Latest Facts and News:
- The global financial planning software market is expected to reach $16.9 billion by 2031, registering a CAGR of 16.6% from 2022 to 2031.
- 82% of businesses that fail cite cash flow problems as a factor in their downfall.
- AI and machine learning are increasingly being used to improve the accuracy of financial projections.
Running a business means dealing with a lot of unknowns. How much cash will come in? What expenses will cut into profits? Will there be enough to keep things running smoothly?
Without solid financial projections, you risk cash flow problems and missed growth opportunities.
Now, imagine pitching your business to investors or banks, and they ask for projections you can’t confidently explain. Or worse, you run out of money because you didn’t plan expenses properly. That’s the kind of situation that can shake trust and derail your plans.
That’s where Focus CPA comes in. We help businesses master financial planning, including how to make financial projections that are accurate and tailored to your goals.
This guide breaks down how to create financial projections step-by-step, plus best practices to keep them precise and useful.
Understanding Financial Projections
Financial projections are predictions about how a business will do financially over a certain time, usually between one to five years. The information comes from comparing past year’s data to understand what the future of the business might look like.
But how to make financial projections can be difficult, which if done right, can be helpful for your business planning and success. These forecasts help with:
- Making smart business decisions
- Getting funding or investments
- Keeping track of budgets and resources
- Looking at possible risks and chances for growth
When discussing financial forecasting, business owners usually focus on two main types of financial projections:
- Short-term projections: Short-term projections typically look at a year and can be divided into monthly estimates.
- Long-term projections: Long-term projections span the next three to five years and are designed to attract investors or help to make a strategic plan.
Key Components of Financial Projections
Before diving into how to create financial projections, let’s understand its key components:
- Cash Flow Statement: Tracks money coming in and going out to ensure bills get paid. New businesses should use sales forecasts and expense budgets, while established ones can rely on past profit and loss statements.
- Income Projection Statement: Estimates revenue, profits, and losses over a set period using sales projections, expense plans, and cash flow data.
- Balance Sheet: Lists assets (real estate, machinery, stock, unpaid invoices), liabilities (debts owed), and equity—things not covered in revenue and expenses.
Steps to Create Financial Projections
Now that you understand the fundamentals, let’s delve into how to generate financial forecasts:
Step 1. Define Your Projection Timeframe and Purpose
The first thing to do when making financial projections is to figure out:
- Timeframe: Projections typically consider periods of one, three, or five years. Short-term forecasts (monthly or quarterly) are most effective for startups or during uncertain periods, whereas long-term forecasts are more suitable for established companies.
- Goal: Grasp what you aim to accomplish, whether it involves securing funding, strategizing for expansion, or investigating market opportunities.
Step 2. Gather Historical Data and Market Research
To make good predictions, it’s important to use both internal information and outside knowledge.
Look at:
- Historical Data: Review past balance sheets, cash flow, and income statements to track revenue, expenses, and cash flow trends. New businesses can rely on market research and industry reports.
- Market Research: Analyze industry trends, competitor performance, and customer demand using reliable sources like market reports and government data
3. Forecast Sales and Revenue
Forecasting revenue is super important for making financial predictions. Here are some revenue forecasting techniques to help you:
- Look at how your revenue has grown in the past to make predictions.
- Think about how big the market is, how fast it’s growing, and what customers want.
- Take into account how much you charge for your products and how many you expect to sell.
4. Estimate Expenses
To prepare for upcoming expenses, consider the direct expenses involved in producing your goods and services, referred to as the cost of goods sold (COGS).
You can categorize your expenses into groups such as:
- Fixed Costs: Rent, salaries, insurance, and other regular expenses. Fixed costs that will stay the same no matter how many products are sold.
- Variable Costs: Costs that change with production, like raw materials and shipping.
- One-Time Costs: Expenses for new equipment or launching a product.
Make sure to use past data and consider inflation or possible changes in how you operate.
5. Create Pro Forma Financial Statements
Pro forma financial statements are a key foundation for making your financial predictions:
- Income Statement: This document shows your expected revenue, costs, and predicted profit.
- Cash Flow Statement: This helps you track the timing of anticipated income and expenses.
Balance Sheet: This projects your future assets, liabilities, and equity.
Best Practices for Accurate Financial Projections
Now that you know how to create financial projections, let’s look at some financial projection best practices:
- Do Your Research: Analyze past data, current performance, and future growth plans. Stay updated on industry trends and shifting customer needs.
- Keep Estimates Realistic: Avoid overly optimistic projections. Plan for lower revenue and higher expenses to stay on the safe side. Many startups fail by expecting constant high growth.
- Plan for Different Scenarios: Consider best, worst, and most likely outcomes to keep your projections grounded in reality and aligned with business goals.
- Get Expert Input: Collaborate with teams across sales, marketing, finance, and product to ensure your projections are well-informed and practical.
Create Financial Projections with Focus CPA
Making financial projections is super important for a business to succeed. It’s a good idea to check and update your projections often so they match your business goals and what’s happening in the market.
Whether you’re getting ready for a funding round or just trying to understand your business’s future, Focus CPA can help you with everything you need.
Besides, we can help you with incorporation services, virtual CFO services, and more.
Financial projections should be refreshed consistently, at least quarterly, or whenever significant events occur, such as introducing a new product or entering a new market. Nevertheless, if you own a startup or a rapidly expanding business, you may wish to refresh them monthly to closely monitor cash flow and identify any possible issues promptly.
There are some really great tools you can use to make financial projections, like QuickBooks, LivePlan, and Xero.
Do scenario planning. This involves developing best-case, worst-case, and most probable outcomes to understand potential results. It assists you in identifying risks and making informed decisions based on the potential performance of different strategies in a range of scenarios.
Yes. Examine your sales forecasts and your expense budget carefully to formulate the most accurate estimates. Additionally, remember the payments that you will not receive immediately. It's wise to estimate that only around 80 percent or fewer of your invoices will be settled in the initial month.
The level of detail depends on the purpose of your projections. If it's just for your team, a simple overview might be enough. But if you're sharing it with investors or lenders, you should add more specifics, like detailed numbers, and the reasons behind your estimates.
