To make smart decisions for your startup, you must have an idea of the money you will earn and spend in the future. But how can you predict your business’s future financial performance?
While you can’t know for sure, you can make fairly accurate predictions and plan accordingly by creating financial projections.
In this article, we cover all the basics you need to start defining and generating startup financial projections.
What are startup financial projections?
Startup financial projections are a forecast of a business’s future income and outgoings. Creating projections involves making future versions of financial statements to show how your cash, revenue, and expenses will likely appear.
This is done by building cash flow statements, income statements, and balance sheets for points in time months or years ahead.
As part of these projections, businesses predict their financial situation based on hypothetical changes like a merger or IPO.
Depending on the approach you choose, you can build financial projections based on information about your industry and market or your business finances to date.
Financial Projections Are Not Financial Forecasts Or Financial Models
It’s not uncommon to see and hear financial planning terminology used incorrectly. While the terms ‘financial model’, ‘financial forecast’, and ‘financial projections’ are closely interlinked, they are not interchangeable.
We’ve outlined these three commonly-used (and misused!) financial planning terms below to provide clarity on how to use the different tools or processes.
2 Reasons Startup Financial Projections Are Vital
Creating financial projections for startups can be time-consuming and complex, so what makes it a worthwhile use of your resources? Two key startup functions require accurate financial projections.
1. Startup financial projections form the basis of business strategy.
If you don't plan accurately for your startup, you may end up spending more money than you earn. This can ultimately lead to your business running out of cash.
Realistic projections help you build a financial plan for your startup business. For example, they help determine the investment needed to deliver on revenue growth targets and set an appropriate expense budget.
Plus, by changing variables in the financial model—such as altering product pricing or team headcount—you can see how these factors will affect the projected revenue and expenses.
2. Startup financial projections are key to securing funding.
Financial projections reveal whether startups have a chance to generate enough profit to survive. These insights help potential investors decide if a startup is a worthwhile investment, making them an essential part of any fundraising presentation.
Investors will compare the business’s actual performance against the initial projections included in the business plan, so they must be as realistic as possible. If your estimations turn out to be accurate, this shows you have a solid understanding of your startup’s opportunities, capabilities, audience, and market, inspiring confidence in investors and making the company attractive for further investment as you grow.
However, if your startup’s performance is consistently out of line with your projections, it indicates to investors that you don’t understand the market or the business’s potential and could jeopardize your chances for further investment.
How To Build Financial Projections For Startups
1. Decide on an approach to your projections.
There are two main approaches: top-down and bottom-up. Each approach is generally used at a different stage in a business’s growth and has its benefits and drawbacks.
Very early-stage businesses might not have enough data points to build projections using the bottom-up approach. While it is possible to use data from your competitors to build bottom-up projections, every business operates differently—so we don’t recommend taking this approach. Top-down projections are a better fit for early stage startups.
With either approach, on-target projections aren’t based only on financial data. The business’s cash inflows and outflows depend on factors including product pricing, promotion, the level of customer demand, and the number of competitors in the market. So for startups, in particular, it’s important to understand your potential market and to know your competition.
A common mistake startups make is to assume they’ll perform at the industry average even when they’re just starting out and only have a handful of customers. Founders who don’t yet know the market well will often make overambitious projections, leading to decisions that harm the business.
2. Gather input from your team.
To ensure you have all the necessary information and perspectives to build realistic projections, consult these team members:
- The business’s owners: The startup’s owners or founders can contribute an in-depth understanding of the business’s needs, the market, and the available opportunities to create sound projections.
- The Sales VP or a sales leader: Involve a team member who has expertise and insight into sales strategy and potential.
- The CFO: The CFO can apply both knowledge of your finances and experience of helping businesses scale to inform your projections. If your startup doesn’t have a CFO, you can work with an outsourced CFO.
3. Generate projections for each financial statement.
Using your chosen approach—top-down or bottom-up—predict the sales your business will generate and the expenses you will incur at a specific point in the future.
Your sales projection needs to take into account seasonality, the health of the economy, and how your industry as a whole is performing.
Your expense projection should include any fixed expenses that will remain the same as well as a prediction of variable expenses that will change in proportion to your sales and business growth.
Based on these assumptions, project how the startup’s three key financial statements will look.
Need expert help building startup financial projections?
Projections can be time-consuming and challenging to complete if, like many entrepreneurs, you don’t have relevant finance experience.
Likewise, the only way to get accurate predictions is if your data is error-free. This situation is difficult when you don't have someone to manage your accounts in-house.
If your startup could benefit from expert help with bookkeeping and financial projections, a financial operations platform might be what you need.