Financial Projections Made Simple
Financial Projection is a financial tool that provides a fair estimate of the future financial path of a company for the coming few years.
Financial Projections are prepared by companies considering the past financial performance, industry trends, economic condition, future business plans, financing plans, etc. Financial Projections are used by companies to get a financial perspective of their future business plans, it helps companies in setting the annual budgets, it’s shared with lenders for their credit assessment, shared with investors, etc.
Financial Projections include constructing the three financial statements i.e., Income Statement, Balance Sheet, and Cash Flow, which are connected to each other. A combination of spreadsheets is one of the most effective tools for preparing these financial documents.
Financial Projections are cast based on assumptions, which should be realistic in their approach and sync with the financials of the company and the market dynamics.
Financial Projections is an important tool that serves several purposes some of which include the following:
Facilitates business growth without running out of cash
Anticipate problems before they become real
Review earlier investments, strategic actions, and if necessary, make adjustments
Enhance value from the budgeting and planning processes
Evaluate the additional equity or debt required for the business
Optimise the use of Capital
Predict trends or assumptions that could impact future performance
Key steps to building up the Financial Projections include:
1. Projecting revenue: It’s the first step toward building the income statement and is based on past revenue, market conditions, and industry dynamics. The absolute quantity of products and product price per unit are used to arrive at projected revenue. Likewise, in the service industry, the services rendered and the per-unit cost of service results in service revenue.
Revenue forecasts also enable companies to decide on important levels such as product range, product price points, and inventory capacity.
2. Estimate cost of revenue: The second step is to estimate the cost of producing the revenue viz. Cost of Goods Sold.
3. Project fixed costs: The costs that do not change with the number of products sold like rent, salaries, insurance cost, selling, general & admin cost, etc. These are projected based on historical data, competitive analysis, and market conditions.
1. Inventory (raw material, work in progress & finished goods), receivables, and payable position is estimated in days based on historical data, competition analysis, and market conditions. The number of days of inventory, receivables, and payables is converted to absolute value based on revenue and cost of goods sold.
2. Investment growth i.e., fixed assets, investments, and other long-term investments are estimated for the projected period. The assumption for investment growth should be in sync with the growth in the capacity to generate the projected revenue.
3. Debt/Equity sizes the capital structure of the company and estimates the sources of capital to finance the increase in the investments. The projected Debt/Equity is derived from past Debt/Equity position, competition analysis, and the debt servicing capacity of the company.
4. Equity growth is driven by new equity infusion and retention of accruals in business.
1. It’s an aggregate statement of cash flow from Investment, Financing, and cash generated from the business.
2. Operating activities detail cash flow that’s generated once the company delivers its goods or services and include both revenue and expenses.
3. Investing activities include cash flow from purchasing or selling long-term assets viz. real estate property, plant & machinery, and non-physical property, like patents - using free cash, not debt.
4. Financing activities detail cash flow from both debt and equity financing.