Sustainability Consultant | Business Coach & Educator | Founder of The Academy of Human Potential.
The financial section of your business plan might be intimidating to tackle, especially if you are a new business owner with little to zero financial history recorded. But it is arguably the most essential piece to master when laying out the foundation of a new business model. In fact, financial projections are also equally as important to existing businesses in order to set new and recurring goals, monitor progress and act as a warning system when things fall off track.
For these reasons among a few others, financial projections are an essential business planning tool that should be carefully considered, and not having them can be detrimental to your business’ sustainability. Here are the top four ways having sound financial projections will set you up for long-term success in your business venture.
Validating Your Business Model
I’ve seen how common it is to see entrepreneurs get excited at the possibility of starting a new business venture. Frequently, business plans highlight the best-case scenarios and focus on industry analysis, overall strategy and products and services. But when it comes to the financial section, assumptions are oftentimes questionable, and critical numbers tend to get glossed over. An entrepreneur’s best opportunity to truly understand the viability of their business idea and gauge its potential return on investment is to scrutinize these other factors.
Furthermore, a lot can be revealed in the process. Although you may be focusing on the next 12 to 60 months in initial projections, you’ll also be conducting research and calculating the size of your total addressable and serviceable markets, target markets and market shares. Additionally, financial projections will show you the likely outcomes of different pricing strategies in order to make a profit, scale your business and eventually reach a point of sustainability.
Without a clear financial plan that analyzes costs, other critical decisions will be impacted such as how big your marketing budget can be, how much overhead you can take on and who you can afford to hire at startup and during expansion. Without knowing your net profit margins, you will struggle to establish feasible milestones and create systems that efficiently maintain operational costs.
Identifying Funding Requirements
One of the most significant threats to new and existing companies is the cash-flow gap. Many entrepreneurs focus on the potential of the endeavor without considering the associated risks involved. Although you might be able to launch lean and initially bootstrap your business, there may be a point where you run out of seed capital due to supplier issues, unexpected events or an influx of business that requires more resources. This can happen whether you are a brand new business or recasting your finances for expansion.
Having solid financial projections requires entrepreneurs to ask key questions such as how much money is needed and, importantly, by when. Specifically, you’ll need to know what is required to reach profitability and get to the next milestone or funding round. This will help you identify areas for cutting unnecessary costs so that you can cover cash flow dips to stay afloat. Your projections will tell you how much runway you have before you run out of cash and how much debt you can take on if necessary. After you know this, you can decide which types of financing are best for your company. This can range from requiring angel funding, business lines of credit or even personal loans.
Getting Buy-In From Stakeholders
Without buy-in from essential figures including people such as lenders, investors, industry partners, employees and other key players, it may prove difficult to gain traction. Financial projections, which are core to completing important documents such as business plans and pitch decks, are required to present to key stakeholders. That is why financial projections are needed to forecast valuations and returns, including when investments will yield a profit. You might even have team members who will be investing their time rather than their finances, or both, so being able to give them a clear indication of how much time is required of their effort will maintain momentum and provide good faith in your leadership. Essentially, all of your stakeholders are going to want to know the potential of your business and that you know what you’re doing.
Financial projections also provide your business with revenue and profit goals. Without having these milestones, you may become stagnant. When mapping out your financials, think about what it is that you want to accomplish.
For existing businesses, it is critical to periodically update financial projections whenever operational changes have been made, such as switching suppliers, hiring new personnel, adding a new location or expanding products and services. As things change, it is critical to assess the financial impact these developments will have on your business. Remember that milestones are essential to continual growth and having them will inspire and motivate your team to reach new heights.
Where should you start?
Financial projections are always educated guesses. To make yours as accurate as possible, do your homework and get some help. Begin with data that you acquired when you researched for your business plan. You will find that a lot of information is available from industry associations, various government sources and similar companies in your industry. I recommend using a robust financial template that includes the main financial statements, detailed revenue and operating expenses, as well as financial ratio analyses. I also suggest working with an experienced accountant in your industry to help fine-tune your finances.
Once you complete your financial projections, keep them up-to-date and refer to them regularly by comparing them to your actual financial statements to see how well your business is doing. If you find that your projections are either too optimistic or bleak, this is your opportunity to make them more accurate and use them as a tool to keep moving forward.