It’s no secret that financial projections will help you anticipate your cash flow needs. Cash is the lifeblood of your business and cash flow planning is vital to business success. But a surprising number of business owners still fail to make financial projections for their business. The result can be detrimental, especially if your business is about to face major cash crunch and you are not aware of it.
Having a rolling financial projection is a vital tool for keeping your business healthy and on a sustainable growth path. The idea is to have a roadmap that you can use to guide your business. Without this, you’re basically leaving everything up to chance. It should be a living document and you can make adjustments as needed.
So how do you prepare a financial projection? Let’s go over the 4 steps to create and use financial projections for your business.
1. Start with planning
Think about what you want to accomplish over the next 12 months. What plans do you have for the company? Will you be hiring more staff? Will you be investing more into sales and marketing? This should be based on your company’s strategic plan.
With a clear vision in mind, you can begin to estimate your expenses and consider the additional costs you will incur to implement your business strategy. These expenses should be added to your current operational costs, such as rent, utilities, payroll, business license fees, insurance, etc.
Also, don’t forget about those one-time big-ticket purchases, such as buying new equipment, revamping your webpage, or even hiring a marketing consultant.
Next, project your sales and consider the effect your decisions will have on your cash flow forecast. What are your collection terms and will your customers pay you on time? Focus on enforcing your credit policy to ensure your business has enough cash throughout the year.
2. Prepare the financial projection
Based on past experience and your strategic plan for the upcoming year, prepare the following three documents:
- Projected income statement. This is also known as the budget, which includes forecasted sales, expenses, and taxes.
- Projected balance sheet. What are the company’s forecasted assets, liabilities and equity based on the effects of the business activities?
- Projected cash flow statement. This is a reflection of the timing differences between the income statement and the actual cash movements, along with investing and financing activities.
It is helpful to prepare projections for different scenarios, such as optimistic, most likely, and pessimistic. You can clearly see the bottom line results for each scenario which allows you to run your business with more confidence.
3. Determine financing needs
With your projections handy, it’s easy to determine your company’s financing needs and decide how you would go about financing your strategic plan. Do you have sufficient cash from internally generated profits, or do you require external financing from lenders and investors?
The start of the year is usually a good time to do your financial projections. But if you have never prepared one, you should do it right away. If you decide that your company needs external financing in the near future, it’ll be a good time to arrange any needed credit lines or business loans. Working out your financing ahead of time improves your odds of getting approval and helps ensure the best terms.
If you go to your banker or an investor and ask for $500,000 next week, chances are you won’t raise the capital you need. Lenders and investors don’t like surprises. They will lend or invest in your company when you can demonstrate that you understand what you’re doing.
Also, don’t make the common mistake of dipping into your working capital for long-term capital investments because you may end up facing a severe cash crunch. It’s better to use long-term financing for long-term capital investments.
4. Monitor with consistency
Finally, review your financial projections each month against the actual numbers to see if you’re on track. This should be a living document, and it’s best to prepare a rolling financial projection on a monthly basis.
Differences between actual and project figures can flag trouble spots in your business. Review monthly and take an even closer look each quarter. Make any adjustments as needed to your operations or changes to your strategic plan.
Depending on your in-house resources, consider seeking outside help to create your financial projections and monitor your progress throughout the year. Cash flow planning is key to running a successful business.