January 11, 2022
Financial projections are an important part of any business plan or startup pitch deck. They allow a company to estimate future revenues, expenses, and profits, and to identify potential risks and opportunities. We have been helping founders create financial projections through our templates, tools, and custom financial modeling services since 2012. I thought it was finally time to write a comprehensive article that should answer the key questions that we get from founders again and again. So here is what I plan to cover:
- Creating sales projections based on data
- Forecasting operating expenses
- Salary projections
- Startup cost forecasting
- Pro forma financial statements
- Existing business vs. startup vs acquisition forecasting
But first, who am I, and do I know anything about financial projections?
My name is Adam Hoeksema and I am the Co-Founder of ProjectionHub. Since 2012 we have helped over 50,000 entrepreneurs create financial projections between our software tool and our business projection spreadsheet templates.
I didn’t spend a decade on Wall Street or make a killing in private equity, and I haven’t even raised VC funding myself.
But I did spend over a decade launching a growing an SBA (Small Business Administration) lender in the Indianapolis, IN area. During that time we made over 1,800 small business loans and we often asked our clients for financial projections along with their loan applications. That is why I started ProjectionHub.
So 10 years ago my experience was with helping small, main street businesses create projections and secure loan funding to start their dream. Along the way, I learned a ton about startup projections for tech-based businesses as well. Today about 50% of our work is with small businesses looking for an SBA loan and 50% is with tech-based businesses looking to raise capital from investors.
With that background in mind, I want to share with you what I have learned along the way to try to make your financial forecasting process just a little bit easier. Let’s dive in!
What are financial projections?
Financial projections are estimates of the future financial performance of a company. These projections are typically based on a set of assumptions and are used to help businesses plan for the future and make informed decisions about investments, financing, and other strategic matters. Most ProjectionHub customers use pro forma financials to help external stakeholders, such as investors and lenders understand a company's financial position and future prospects. Financial projections typically include projections of income, expenses, cash flow, and balance sheet items.
There are many opinions on whether a startup needs to create a forecasted balance sheet and how many years a set of projections should be. At ProjectionHub, all of our financial projection templates have an integrated pro forma income statement, cash flow and balance sheet in annual and monthly format for 5 years. This seems to meet the needs of 99% of our customers, so I think it is pretty safe to say that your investor or lender might not require all of that level of information, but they probably won’t require more than a 5-year forecast of your 3 statement financials.
Why should a startup create financial projections?
So it sounds like a lot of work to create a financial forecast, so why do we create projections? No one can know the future. Isn’t it just a pointless exercise?
Well, I think it is smart for an entrepreneur to create a set of projections before they start a business to understand what they are getting themselves into and what it will take to break even and generate a profit.
I could beat that drum all day, and you know what it doesn’t really matter. Even if we know it is a good idea to create projections before throwing our life savings into a new venture, most entrepreneurs will not create projections before starting their business. I have just come to accept this!
So the real reason to create projections is because the people with the money, the investors and lenders ask for them.
- Investors will ask for a financial model because they want to see how you plan to use their money, how long you think it will last, and what the potential return could be.
- Lenders will ask to see financial projections for startups or new projects or divisions in a business because they want to be able to see whether you think you can pay them back or not. How does your debt service coverage ratio look? How many cups of coffee are you going to have to sell to make your monthly loan payment?
Now that we know why we are creating projections and who the audience is, let’s get into the “how.”
Pro forma financial statements
Finally, I wanted to show you some example pro forma statements so that you can see what the end product should look like.
Pro forma P&L Example
Here is an example of our 5 year pro forma income statement.
Pro forma Balance Sheet Example
Here is an example of our 5 year pro forma balance sheet.
How to know whether my projections are realistic?
Once you have a complete set of projections (if you are using a ProjectionHub template) I would suggest taking a look at the profit and loss at a glance table as seen below:
In this example, I am looking at projections for a technology company that is looking to raise investment. So a couple of things that I would look at for a tech company pro forma.
- The first year should probably be a loss because that is why you are looking to raise investment right? I would just make sure you are assuming that you will raise enough investment to cover that first year loss.
- Next I would look at how fast revenue is growing. For an investable company there is a rule of thumb “triple, triple, double, double” which means after investment an investor will be hoping that you triple sales the first 2 years and then double sales the following two years. This is really hard to do, so if you are forecasting that you will do 10x every year you are probably off base!
- For tech startups you can look at this study with our partner Story Pitch Decks where we looked at what is a reasonable projection for a tech startup. This study will show you what other similar companies are projecting, so that you can ensure that whatever you project will fall within the norms that investors see.
What will investors and lenders be looking for in my projections?
Investors and lenders will likely be looking at the following numbers and ratios to make sure your projections seem to be reasonable:
- Gross Profit Margin
- Profit Margin
- Debt Service Coverage Ratio
- Comparing to industry averages
- Do revenue projections, units sold make sense?
- Does your balance sheet balance?
- When do you reach breakeven?
- Do you have room for error?
I suggest that you simply Google these things and make sure your numbers seem “normal.” For example, if you are opening a coffee shop you could Google “average profit margin for a coffee shop” and you would probably find our article on coffee shop profit margins. Confirm that your forecasted profit margins are in line and reasonable. Do this same exercise with each of these key ratios and numbers.
Tools used for financial forecasting
As a thank you for reading this behemoth of an article, you can download our free financial projection template. Other tools that I utilized or mentioned in the article include:
- Ahrefs - For competitor research
- Google Trends - For seasonality trends
- Google Adwords Keyword Tool - For search volume and cost per click
- Bizminer - For industry expense ratios
- ProjectionHub Pro Forma Templates - You can use our library of templates built specifically for over 70 unique industries and business models.
If you would like to learn more about my process for creating financial projections, you can watch this course that I put on for tech startups looking to create investor-ready financial projections.
Insert Webinar video below
Well I hope this has been helpful to you. If you have specific questions please feel free to reach out directly to us at email@example.com