Blog

What are financial projections and why do you need them?

financial projects and graphs on document

What are financial projections, why do you need them, and what should be included? While creating financial projections can seem like a hassle, they are a necessary and vital piece of your business.

With financial projections, your business can plan for change and ultimately, success.

Let’s take a look at financial projections, what they are, why they matter, and how to create them.

What are financial projections?

Financial projections are a road map for your business, and to manage a business successfully, you need financial projections. Think about it this way: You wouldn’t go on a vacation without a plan of where you’re going, how you’re getting there, how long you want to take to get there, and what your budget is.

Why are financial projections important?

Financial projections give you, your employees, and your current or potential investors the estimate of the resources you’ll need to fund and deliver your product or service.

This can include money, staff, office space, and manufacturing equipment. These resources and the timing of them will be tied to your projected revenues and profitability.

For example, you may only need three employees starting out. However, once sales start rolling in, you may need to add more staff.

Great planning also includes the financial resources needed to complete the journey – including working capital, bank loans, or even soliciting new investors. This ensures you will have the cash required to complete the journey and not end up being stranded on the road when you’re only halfway there.

Financial projections are important for your company to set and track against goals and are absolutely essential if you are looking for investors or loans.

Keep Reading: Should I outsource my CFO?

What’s included in financial projections?

Half of businesses fail to plan on a yearly basis. Even fewer businesses fail to plan ahead 3-5 years – which is what most CFOs recommend.

Financial projections should cover a minimum of 3 years; this is the minimum requirement of most lending institutions and investors. It also reflects the time frame needed to make real changes to a company – which allows your vision to steadily progress to reality.

Here’s what should be included in your financial projections:

  • Estimate of Revenues and Expenses: This will be based on sales forecasts, operating expenses, payroll and any start up costs associated with a new business or line of products or services.
  • Pro Forma Income Statement: This is a projected income statement based on your revenues and expenses that also includes Total Income, Income Taxes, and Net Income.
  • Cash Flow Projections: Cash flow should be projected every quarter (13 weeks) on an ongoing basis and for a minimum of 3 years in initial projections. The equation for Cash Flow is:  Beginning Cash + Total Accounts Receivable – Total Accounts Payable – Cash Flow Projection.
  • Pro Forma Balance Sheet: Similar to the Pro Forma Income Statement, the Pro Forma Balance Sheet is a projection of your assets, liabilities and equity (Assets – Liabilities = Equity) for a defined point in time – in this case, at end of years 1, 2 and 3 (just like the Pro Forma Income Statement).
  • Reporting & Monitoring: Every goal, milestone, critical task and expected outcome from the above documents needs to be monitored and reported on at least a monthly basis to the management team. This will help everyone understand progress (or lack thereof) and to spur corrective actions when necessary.

Keep Reading: What’s the difference between a CFO and a finance director?

What can financial projections be used for?

  • New Business, Product or Service Viability: Any time you are considering starting a business or introducing a new product or service line, financial projections are a necessity to determine if the undertaking is profitable or if adjustments need to be made to make it so.
  • Future Planning: Is your business seasonal and therefore has ebbs and flows of revenue and expenses or do you anticipate new equipment or building expenses in the future?  If so, financial projections can help you understand when you may need additional investments or bank loans/line of credit.
  • Improving Productivity, Profitability and Managing Risk: Financial projections can uncover areas of opportunity in increasing productivity, profitability and in risk mitigation by optimizing resource use.
  • Investment/Capital Infusion: 3 years of Financial Projections encompassing the elements above are table stakes for investor and bank loan discussions.
  • Continuous Business Improvement: As you continually produce and measure projections, you will get better and more accurate in your projections, allowing your business to improve performance over time.

Need help getting started with your financial projections?

At New Life CFO, we provide fractional CFO services for companies of all sizes and industries, and we’d love to help yours, too. We can assist your company in developing and maintaining healthy financial projections for your company.

If you’d like to learn more about these services, reach out to us online. We’d love to talk.

If you need improved financial results immediately, watch our three-part series on how to create financial stability now and improve profitability for the long term.