Financial Projections Definition:
Estimates of the future financial performance of a business
Planning out and working on your company's financial projections each year could be one of the most important things you do for your business. The results--the formal projections--are often less important than the process itself. If nothing else, strategic planning allows you to "come up for air" from the daily problems of running the company, take stock of where your company is, and establish a clear course to follow.
Regular planning also helps your company deal with change, both inside and outside the company. By constantly reevaluating your company's strengths, markets and competition, you're better able to recognize problems and opportunities. You can react to new developments, rather than simply plugging along.
But what keeps it from just being a number-crunching exercise? Here are three good reasons to project your financials:
- First, the financial plan translates your company's goals into specific targets. It clearly defines what a successfully outcome entails. The plan isn't merely a prediction; it implies a commitment to making the targeted results happen and establishes milestones for gauging progress.
- Second, the plan provides you with a vital feedback-and-control tool. Variances from projections provide early warning of problems. And when variances occur, the plan can provide a framework for determining the financial impact and the effects of various corrective actions.
- Third, the plan can anticipate problems. If rapid growth creates a cash shortage due to investment in receivables and inventory, the forecast should show this. If next year's projections depend on certain milestones this year, the assumptions should spell this out.
Depending on your company's situation and objectives, you'll need to develop several types of projections and budgets:
- A model that projects either the current year or a rolling 12-month period by month. This type of forecast should be updated at least monthly and become the main planning and monitoring vehicle. Information in this model can be the springboard for preparing the other types of plans discussed below.
- A long-range, strategic plan looking out three to five years. While the 12-month forecast often reflects short-term expectation and tactical plans, the long-range projection incorporates the strategic goals of the company. For startup companies, the initial business plan should include a month-by-month projection for the first year, followed by annual projections going out a minimum of three years. Some investors may prefer to see the second year broken out by quarters. It's fine to append the projections for years two and beyond to the 12-month forecast, but the numbers should be more than just a simple extrapolation of the current year. A strategic planning process should accompany development of the "out year" projections.
- Budgets, typically covering one year. Budgets translate goals into detailed actions and interim targets. Budgets should provide details, such as specific staffing plans and line-item expenditures. Given the detail required, the size of a company may determine whether the same model used to prepare the 12-month forecast can be appropriate for budgeting. In any case, unlike the 12-month forecast, budgets should generally be frozen at the time they are approved. They should also be consistent with the goals of the long-range plan.
- Cash forecasts. These break down the budget and 12-month forecast into even further detail. The focus is on cash flow, rather than accounting profit, and periods may be as short as a week in order to capture fluctuations within a month.
All projections should be broken out by months for at least one year. If you choose to include additional years, they generally do not need to be any more detailed than by quarters for another year and then annually after that.
The projections should include an income statement and a balance sheet. Expenses can be summarized by department or major expense category; you can hold line-item detail for the budget. Cash needs should be clearly identified, possibly by adding a separate statement of cash flows. If your financial statements usually report financial rations or expenses as a percent of sales, calculate and report these as part of the projections, too.