“How do startups get financial projections?” Financial projections for a business plan start with forecasting an operating budget and then a cash budget for the first five years of business. With these budgets, pro forma income statements and balance sheets can be created. Coupled with the inclusion of capital budget(s), an all-around picture of your startup’s financial future will come into focus.
The financial projections section of your business plan is the foundation for the funding request section. It’s also, in part, where you quantify the viability of your business idea. Lenders and investors will be very interested in this particular section. There are three primary components of the financial projection section.
Those are:
- Capital budget
- Operating budget
- Pro forma income statement
- Financial budget
- Pro forma balance sheet
- Pro forma cash flow statement (if needed)
Capital and assets needed for success
Some businesses require big investments in capital to get off the ground. The capital budget looks, in detail, at these investments and the return expected to be earned from them.
Furthermore, a capital budget can provide insight into projects related to market penetration, market development, product expansion, diversification, or maybe even business acquisition.
A capital budget for these types of big cost/reward ventures can help you with the timing and amounts of revenue, expenses, and cash flow in the budgets that follow.
The reader of your business plan will appreciate the supporting information Plus, the extra analysis will help ensure that you are spending your funding wisely.
Start with sales
As emphasized in the operating budget template for small biz post, most financial projections start with forecasting sales. Why? Because of the volume of sales you (expect) to make, will drive how much you spend.
In the calculating funding requirements post, the point was made that you should project your financials out for five years. Yes, it’s nearly impossible to accurately predict your monthly revenue several years from now. However, the reader of your business plan will want to know that you’ve at least thought that far out.
Keep in mind that month 1 of your forecast probably won’t be the first month you expect to make sales. Rather, it will be the first month after you receive your funding requirements.
Your first month of sales might come well after that.
Spending money to make money
Now, knowing how much you expect to sell, you’ll have a better idea of what you’ll have to spend to make those sales.
It’s here that it’ll become obvious why you started forecasting after you received your funding requirements. Because, depending on the industry your business is in, you might have to spend a significant amount of your funding just getting set up. For instance, you might need to spend money on things such as:
- Licenses, permits, and registration fees
- Beginning inventory
- Deposits
- Down payments on fixed assets
- Utilities
- Other startup expenses
Plug these expenses into the appropriate months following the receipt of your funding requirements.
Once your pre-launch expenses are forecast, then you can focus on your operating expenses – the ones that will correspond with earning revenue. Different industries will have different costs in different proportions. But, here are some categories of costs to consider as you complete your forecasted operating budget:
- Materials
- Labor
- Overhead (utilities, depreciation, real estate)
- Marketing and sales
- Administration (accounting, human resources, IT)
Match these costs up with your forecasted revenue and subtract them from that revenue. You should now have monthly estimates of your operating profit for the next five years.
Interest and tax expenses will be deducted from operating profit to arrive at the forecasted monthly net profit.
Remember your capital budget? Don’t forget to account for the revenues and expenses related to your projects and capital expenditures. A capital budget is built on cash flows in and out. So, you might have to adjust the timing of corresponding sales and expenses.
Pro forma income statement
With your revenue, cost of revenue, selling general and administrative expenses, interest expense, and income tax expense estimated, you can now put together yearly pro forma (expected) income statements.
This pro forma income statement will serve as a snapshot of your (hopefully increasing) profitability over the next five years.
Cash budgeting
The cash budget, not to be confused with the cash flow statement, specifies when cash will actually come into and leave your business.
The operating budget stated when you’ll make the sales, but not when you’ll actually collect cash. Some businesses collect cash more or less immediately. Restaurants and retail, for example. Others issue invoices and have to wait to collect cash. Some might even have customers who never pay.
Forecasting sales for the reader of your business plan is important. But, beyond that, they’re going to want to know when you’ll actually collect on the sales. That’s the point of the cash budget.
Why make a cash budget if it’s so similar to the operating budget?
Sales are good obviously. However, it’s cash flow management that frequently causes a small business to become insolvent. Not necessarily (though it can contribute) a lack of sales.
A cash budget tells the reader of your business plan that you take cash flow seriously. That you understand cash must come in quickly and leave slowly – to the extent that it’s practical.
As mentioned, the cash budget is built off of the operating budget.
Just simply adjust all of those sales into the future and enter them in the month you expect to collect cash.
Alternatively, for each expense, adjust it to the month in which cash will actually leave your bank account.
From there, all that’s left to do is make a note of your starting cash. Then, add the cash you expect to collect every month and subtract what you expect to spend. This will leave you with a new cash balance at the end of every month which, in turn, becomes your starting balance the following month.
You haven’t forgotten about your capital budget, right? Those capital expenditures and projects can have a huge effect on cash flow. Make sure they’re being accounted for in your cash budget.
Pro forma balance sheet
The pro forma balance sheet is a snapshot of your company’s owner’s equity for each of the five years forecasted.
With your operating and cash budgets in hand, you have what it takes to calculate your assets, liabilities, and owner’s equity balances at the end of each year.
Remember…
Assets = liabilities + owner’s equity
Owner’s equity = assets – liabilities
Liabilities = assets – owner’s equity
These equations must always balance.
Admittedly, calculating a pro forma balance sheet can be a little daunting. If you’re not well-versed in accounting you might reach out to someone for help. Alternatively, you can use the Spreadsheets for Business example + template of a small business financial budget for inspiration. The pro forma balance sheet is automatically calculated based on what you enter for the cash budget.
A pro forma cash flow statement is also automatically calculated.
How do startups get financial projections?
The information above outlines the quantified information to include in your business plan.
I would suggest that you accompany each budget and pro forma statement with some qualifying information too.
For instance a written synopsis of why you forecasted what you did. A reasonable narration of your startup’s financial position over the next five years. This will help flesh out your vision of your company’s future and why it would be a smart investment.