What Financial Projections Are Really For
Have you ever been told that you should create financial projections for your startup, but you weren’t quite sure of its immediate use after creating them?
When you’re in the full ideation and dreaming phase for your new startup, financial projections seem too far ahead to use as a true goal post or as a realistic reflection of a future that hasn’t started yet.
Financial projections can be a great foundation to help answer some immediate needs for your business, but also has its limits. Here are some ways that creating financial projections can help your startup and areas where it won’t provide much guidance.
When Financial Projections Help
A Roadmap For Your Spending
On a granular level, financial projections are great at providing a punch list of all the expense items that you shouldn’t forget to factor in when projecting your expenses for the upcoming month. It’s so easy to think you’re in the black with your revenue and expenses when you’re actually in the red because you forgot about some miscellaneous bill that gets automatically removed from your account every month.
To avoid this, I personally make it a habit to create a monthly version of my 5-year financial projections so that I can see what monthly expenses I should be planning my revenue goals around.
Having financial projections also allows you to see when you can start investing in future needs like business insurance, an accountant, a new computer, and more. With a solid roadmap in place, you can accurately track your current spending (without receiving surprise invoices) while also working towards the desired expenses you’d like to acquire in the future.
Financially planning for new hires can feel like a large undertaking if you’re not aware of the specific expense items to account for and how it affects every other spending category for your business.
Instead of putting a ballpark estimate on the cost of hiring someone or even bringing yourself on payroll, a financial projections document breaks down those costs line by line. You can see all the direct expenses of hiring (salary, employer taxes, fringe benefits) along with its contribution to indirect expense increases for your business’ financials overall (administrative expenses, travel expenses, rent, meals and entertainment, etc.).
Pricing That Covers Everything
When figuring out your pricing for your products and services, it’s important to understand what indirect expenses that your products and services should also account for. Other than the direct expenses of creating your product and services (COGs), you also need a perspective on how much revenue you need to generate to uphold your operating expenses (keeping the lights on in your office and paying yourself and your team). Financial projections are fantastic for providing this perspective.
With financial projections that outline your operating expenses for the next 5-years, you can break down your operating expense per unit needs and roll them into your pricing. Doing this math also helps your determine your floor when it comes to pricing, or what your pricing can’t dip below if you want to break even or make a profit.
Finding Revenue Ceilings
If you’re a business that can only sell a specific number of units per month or year (consulting, retreat, experience-based business are a few of many examples) financial projections are a great way to discover your business’ revenue ceiling.
For example, if your revenue is barely able to keep up with your business’ growing expenses in the next 5 years due to a limited number of unit movements, it gives you the data you need to reassess and revamp your business model and pricing strategy.
When Financial Projections Don’t Help
Calculating Your Future Revenue
There’s one thing that financial projections can’t do and that’s fortune telling. Although revenue lines for financial projections are usually created with a lot of sound assumptions, it does not account for changes in market and purchasing trends, what your competitors are doing, company pacing, customer acquisition speeds, and more. Simply put, there are too many real-world variables that can fluctuate your revenue calculations on a daily basis.
So although your financial projections cannot calculate your business’ future revenue precisely, it provides a great exercise on how your company plans on spending its money if it were to receive $1 million in revenue, for example.
Similar to the section above, there are too many variables that affect the growth speed of a company so any attempts to predict a startup’s growth rate will only serve as an exercise rather than an actual prediction.
A company can see next to nothing in sales for its first two years and then make all of that money back in year three because an influencer with 20 million followers tweeted about their product. You never know what the lever is going to end up being that attributes to your company’s growth and exactly when it will happen.
Product Or Service Pricing
Pricing a new product or service is not purely a math equation. Pricing requires interaction with your target customers so that you can align your math equation with the prices that customers are willing to buy your product or service at (something I call price thermometering).
As described under the Pricing That Covers Everything section above, your financial projections will help you figure out your floor when it comes to pricing your products and services, but it will only provide one consideration for a multi-step answer.