Chapter 5: Financial Projections
What are financial projections?
What are they for?
Financial projections are a set of forecasts you make about your income and expenditure over a three to five year period. This information helps you plan and adjust your marketing and operational activities so you can continue to run a viable business.
Use a spreadsheet to record your data and make calculations. Remember, spreadsheet calculations are no guarantee of reality. It’s better to err on the side of caution while remaining confident in your forecasts.
What to do
Using an Excel spreadsheet or Google Sheets, create a forecast for three to five years. For year one, create monthly forecasts and for years two and on, quarterly projections. Include an income statement to cover projected sources of income, cost of goods, gross profit, operating expenses and net profit.
Tip from an Expert
Never let the business become more important than your health. Have set work hours. Get yourself in a schedule that you can live with (emphasis on the “live). Don’t eat to avoid working or because you’re stuck in your house and bored. Go to the gym. People who work out live longer, are happier and use more of their brain. Don’t become a hermit and only talk about your business or hangout with people related to your business. The number one mistake I see new entrepreneurs make is that they sacrifice their lives and their health for this thing they’re trying to create. Be smarter than that.
–Lisa Barone, VP of Strategy at Overit
Create a set of assumptions
What are they for
To begin the spreadsheet, you need to make a set of assumptions about revenues and expenses. These are not guesses, you must take careful account of every factor.
What to do
- Revenue: To calculate revenue, consider your selling price for the product and the level of discount you offer wholesalers and retailers. Take account of all the existing and planned products you will offer and identify any other sources of revenue, such as licenses or charges for your services.
- Cost of goods: Go back to that pricing model you created and include the cost of all the elements you identified. Factor in volume discounts based on planned increases in production levels.
- Operating expenses: Include regular costs such as salaries, rent, telecoms and utility charges, equipment rental or leasing charges and maintenance. Calculate the cost of sales and marketing campaigns to meet revenue targets.
- Staffing costs: One of the largest components of operating costs is the wages, salaries and benefits payable to your current and planned workforce. Create a separate staffing sheet that shows the job title for each current and planned employee. Show the cost of their monthly wage and benefits package. For new hires, show their month of coming on board and their corresponding costs. Then create total costs for each month. Link the staffing sheet to the salaries and wages line item of the operating expenses sheet.
Consider all possible factors
Create a financial forecast
The following bullets describe each main section of your profit and loss projections. The first section is revenue; second section is cost of goods (ending with gross margin); then the third section is operating expenses. Finally you show the bottom line, which is net profit (gross margin less operating expenses).
- Revenue projections: Using your pricing assumptions (see above), calculate the planned monthly or quarterly revenue for each of your products, services or other income streams. Show each product on a separate line. Use factors such as planned promotional campaigns or new product launches to forecast revenue changes.
- Cost of goods and gross margin: This part of the financial projection is critical and requires greater detail if running a product-based business. Use the data in your pricing model to calculate cost of goods for each product or service. Include all materials so you do not have any surprises.Gross margin is the percentage of sales revenue a company retains after incurring the direct cost of producing the goods or services. The higher the percentage, the more a company retains from each sale to service other operating costs.
To calculate gross margin, use this calculation. For example, if sales are $10k, and cost of goods is $6k, gross profit is $4k. Gross margin = gross profit divided by gross revenue and is 40%, or $4k over $10k, in this example.
Gross margin varies by industry, but it is a good practice to benchmark your results against the average for your industry. Benchmarking also gives you the information you need to analyze the need for reducing costs and improving margins.
- Operating costs and net profit: Operating costs are regularly recurring costs such as wages and salary, rent and leasing payments. List all the regular expenses and show if they occur quarterly or monthly. Calculate totals for each month.
-Ogden Nash, Famous american humorist
What is it for
An investor summary highlights the most important projections and shows investors that you are in control of finances. It also indicates the timing and size of their return.
What to do
Create a table that captures the key items from your profit and loss projections. They are gross revenues; gross margin; operating expenses total; and net profit. The table can be organized showing annual projections. Also include the forecast distribution for each year.