Every business leader spends time looking ahead. (In fact, if you’re not looking ahead, you risk getting boxed in and making fatal short-sighted mistakes.) But the question is, how do you make accurate and realistic financial forecasts that benefit your business in the long run?
What is a Financial Projection?
In the most basic sense, a financial projection is a financial statement from the future. It’s a financial statement that you create in anticipation of where you want to go. It’s based on past data and trends, expectations, foresight, and a combination of both objective and subjective information.
“Financial projections can be done for a business as a whole or for a project or department. This is especially useful when a large, costly project is proposed,” Brex explains. “A financial projection allows you to have a more educated view of how the project may impact your revenue, what it may cost, and whether it will harm your cash flow in the short-term or long-term.”
Most financial projections are done just a year out. However, you can also do longer-term projections over three to five years. Because of the uncertainty of this timeframe, these projections tend to be much less reliable. Nevertheless, they can be useful for casting a vision of where you want to go.
The Role of Financial Projections for Businesses
Financial projections don’t just happen. They require a lot of work, planning, and analysis. So if you’re going to put a lot of time and energy into developing accurate projections, you better make sure it’s worth it. Thankfully, it almost always is.
Here are some specific scenarios where projections are valuable:
- Creating a business plan. When you create a business plan to satisfy a lender’s loan requirements, you’ll have to provide some type of cash flow projections. The more detailed your projections, the more compelling your loan application will be.
- Attracting funding. If you’re trying to attract investors and equity-based funding partners, they’re absolutely going to want to see financial projections. (And they expect them to be detailed and specific – irresponsible guesswork won’t cut it.)
- Planning expenditures. Sometimes you just need financial projections for internal purposes. When it comes to planning ahead, it’s nice to have an idea of what sort of revenue you’ll be bringing in. This helps you plan out expenses and investments in order to grow.
How to Improve Your Financial Projection Accuracy
Thanks to technology and automation, developing financial projections is easier than it was in the past. However, there’s also a certain amount of skill that goes into it. With this in mind, here are several suggestions for improving accuracy:
Start With Expenses
When projecting finances, everyone wants to talk about revenue. It’s the fun and exciting part of the equation. But accurately predicting revenue is a lot more difficult than predicting expenses. That’s why we recommend beginning with the latter.
Start with the numbers you know. This includes fixed expenses such as rent, debt payments, utilities, insurance, etc. Then layer on top the variable expenses that you can reasonably predict.
This includes payroll, cost of goods, taxes, etc. (These can usually be projects based on revenue growth. For example, if revenues grow by 10 percent, you can assume your shipping costs will also grow by 10 percent.)
Study Your Customers
As you think about future sales and revenue, it’s helpful to consider your customers. If there’s a lot of excitement in your customer base today, then it’s a likely indicator of sales growth tomorrow. But if customers are disengaged and frustrated, the opposite might be true.
One way to study customers is by using a Net Promoter Score (NPS). An NPS survey, such as delighted.com is very simple yet effective. It’s a one-question survey that’s typically sent out via email and asks: “How likely are you to recommend [insert your brand name] to a friend?” The customer then ranks their sentiment on a numerical 0-10 scale. This benchmark is then tracked over time.
You can’t bank everything on how customers feel, but it’s a pretty good place to start. Combined with other data, like current retention rates and loyalty, you can get a feel for where things are going.
Look at Larger Market Trends
Not everything is in your control. There are always larger market trends that come into play within your industry and target audience. Keeping your finger on the pulse of these trends will help you figure out where things are going over the next 12 months.
For example, businesses that run coworking spaces can look at the larger trends in the marketplace and see that there’s a mass migration away from corporate offices and toward remote work. This bodes well for their business, as many remote workers will want places to work outside of their homes. That’s a market trend that they’d be interested in tracking.
Use Multiple Scenarios
If the recent pandemic has shown us anything, it’s that the future is incredibly unpredictable. In light of this, you should always run multiple scenarios. Having at least two different projections – one optimistic and one conservative/cautious – will serve you well. If nothing else, you can split the difference and come to a safer projection.
Try Projection Software
It might be worth investing in some forecasting software to make this task easier for your business. These solutions allow you to input data and run simulated scenarios. This results in automated projections that typically feature fewer errors and more insight than most human-run projections.
One of the benefits of using projection software is that it allows you to conduct rolling, real-time forecasts that automatically update over time. So rather than dealing with a forecast that’s six months old, you’re working with a projection that’s constantly iterating as new data comes in.
Adding it All Up
Being able to create accurate financial projections for your business is kind of like having a superpower. It sets you up to be successful in so many ways and removes a lot of the uncertainty that swirls around running a business. Perfect this skillset – or hire for it – and you’ll reap the rewards.