Business executives and other decision-makers need to make the tough calls. The direction they decide to go dictates the success of their business. Then again, nobody can see the future. This is especially true in competitive industries and volatile markets. So how can decision-makers navigate through all of this uncertainty?
Business decisions need to be data-driven in any industry to get the most accurate financial projection they can. These projections are integral when preparing a course of action. But what exactly are financial projections, and why do businesses need them?
What are Financial Projections, and Why are They so Important?
Financial projections are what your business expects to happen in the future. These projections are based on facts and data available to your business through analytics and reports such as:
- Projected income
- Balance sheets
- Cash flow statements
Decision-makers rely on these projections to identify financing needs and when to make capital expenditures. It also helps monitor cash flow, find underlying issues within the organization, and strategize new production plans. Still, despite its distinct features, financial forecasts are often mixed up with financial projections. Here are the key differences.
Financial Projections vs. Financial Forecasts
Forecasts and projections are words that are often used interchangeably. But when we talk about business and finance, there are several key differences to take note of. For starters, a financial forecast is an estimated financial statement that shows a business’s predicted financial situation, cash flows, and results of operations.
It’s based on assumptions about your business’s most likely actions and economic conditions throughout a period. The most likely possibilities in a financial forecast are offered to external stakeholders, such as potential investors, to value your organization. Here are the main differences between financial projection and forecasting:
- Forecasts are based on the most likely conditions.
- Forecasts are often used externally to present to stakeholders or potential investors.
- Financial projections are used internally to assist you in making business choices.
- Projections help you answer hypothetical “What if?” questions about your business.
- Projections also identify when your business should hire new staff, create new product lines, and more.
Making Financial Projections for Your Business in 5 Steps
Both financial projections and forecasts are important factors that keep your business going in the right direction. However, forecasts are mostly used for external reports, and projections are used to support internal decision-making.
You can use financial projection templates to help you streamline the process. But if you want to do it manually, here’s a guide on how to create your own financial projections for your business:
This spreadsheet forecasts sales over a certain period. Most established businesses cover three years. Each line of sales should have a section that shows unit sales, pricing, cost, and gross margin.
Startups, on the other hand, can make projections monthly in their first year. These businesses don’t have the luxury of long-term sales data. Projections can be based on industry and market patterns. This can have a positive impact on your reports when presenting to potential investors.
Cash Flow or Income Statement
A business’s cash flow statement shows the amount of money expected to flow in and out in a forecast period. Established businesses can use past profit and loss (PNL) statements and balance sheets.
New firms, however, need more research since they have no data to make accurate projections. To make accurate decisions, examine your sales estimate and cost budget. Certain bills may not be paid for two or three months. So you can assume just 80% of bills will be paid within 30 days.
Anticipated Expenses and Costs
Your cash flow statement illustrates how much money you expect to come in and out of your firm throughout the forecast period. For reliable three-year projections, established businesses should use their past profit and loss statements and balance sheets.
Since you have no historical data, a new firm anticipating its first year will need to undertake some study. To make accurate judgments, examine your sales estimate and cost budget. Remember that certain bills may not be paid for two or three months. Assume just 80% of bills will be paid within 30 days.
Projected Balance Sheet
Your planned balance statement must include all corporate assets and liabilities. These are excluded from sales and expenditures. Unsold merchandise, unpaid invoices, and business property are examples of assets. Liabilities include company loans and unpaid supplier invoices. The difference between assets and liabilities is your balance.
Projected Break-Even Point
The break-even point is when revenue and expenses are equal. It’s when your company’s income covers all its costs. The point where total revenue equals total cost will change your financial projections. Fixed costs, variable expenses, and revenues determine break-even.
Financial projections and forecasting are both integral factors for decision-making. However, forecasts are used more for external reports, and projections are for internal ones.
Here’s a rundown of some important things to consider:
- Financial projections use the income statement, balance sheet, and cash flow statement.
- There are short-term and long-term projections.
- The financial projection estimates the business’s future revenue and expenses based on past data.
- Use short-term budgets for immediate plans and long-term projections for company goals.
- The firm must create a financial forecast spreadsheet including sales estimates, operational expenditures, COGS, and other indicators.
If you want to learn more about financial projection templates, visit Projection Hub! Pick a template for your project, choose your industry, and start streamlining your projections today.