Your small business’s financial projections are among the most effective and powerful tools to guide growth. Using these figures can help you keep your business on track, monitor cash flow, and identify problem areas before they become serious.
In this article, we explain why it’s smart to use financial projections as a tool for growth and how to do so successfully.
Why use financial projections?
Business leaders, lenders and mentors consistently tell the same story: The reasons why most small businesses fold within five years of opening are 1) undercapitalization, meaning that there isn’t enough money to fund operations, and 2) poor financial management – usually, a combination of a lack of business planning (or sticking to plans), unrealistic goals and a lack of proper bookkeeping.
Using financial projections to guide growth can help you avoid these pitfalls, because you’re using historical information to guide decisions and investments rather than “gut feelings.” When you tie your business decisions in with your financial plan, you can avoid costly mistakes that sidetrack businesses and drain resources.
How financial projections can help your business
When you track your business’s progress against your projections, you can identify both opportunities and areas for correction. In addition, using projections regularly forces you to consistently take stock of changing scenarios that can have significant impact on your business. At the very least, this should be an annual review but to be most effective, monthly or quarterly reviews are best.
Steps for successful financial projections
Step 1: Conduct a market and performance review
Each year, as you consider your business’s immediate past performance and plan for the upcoming year, perform a market review that considers:
- Location: When creating and evaluating your financial projections it’s important consider how the location of your business can impact on your financial outcomes. Factors such as competitors moving in (either physically or online), changes in your local/regional market size and demographics, or nearby construction/development can affect your ability to meet your goals.
- Market size and demographics: As businesses grow they can experience shifts in their market size and demographics. Before creating your financial projections for the upcoming year, look back at previous years to see if your target market has changed. If it has, consider introducing new products or services to help you retain current clients while still focusing on your target demographic. Your financial projections can help you answer questions you might have about your target market and can also help you identify potential new revenue streams.
- Demand: As you create and use your financial projections, evaluate the demand of your products and services and how it might impact business growth. If your target audience has changed, this might be due to a shift in the demand for your products and services. Knowing the market and what’s in demand can help you anticipate any opportunities for success or problems that might arise.
- Competition: One critical step in creating successful financial projections is conducting competitor research and applying this research to your projections. Changes in the competitive landscape, such as competitors moving in or out (physically or otherwise) can impact your business and its profitability.
- Your competitive advantages: Once you have researched your competitors, evaluate what sets your business apart from the competition or gives it a competitive advantage. Ask yourself the following questions: Why should customers do business with you and not your competitors? Are the advantages of doing business with you still the same as when you started? What’s gotten better? What have you shifted? Continuously seeking the answers to this will ensure you don’t get complacent and that your business keeps improving.
Step 2: Create realistic and relevant projections
Once you’ve done your market and performance review, you’re ready to create realistic financial projects that are reinforced by research. Here are some examples of the kinds of assumptions you’ll want in your projections:
- The number of customers you anticipate on an hourly/daily/weekly/monthly/annual basis (whichever is most relevant to your business)
- The average revenue you anticipate per customer
- Growth in revenues and/or expenses
- Salaries paid to the business owner(s)
- Cost of goods sold (COGS)
As you’re developing your financial projections, also look for areas that hold revenue-growth potential and consider how your projections reflect those opportunities. For example, if historical information shows that each time you spent $100 on email outreach, you earned $1,000 back in new or repeat business, that’s an area in which you’d want to invest more in the coming year.
Conversely, if your historical data shows that every $100 you invest in print advertising only results in $50 in sales, you’ll want to reconsider this spend before investing more.
Step 3: Ensure that historical and projected information align
When creating your financial projections, it’s important to take into consideration your business’s prior performance and historical expenses and to make sure that this information aligns with your projections. Any major changes in projections should either be backed by significant plans and funding or should be reconsidered, as they may be unrealistic.
For example, if you’re projecting year-over-year revenue increases of 30% and net profitability increases of 20%, what information backs up those assumptions? What changes are you making to your business to expect such growth? All major changes should be reflected as accurately as possible. Here are some helpful tips to keep in mind when creating and evaluating your financial projections.
- Projected margins (gross profit margin, operating expenses as a percentage of sales, net profit margin) should remain relatively constant with historical figures, regardless of growth in revenues.
- If your business hasn’t yet been profitable, it may take more than a few months to ramp up further and become profitable and this should be reflected in your projections. If you project that your business will become profitable within the year, make sure to identify any changes that might make this possible.
- If your business has operated profitably, what are your plans for continued growth? Even modest annual growth is necessary for all businesses.
Use financial projections to benchmark and monitor progress to growth goals
Using your business plan alone, or just going “by instinct,” isn’t enough to successfully build your business. It will have the strongest foundation if you use your business plan to guide major decisions and your financial projections to see how your decisions will impact your bottom line. Make it a goal for 2019 and by this time next year, you won’t want to run your enterprise any other way.