A Cheat Sheet To Creating “Accurate” Financial Projections
Financial projections are usually the scariest aspect of a business plan for most of the business plan clients that I work with. I find that a lot of people are so scared of putting down the “wrong” numbers that they paralyze themselves from even starting a conversation with themselves and/or their business partner about money.
At a baseline, financial projections require an honest conversation with yourself and your business partner(s) about where you both want to see the company go financially, and how you plan on spending money in the next 5 years. Without this conversation, completing financial projections for your business will not be accurate, so start there.
Although creating financial projections is largely specific to one’s business and industry, there are general rules and guidelines that can be followed when conjuring major sections of a financial projections document.
Below are some guidelines that I recommend you follow to create realistic financial projections for your business.
Keep Your Numbers Out Of The Clouds
If I see revenue projections above $1 million in your first year of business and:
1) you’re not a Kardashian,
2) you have no existing audience/following/brand, and
3) you sell products with a price tag less than $100K,
I am probably going to let you know that your numbers are in the clouds.
No investor will expect you to generate 7-figures in your first year of business without any foundations built and you shouldn’t expect that of your business either. There are way too many steps such as audience-building, crafting a functioning marketing and sales funnel, refining your product, locking down a great customer service team, and more that will have to be figured out in your business’ initial years before it can fly off the runway to moneymaking bliss.
A more realistic layout of your revenue numbers will calculate revenue according to reach from planned sales events. For example, if you are launching a new clothing brand from scratch and you’re selling your first line at a music festival with over 100,000 attendees, you can project that you will have 1% of those attendees purchase something from you.
If your average product cost is $40, you can project that your revenue for your first year will be $40,000. Make sure that when you’re calculating these numbers, that you are drawing them from concrete inputs with actual figures you can work with.
If you plan on selling your product by just announcing your line on social media, that is not a concrete input (nor strategy) and will not generate predictable revenue numbers. However, if you’ll be investing $10,000 into your digital marketing budget with the objective of generating sales, there will be a (somewhat) predictable return on investment depending on the channels that you use.
If you don’t have a plan on what exactly your revenue inputs will be because it’s contingent on too many things, you can calculate your numbers according to market share calculations. To calculate market share calculations, you should start by figuring out how much your industry is valued at. So for example, if you’re selling a product in the online pet food and supply industry, you would find that the US online pet food and supply industry is currently a $6.6 billion market.
Now, in year one of your business, you can assume that you’ll capture at least .001% market share of this industry since you’re a newcomer, making your year one revenue $66,000. As the business establishes itself in its industry and builds a customer base, you can assume that your market share percentage will increase by a substantial amount every year.
This is a great way to base your revenue projections in some reality so that your numbers are not just being pulled out of the air.
As you calculate your revenue numbers, remember that you are not a fortune teller and that these numbers are not meant to reveal your startup’s financial future. What truly matters is how your revenue and expense numbers interact with each other, so that you gain a perspective on how to spend your startup’s money under different revenue scenarios, and more. These projections are meant to serve as an exercise that helps guide your business’ spending habits in the future, rather than predicting them.
Also a side note: It’s common to not pull a profit and to lose money in the first few years of your business, so don’t be spooked if you see a lot of red in your gross profit numbers.
If you do some research on what items you need to run your business, filling out the expenses section of your financial projections can be a cake walk. Obvious expenses such as your cost of goods sold should be the most accurate and predictable line in your financial projections.
What makes projecting expenses difficult are the ambiguous item lines that are hard to put a number on or common, indirect expenses that are often forgotten.
Listed below is not a comprehensive list, but just a few major pointers to get your brain going on what you shouldn’t forget, and what to do about those ambiguous item lines.
Administrative Expenses, Meals and Entertainment, and Miscellaneous Expenses
I try not to predict these expense lines and instead, create a budget for each. It’s pretty difficult to figure out what scenarios will come your way that will bump up your meals and entertainment numbers, or when an out of the blue accident will come about that requires you to purchase a new computer.
Therefore, I try to put a nice cushion in here when projecting my administrative, meals and entertainment, and miscellaneous expense lines so that I can cover most opportunities and hiccups that will come my way throughout the year.
What’s great about viewing these expense lines as a budget is that you’ll often come under your budgeted number which means extra money — yes!
Unless you’re 100% clear on what your marketing expenses will be due to prior industry experience, I always recommend that startups set aside a marketing budget that’s 20% of their anticipated revenue.
This will give your business the wiggle room to establish and solidify its marketing and sales strategy and build a customer base. As the business hits traction in about years 3–4, you can start reducing that percentage as you begin to benefit from referrals, word-of-mouth marketing, and other evergreen channels.
A common expense that’s often forgotten about when creating financial projections is the money we have to give to the government to run our business. If you are planning on establishing a brick and mortar business, you’ll have even more expenses to look forward to such as permits, fire inspection fees, and more. Some common government fees to remember are the following:
Fire Inspection Fee
Permits (sales permit, health department permit, fire department permit, etc.)
Licenses related to specific activities such as food handling, etc.
Employer Taxes and Fringe Benefits
If you plan on hiring and paying any employees including yourself, you will have to pay employer taxes every time you run payroll (this is different from the taxes employees get deducted from each paycheck).
If you plan on providing benefits to your employees such as health insurance, 401K matching, and more, you’ll have to add all of that into your projected expenses. I usually just take 20–25% of each employee’s salary and add that as an additional fund to pay employer taxes and fringe benefits.
If you’re looking to get a specific breakdown of how much employer taxes will cost, I recommend using a tool like this one to calculate those numbers according to your state. Depending on what health insurance provider you use, you can usually retrieve a quote from that provider on how much it’ll cost your company to adopt a specific health insurance plan for its employees.
Business Operations Expenses
Don’t forget to include business operation expenses that will help you run your business from the back end such as accounting software to run your numbers, a CRM software to manage your leads, any marketing and sales platforms or channels (website fees, email marketing platform fees, etc.).
After purchasing your business’ initial equipment, products, and essentials, remember that these investments usually need to be maintained! Whether it’s a renewal fee for your computer’s insurance every year, renewal fee for your business license, printer ink, packaging, anything that needs replenishment — remember to include them in your maintenance expenses line in your financials.