.  But also, you should have done the research to set your expectations based on a reasonable set of (documented) assumptions. 

Banks and investors will expect you to know your stuff upside down and backwards.  If you bring in a boiler plate business plan with canned financial projections, or ones written primarily by another person with numbers that you can’t explain, you won’t be getting any money any time soon. 

After all that I hear:  “Well, all of that’s nice, but I still don’t know technically how to complete my financial projections.”  So here is the process:

  1. Make sure you have a solid financial projection program to begin with.   It can be a stand alone program or excel templates but make sure the three statements (Income Statement, Balance Sheets, and Cash Flows) are interconnected. 
     
  2. A well researched and written business plan is a must.  Every section of the business plan holds key data related to the financial statements.
     
  3. Build a Beginning Balance Sheet or Sources and Use of Funds.  Your Operations Plan should have laid out the assets you need to purchase to get started (Building / Equipment / Furniture & Fixtures / Inventory).  Get firm quotes from several sources on each.  Then document your funding based on sound business banking criteria including proper equity injection.  Finally, your balance sheet should balance i.e. sources of funds=uses of funds (otherwise they wouldn’t call it a balance sheet!).
     
  4. Build your sales / revenue projections.  The data in the Market Potential section of your business plan or independent Marketing Plan will help you bracket your expectations for sales but in general, Sales projections are determined two ways:
    • Driven from market data:  Target market size is determined in units or dollar volume and you estimate the amount of that market you can capture…bracketed by competitive factors (number, advantages, price) and industry factors (growth, decline, obsolescence). 
       
    • Driven from budgets:  When pursuing a broad market strategy it is better to determine break even point then estimate a sales goal to reach break even and eventually profitability. 
       
  5. Build your expense projection.  Again, the information you compiled in your operations plan and other parts of your business plan will help you determine appropriate business overhead expenses. 
     
    For example your location/building will determine your lease, utility, maintenance, insurance and property taxes.  Your inventory section will help you determine cost of goods sold and cash flow terms such as accounts payable.  The marketing section will help you budget your advertising and promotion expense.  And, your personnel section will help you forecast your salaries and wages, payroll taxes and benefits. 

There is no great mystery to building financial projections.  And now that we have demystified the “art and science” of it, you have the tools you need to get started and confidently plan the launch of your new business idea.

On a final note, you don’t have to go it alone.  There are business consultants located at Small Business Development Centers all across the country.  These counselors are usually well versed in business planning and helping your produce solid financial projections for your business.  So look them up and get started today! 

Or if you just can’t seem to find the answer you are looking for, ask me!  I am always happy to help an entrepreneur in need!

Donovan Wadholm
www.DIYBizPlan.com

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