Learning about financial forecasting is an essential step in your journey toward growth as a small business owner. Being able to accurately project what your future revenues and future expenses will be is vital to helping your small business not only survive but thrive. For this reason, it's time to get comfortable creating and reviewing a financial forecast and cash flow projections.
If you're just starting out in business, then you're likely to be assembling your business plan and financial statements from the ground up. What I do is help business owners understand the need for creating financial projections, why financial planning is a key part of becoming a successful small business owner, and how you can leverage these numbers to make growing your business more predictable.
A financial forecast consists of a cash flow statement, financial statement, or pro forma statement. The cash flow statement details the company's cash management habits and complements the balance sheet and the income statement. A financial plan usually contains three statements: an income statement, a financial balance sheet, and a consolidated financial statement, which combine to give you a better understanding of your financial information based on actual results.
Your income statement outlines the funds going in and out of your enterprise, while the cash flow statement focuses on analyzing these figures in the context of how you'll make profits.
Financial projections are often used to attract potential investors or to qualify for a bank loan and are an important component when preparing a strategic business plan. Short-term financial projections tend to focus on your first 12 months in business, whereas a long-term financial projection usually covers three to five years.
You can build out both short-term and long-term financial projections for a solid understanding of where your business plans are really taking you.
The process of creating financial forecasts fits broadly into the following five categories and provides a great jumping-off point for building out the projected income statements for your small business.
Your Break-Even Point (BEP) refers to the point where your business has the same level of expenses as earnings. Typically, your small business generates revenue from its operations that pays the costs or expenses associated with those operations. The BEP varies depending on your industry but is calculated by looking into your fixed and variable expenses.
Knowing the Break-Even Point allows you to see when your business will start to be profitable. To put it simply, your business needs greater monthly inflows of cash than the total value of the monthly expenses and cost of goods sold. If your revenue is below the Break-Even Point, your small business is operating at a loss, and if it’s above, then it’s operating at a profit.
A projected income statement shows your best attempt at projecting sales, income, and profit over a particular time period. Unlike a normal income statement, components of a financial projection include sales forecasts (revenue coming in) and an estimate of operating expenses (money going out), gross profit (your income), and your balance sheet.
Your financial projection demonstrates to your investors or bankers how you plan to repay loans, what you intend to do with the net income, and your business plan for growth. When preparing a projected income statement, leverage any available historical data to compare accounts receivable and accounts payable values throughout various statement periods to help you calculate the most accurate estimates possible.
You should always put financial backstops in place for your business in case of unexpected expenses. Just as you probably prefer to have an emergency fund for your personal finances, your business should have an emergency fund too!
The plan for unexpected expenses is primarily based on cash management and ensures the company has enough cash for operating activities. For example, unanticipated equipment repairs or replacements can derail an expense budget if not planned for. Some options to secure positive cash flow include having a business savings account, overdraft protection on your business bank accounts, or even a line of credit.
Fixed expenses do not alter according to amount, type, or price point of product sold. Your business sustains these yearly or monthly fixed expenses, no matter how much or how little you sell. Proper anticipation of fixed costs helps you accurately predict your cash flow and balance variable costs. The most effective way to anticipate fixed business costs is to research typical costs in similar industries and prepare a budget using ballpark numbers from other businesses. Fixed business costs will usually include:
When you're first starting out and searching for business financing, you will need to project sales based on past revenues and industry statistics. These projections can help you and your banker to understand potential risks for the business, how you can best manage staffing levels, and how much to spend on essential resources like raw materials. Using industry trends to help create a sales forecast will also help you decide on key aspects of the business such as product range, price points, and inventory capacity.
Most small businesses fail because they don't have the adequate cash flow to fund their operations, much less sustain adequate growth. However, since you're here, I know you're making a strong effort to get ahead of the game.
A good financial forecast allows a small business owner like you to reflect on existing business operating expenses and adjust the business plan accordingly for the future. You can create financial projections that take sales revenue and your expenses budget into account and demonstrate the financial peak and the bottom line of your small business.
If you fail to prepare a comprehensive financial statement with adequate financial modeling, you may be unknowingly turning capital investments away from your company. Thorough financial statements and a well-calculated balance sheet allow you to provide accurate details of your sales forecast and cash flow projection, which not only prepares you for your financial future but acknowledges that you are committed to managing your small business well.
Since preparing projected financial statements (estimates of what your business's future could look like) requires you to gather historical financial statements, it's a great time to look at what purchases, decisions, clients, and products made the most positive impact on your business and come up with a plan to do more of what worked well.
Being smart with your financial projections means anticipating the right time to scale. By preparing a comprehensive financial plan, not only are you becoming a more informed business owner ready to make those tough decisions, but you're also more prepared to attract angel investors and/or qualify for a loan, from a bank or from the small business administration, as any bank would require the same information in a loan application.
Well-planned financial forecasting reveals where financing can support growth through an influx of money to cover expenses while the business is expanding.
Forecasting and budgeting are similar, but where a budget provides a roadmap to achieving the profit target, a financial forecast tries to accurately estimate the amount of revenue that will be achieved in a defined future period.
Budgeting describes the financial direction of the business and aims to quantify how much a business wants to make. The budget acts as a baseline so that you can see if your business is performing as expected.
Financial forecasting determines how businesses should allocate their budgets, but unlike budgeting, financial forecasting doesn't analyze the difference between financial forecasts and performance. Financial forecasts give an overview of whether the business is on its way to achieving its goals by estimating the revenue and income that will be achieved in the future.
Automating your financial modeling process can make life much simpler as a small business owner. Accounting software and financial planning software allows you to manage complicated data and leverage sophisticated visualization capabilities, as well as simplify financial forecasts.
If you've gotten to the point where your business' finances can no longer be tracked cleanly on a single-page spreadsheet, it's probably time to hire a bookkeeping service. This is great news because as you're interviewing bookkeepers, you can talk with them about producing cash flow statements and projected financial statements.
Automated data analysis provided with many bookkeeping and accounting services allows you to compare the real and predicted financial outcomes of your business. Even if you're not feeling ready to scale or make any big, capital-intensive moves yet in your business, get into the habit of reviewing your income statement, balance sheet, cash flow statement, and profit and loss statement.
Your role as the CEO and conductor of your small business train depends on your ability to understand and analyze these documents and make great decisions based on the numbers you see. If you have any questions about how to create or read your financial projections or about what you need to assemble before applying for a small business loan, I’m here to help! Just email me at [email protected]