An Intro to Startup Financial Projections
Startup financial projections provide new businesses with a roadmap to understand financial health and organizational needs. By using appropriate financial statements, scenario analysis, and developing accurate financial forecasts, you can lead your strategy with confidence.
Running a startup can be a thrilling experience. Making your first sale, building your team, and celebrating your first year are all milestones worth looking forward to. Creating financial statements and projections might not be part of the appeal of operating a startup—but it’s a crucial process.
As your business grows, you’ll need clarity on how much cash flow you can expect to generate in order to best utilize it. Mastering financial projections can give your startup a competitive edge.
This is a step-by-step guide on how to create financial projections and position yourself for success.
What is a startup financial projection?
A financial projection is a financial model predicting future revenues and expenses.
It’s the GPS navigation that keeps you headed to your intended destination and prevents you from driving your business off a cliff.
There are two basic types of financial projections:
- Short-term: Typically one year broken down by each month. These projections aid in the development and execution of short-term goals.
- Long-term: Typically three to five years. These projections inform longer-term strategic initiatives and investments.
You will want to account for both internal and historical data, as well as external market forces when creating your financial projections.
The “Big Three” Financial Statements
Three financial statements are essential to preparing financial projections:
The Income Statement
Also known as the P&L, or profit and loss statement, this contains all your expenses, revenue, and profits over a given financial period. Potential investors use the income statement to understand your startup’s financial health and competitive strength.
The income statement should include:
- Expenses, including both fixed costs and variable costs
- Net Income
- Income Taxes
- From here you can calculate your earnings before interest, taxes, depreciation, and amortization, which is a proxy for cash flow and the figure most investors are interested in.
The Cash Flow Statement
Having an understanding of cash flow is absolutely essential for startups, especially since 82% of small businesses fail because of cash flow management issues. Your cash flow statement summarizes cash inflows and outflows by category.
There are 3 parts to the cash flow statement
- Operational cash flow: relates to essential business operations such as revenue and operational expenses.
- Investment cash flow: relates to investments in or selling of assets, as well as the cost of goods and equipment.
- Financial cash flow: relates to financing activities or fundraising.
The Balance Sheet
Your balance sheet contains all assets and liabilities. Basically, it is what you own and what you owe. It also details the amount of capital invested by shareholders or owed to lenders.
This is another statement that financial analysts or potential investors can use to understand your startup’s financial health. They can derive important ratios such as the debt-to-equity ratio and acid-test ratio from the balance sheet.
Scenario analysis for financial projections
The future is uncertain. A banner year might lead to your best-case scenario, or a global pandemic could hit and cause a worst-case scenario.
Scenario analysis is the process of evaluating various possible scenarios that could occur in the future and predicting feasible results or possible outcomes for each.
Typically, business owners start with creating multiple financial models:
- Base case scenario: the average scenario based on management assumptions. You would either use historical data or industry benchmarks to make conservative predictions about likely outcomes.
- Worst case scenario: the worst or most severe possible outcome. For all of your assumptions, use the worst numbers that might realistically occur.
- Best case scenario: the best possible outcome of events. Your assumptions will operate under the best possible conditions realistically possible.
Why you should create financial projections
Thomas Edison is quoted as saying “Genius is 1% inspiration, 99% perspiration.” If you put in the effort, you may find that projections will serve you in the following ways.
Financial projections allow you to create relevant key performance indicators for your small business. For example, your financial forecasts guide you in creating your budget, which helps your business plan accurately for the future.
Making strategic decisions
Strategic business planning is also dependent on realistic financial projections. Understanding your potential growth rate, cash flow projections, and operating expenses lays the groundwork for a successful business strategy.
Establishing achievable goals
In running a business, you need goals that will push your teams, yet are still within striking distance. Realistic financial projections provide benchmarks that your team can buy into.
Debt lenders and potential equity investors will look at your financial projections to understand the financial health of your business and the potential return on their investment.
Financial projections help formalize the financial needs of your business. The growth and success of your small business depend on your ability to construct realistic and dependable financial plans.
Top down projections begin with assessing the market as a whole. Begin by understanding the market size and prevailing sales trends, then estimate what portion of the market you can expect to buy your products or services. Examine your company’s strengths and weaknesses in the context of the market, and plan out how to capitalize on strengths and remedy your weaknesses.
Some businesses opt for top down analysis due to reduced variability and faster results.
Bottom up analysis uses the product or service itself as the starting point. Projections are then made about how best to get your offering to market. Production capacity, department-specific expenses, and market factors are considered and used to create financial forecasts.
Businesses that employ bottom up analysis prefer item-level forecasting and employee involvement. Since it employs actual sales data, some experts indicate that bottom up analysis may lead to more realistic forecasts as well.
How to forecast startup financials
Accurate financial forecasting can mean life or death for your small business. Realistic metrics will allow you to make informed strategic decisions, while inaccurate assumptions can lead you down the wrong path.
Be sure to do your homework. Use industry research and historical data to make well-informed, realistic assumptions when forecasting.
It may even be worth hiring a consultant with industry experience to ensure that your strategy is rooted in sound forecasts. An ounce of prevention is worth a pound of cure.
Execute with confidence
Even if your startup is pre-launch, financial projections are a critical part of a business plan that can help you clarify your vision or secure funding. Until you have clear numbers in front of you, it’s difficult for you or potential investors to judge the viability of your business.
Accurate financial projections provide you with the foundation to launch, create new products, and execute on a vision you can be excited about.