This article will help you understand
- WHY financial projections are important
- WHAT information is needed to create them
- HOW specifically to create projections
When it comes to numbers, most businesses look backwards without realizing it. While looking at the rearview mirror can give you some great insights, it’s not enough to propel you safely forward.
What do I mean by looking backwards? Every month, you probably work with your bookkeeper to pull together your monthly financials. But by the time you see your income statement, you’re already looking at historical information. How do you help your business prosper and grow if you don’t know what the future will bring? Developing financial projections are an essential component of helping you make the right decisions for your business. This is also known as your budget, and the two can be used interchangeably for many things. This is a roadmap for you to figure out what your revenues could look like in the future and what costs you would need to have to support growth in said revenues. Do you need to move to a bigger space? Can you afford to hire more staff? Financial projections will help you be able to answer those types of questions.
I advise creating 3-year financial projections in order to help your business get a better sense of both short-term and longer-term needs. A one-year projection is also great to use as your operating budget, three-year projections give you the opportunity to plan for the long-term success and viability of your business – and a chance to dream of the future and where you could go… and HOW you will get there.
So, what do you need in order to create your projections:
- Your historical numbers will help you understand how your business has been operating so far. Pull together your P&Ls (from quickbooks or whatever accounting software you use.
- Start by pulling your staff together to brainstorm on ways you intend to grow your business going forward. Would that include new products, services? Would it consist of growing revenue with current customers, or breaking into new customer segments with your current services? What opportunities do you see that your company could conceivably take advantage of?
- Pull together your current staffing info and then start to think of new hires you’d like to add. The info that would be helpful are titles, salaries for employees and hourly rates and number of hours for non-employees or those that work on an hourly basis.
- What are your currently monthly expenses (and annual for one-off type expenses like insurance or certain licenses, taxes, etc.)?
- If you’re thinking of expanding, what would the costs be for a new space? Rent? Construction costs, upgrades to equipment, etc.
Now that you have that info, you can start to create your projections. Hopefully you LOVE excel. If you don’t, you can hire people to help you with this part. You want to think about your projections as having three major sections: Revenues, Cost of Goods Sold (COGS), and Expenses.
To build your model, in excel, you’ll build the revenues and expenses by month and a total for the year. You can set up the model with these categories (and under each section you’d have a list of your revenues or expenses within that category).
- Cost of Goods Sold
- Gross Profit
- Sales, General and Administrative Expenses
- Operating Profit
- Interest, Taxes, Depreciation, Amortization
- Net Income / Profit
For revenues, you can look at your historical numbers and start to think about growth. Create some categories for your revenues (classes, merchandise sales, etc.).
Cost of Goods Sold will include things like the cost of your merchandise. You could also include your instructor costs, and sometimes people also include transaction costs here (for example, credit card fees).
Sales, General, Administrative expenses include your personnel costs, rent, utilities, cleaning, sales and marketing costs, travel costs, insurance, etc.
When you put this all together, you’ll have a sense of your monthly profit. And now you can use the inputs above to test out ways to increase your profit by figuring out ways to increase revenues, decrease costs, but also to plan for your growth (for example, if you plan to increase the number of classes you offer, it may cost you more in instructor costs) so you want to account for things like that.
Now that you’ve created a draft of the projections, you can start to adjust some of the inputs to see the impact on your business by creating several scenarios to achieve your goals. For example: In scenario A, you will see that the business is expected to grow at 5% per annum with current marketing and distribution efforts. After reviewing strategic opportunities, you may find that adding staff in marketing and partnerships could drive revenue growth to 15% per annum, and still increase your overall profit. With that information, you might decide to pursue that strategy, as you’ve seen the potential positive impact of those strategic hires. On the flip side, the model could show you that those two hires would increase revenues, but after the extra costs, profits are in fact, lower. With that info, you may decide that it isn’t worth the net impact to your bottom line. You could repeat this scenario analysis with new products or services and see the impact to your overall revenues and profit.
In the above example, it is clear that there are strategic & financial tradeoffs between pursuing new services versus a more aggressive sales strategy, or adding new hires. Which one should you choose? Well that would depend upon many different variables in your business, and this is where you need all of your best thinkers at the table. In my 10 years as a consultant, I have worked with over 135 companies, and learned that it takes the right combination of growth thinking, thoughtful planning, and disciplined execution to choose the right strategy and focus on its successful implementation. Time and again I have seen companies fall short by not appropriately incorporating the financial plan as a key component of that strategic plan, and have not been able to raise financing when needed. That’s why I encourage all CEO’s to plan ahead, focus on actionable plans, and constantly check the viability of those plans with a strategic financial plan, or strategic financial advisor, if they should want help.