09 November 2021
There are many reasons why a company might need to prepare financial projections; to attract investors or for approval of bank loans. However the most important one is that it provides the business with a rationalisation that its future is guaranteed, if it can deliver what the projections says.
Financial planning is a critical aspect of the journey of startup founders and it’s something they have to nail early on. This might seem intimidating especially for those who do not have a financial background but in truth there is little to be afraid of. Ultimately, what one has to keep in mind is that the financial plan is not something that one can get right or wrong; it is an estimate which will invariably have a lot of uncertainties. As long as those are well considered, the projections themselves should be fine.
Why is it important?
Can you find the place you’re looking for in a new city without looking at a map? You might and it is possible that you will find it, but you are also likely to take a long time to arrive there, probably taking a number of wrong turns along the way, and might even get lost along the way.
Starting a business without a financial plan is exactly the same. Done well, it can help guide the business as it develops, providing vital information such as how much profit can be generated at various levels of revenue and how much money will be needed to run the business.
What should it include?
There are three vital elements that should be included when preparing financial projections.
The first is the income statement which (also referred to as the profit and loss) is fairly straight forward as what needs to be done is list the expected revenues along with the running costs.
Ideally one would make it as easy as possible to change assumptions to evaluate what happens at various levels. This allows users to understand better both the potential and the risks involved depending on how the business performs.
The thing to look out for when preparing the income statement is that it isn’t too reliant on one or two assumptions. Let’s say that a projected profit swings significantly towards a loss if sales of a particular item decrease by a few percentage points. That shows that the business is reliant on getting that particular assumption right which is never a particularly comfortable place to be in.
Apart from the income statement financial projections should also include a balance sheet. As its name indicates, the balance sheet provides a snapshot of the balances of the business at a point in time, typically the end of the financial year.
This means that through a balance sheet one can judge the financial status of the business including what assets exist, the liabilities and how much equity has been issued. Naturally any business that has more liabilities than assets indicates that it is far from healthy and could be at risk of default so that is something to look at.
The final and, arguably, most important element of a financial projection exercise is the cash flow. Again, the name is self-explanatory: this looks at how money will be flowing in and out of the business. For a startup, ensuring that there is enough money to pay all expenses is often the biggest struggle, which is why this document is so important seeing that it will highlight how and when issues will get tight.
How to do it?
It is often best to start with the revenue side of things: how much does the company expect to sell of the product at the heart of the business? And what are the costs needed to deliver that level of sales? Carrying out some market research to discern the level of interest and what people are ready to pay can be really useful at this stage.
With that as the basis, discerning the credit terms that the business can get for anything it purchases along with what it is willing to allow its debtors to get away with should be enough to build all the documents.
The key factor in all of this is to be as realistic as possible. There is always the risk of being overly positive when it comes to assuming sales or how quickly people will pay so that is a pitfall that should be avoided. Indeed, apart from having a number of scenarios, ideally there would be some kind of research to help underpin the assumptions to some level of reality.
What is also important to remember is that financial projections are a tool to help management. Of course, one cannot keep updating the projections given to a bank or to investors but there is nothing wrong with updating your own projections to use real life performance as a basis for any assumptions.
After all, these financial projections are intended to help guide the business as it moves forward. The clearer the picture, the better the guide.
We hope the above information gives you enough information and guidance about how critical financial planning is for startups.
GO Ventures is a GO subsidiary, speciliasing in innovation and technology. Our aim is to help great ideas grow by supporting the startup scene and invest in many of the great ideas there are out there.
Have a look at our website and contact us. Apart from financial support, we offer a mentorship program that supports startups to succeed.
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About the Author
Paul Grech joined GO in 2000 as part of the Finance Team and since then has gained further experience working in both the commercial as well as the strategic arms of the company. Currently, Paul leads GO’s Strategic Planning and Insights Team.
He has been involved in GO Ventures since its inception and has had a significant role in shaping its development. Apart from heading GO Ventures’ investment process and sitting on the board of two startups, Paul also serves as a mentor to several startup founders focusing mainly on helping them establish a strategic framework and achieving growth.